Managing cash flow in a construction company is a daunting task. The unique nature of the construction transaction makes it almost impossible to match cash flowing in with cash flowing out.
- Low bid margins are often so tight they’re insufficient to maintain ongoing operations.
- Multiple jobs for multiple owners at different stages of completion reduces the estimating of cash needs to an algebraic dilemma.
- Contention with the designer or owner over the estimated percentage of completion of a project often delays payments dramatically affecting cash flow plans.
- Owners often ignore clearly defined contract payment terms and contractors rarely think they have the leverage to challenge them.
- Cash flow is critical for timely funding of payroll and material and subcontractor payments required to keep projects running.
- Some material suppliers will extend thirty- or sixty-day payment terms (or longer) to preferred customers, but some won’t.
- Cash requirements for the timely payment of corporate overhead remains constant throughout the life of the project.
- Working capital lines of credit are not based on need but rather on the construction company’s collateral and ability to repay, which can leave a growing organization short of necessary working capital.
- Contractors rarely have access to capital markets to raise growth capital.
- Contractors are seldom able to retain earnings for future growth so the industry is notoriously undercapitalized.
Estimating Not Guesstimating
The complexity of cash flow management in the typical active construction company boggles the mind. It is extremely difficult to manage funds flowing in and out of a construction company with any sense of predictable results. Only a competent Chief Financial Officer can do it. As we discussed last week, CFOs use statistical and financial analysis to predict with a reasonable degree of accuracy cash needs going forward. It takes the worry out of ‘guesstimating’ how much cash will be available to pay the bills.
Handicapping Construction Cash Flow
Construction cash flow management is a step-by-step process not unlike handicapping bets at a Las Vegas sports book.
Step 1. Analyze a minimum of several years of financial statements with careful attention to trends and risk factors that affect the availability of working capital to fund ongoing operations and growth.
Step 2. Assign a value to the impact of the following risk factors:
- Each client owner’s ability and willingness to pay promptly. (A self-generated FICA-like score).
- The construction company’s efficiency at producing percentage of completion estimates, submitting timely invoices, and insisting on payment.
- The adequacy of the company’s working capital line of credit.
- The size and duration of all new projects as compared to the success profile of similar past projects effects on cash flow.
- What effect do unfamiliar, or unusual construction projects have on cash flow?
- Is retainage considered in cash flow planning?
- Is the impact of not having enough work or having too much work considered on the company’s cash position?
- How will past job losses impact cash flow and ongoing operations?
- When do extras provide cash and when do they use cash? (Few imagine that extras can end up as net ‘users’ of cash. Payment for extras is often delayed waiting for signed change orders.)
- At what stage in an ongoing project does it become apparent that the project will not ultimately produce positive cash flow so you can plan for the negative impact?
Data Tells the Story
Cash flow planning must first look to the past before it can reliably plan for the future. The CFO begins cash planning with a careful analysis of the last several years monthly financial transactions with an eye on the risk factors listed above. This list, of course, is only an example. It is impossible to include a complete analysis in the space of a 750-word weekly blog. A more extensive list of risk factors and the measurement of their impact can be found in my new book, (The Business of Construction Contracting, Thomas C. Schleifer, Aaron B. Cohen, Wiley, 2025).
Next Week
We’ll take a little deeper dive into how the CFO starts with historical factors to project future results. Stay tuned.
For more information on cash flow, read more at: FLOW
For a broader view of financial management, read more at: MANAGEMENT
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