If you are an owner of a construction business, chances are cash flow issues are not new to you. The long wait between sending your invoices and collecting payment from clients can take a huge toll on your cash flow. If you don’t have a firm grasp of your finances, you may end up depleting cash reserves to pay for fixed expenses, buy construction supplies, and make payroll. You may also end up paying subcontractors using your runway, way before clients settle their bills.
How can you deal with cash flow challenges in the construction industry? Being aware of the top causes of cash flow issues in construction can protect your business. Here are some of the most common cash flow issues that hurt your construction business.
1. Uncontrolled business growth
It may seem counterintuitive to think that growth can cause problems for your business. After all, growth is a positive thing and should be one of the goals of your business, especially when you are starting out. Growth is good for your business, but not when it gets out of control.
The growth phase can bring a lot of changes to your business operations. Because of the increase in sales, it’s typical for contractors to have to take multiple commitments at once. To meet this demand, the company will need to expand operations. This includes hiring more staff to deal with the increased workload, renting a bigger office to house additional staff, buying more inventory from suppliers, and hiring more contractors.
These are all necessary expenses that can burn through your cash reserves. And because the industry is known for lengthy billing cycles, you will need to pay for these growth expenses even before invoices are paid. If your company is growing too fast and you are unprepared, you might not have enough cash to deal with your day-to-day financial obligations. You might have not been able to device a credit policy to ensure that you are not fully risking your liquidity.
Fast growth can be challenging to handle, but with a proactive approach, it can be more manageable. First, analyze which aspects of your business are absorbing your cash flow and take the necessary steps to control them. Next, ensure that your growth is sustainable and not just caused by seasonal factors before making permanent operational changes. Finally, create a cash-flow-based budget and stick to it as much as possible. Minimize impulse spending and purchase things only when you need and can afford it.
2. Scope creep
The scope of a construction project specifies the deliverables needed to complete the project. All stakeholders agree to follow the requirements included in the scope. However, there are instances when these requirements are altered, new deliverables are added, and the goals of the project change. This is called scope creep and if left unchecked, it can hurt the cash flow of your business.
The lengthy duration of construction projects makes scope creep somewhat inevitable. Stakeholders deal with a lot of unpredictable variables that may result in necessary changes in the scope. These changes can gradually accumulate and the project can shift away from what was originally intended.
One of the ways to protect your cash flow from scope creep is by setting a solid baseline for the scope of work. When clients are pushing for changes in the scope, remind them of what you have agreed upon early on in the project. If changes are still necessary, charge the appropriate fee.
3. Payment delays
The construction industry is notorious for payment delays and even nonpayments. If you are too passive in reminding clients when their invoices are due, your clients are more likely to delay paying you. These payment issues can have a negative impact on your operations, especially if you have no cash cushion to rely on.
There are several causes of payment delays and nonpayment. If there are mistakes in the invoice information or if the person needed to approve the payment is unavailable, payment will be delayed. In some cases, clients may withhold payment if they deem that the work done in the project is unsatisfactory. If the client is experiencing financial problems, they will also be unable to pay you.
Smart contractors are aware that sending preliminary lien notices is crucial to avoid losing out on profits and even capital outlay in case of a delinquent client. Of course, filing a mechanics lien is not always the best solution when going after non-paying customers but securing your right to file one gives you leverage. Communicating with your client to reach a new payment agreement is always a better option, but if you’ve exhausted all options, the mechanics lien will save your finances.
Construction industries can experience cash flow problems that are unique to the industry. Being aware of these issues and developing strategies on how to deal with them will help ensure the success of your construction business.
Patrick Hogan is the CEO of Handle.com, where they build software that helps contractors, subcontractors, and material suppliers with late payments. Handle.com also provides funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.