5 Best Practices for Managing Your Construction Company’s Cash Flow

What’s the most critical factor for sustaining a successful construction business over time? Without a doubt, it’s cash flow. Cash flow can make or break any construction business at any point. In fact, it’s so important to the viability of the company that without careful management of the treasury, it’s possible to grow your business out of business as you’re increasing the number and/or size of construction projects you take on.

While cash has always been king in this industry, it’s more vital than ever given the current volatility amid rising materials and labor costs. For the finance team, treasury management is job #1. By managing your FP&A cash flow and forecasting cash requirements, your finance team helps make sure your business can procure materials, pay salaries, fund new projects and support other functions of your day-to-day operations.

Here are five best practices your finance team can use to optimize the cash flow process and help your construction organization grow profitably without running out of cash and putting the future of the business at risk.

Best practice #1: Make your pay application process rock solid.

To get paid, your company needs to submit a pay application package to your customer. Unfortunately, no two customers ever want to see pay applications done the same way. From the AIA Schedule of Value line item details to the additional support such as invoices for materials and contractors, each customer will have requirements for how they want you to provide pay applications.

If you fail to meet their requirements, they will reject your pay application, forcing you to fix it and resubmit before you get paid. Rejected pay applications mean delays in receiving cash and negative impacts on your expected cash flow.

That’s why it’s important to have a solid construction payment application process in place. Your team members need to understand on a customer-by-customer basis what is required and work proactively on the front end of the project to capture costs in the Schedule of Value consistent with how the customer wants to see them. An important part of this process is proactively talking to customers to understand their needs and avoid unpleasant surprises and delays in receiving payment.

Technology can help your people, particularly your billing specialists, get the pay application for each customer right the first time. Your construction software platform should let you create a customer-specific billing template. The template allows you to automatically group costs the way the customer wants to see them on the pay application.

Bonus best practice: More banks are asking for full lien releases with pay applications in support of a construction note draw. Make sure you understand these lien release requirements and create a lien release template (for both partial and full lien releases) to use with your subcontractors to get sign off from them in a timely manner so that you get your customer payment when you need it.

Best practice #2: Proactively monitor your accounts receivables.

If you don’t realize that your company hasn’t been paid on time until you are trying to make payroll or a large material purchase, it’s too late. You have a cash flow crunch by the time you start investigating which customers still owe you money and begin reaching out to them.

Instead, have someone on your staff dedicate time to monitoring your accounts receivables. This will enable your team to pay close attention to the company’s cash position, needs and timing of expenditures and payments. Given that retainage is typically 10% of the project, you don’t want to let the other 90% age.

As described in best practice #1, having proactive conversations with customers lets you immediately identify whether a pay application was rejected, understand how to correct it and address it quickly to get paid in a timely fashion.

Lien rights differ across the U.S., so another best practice related to managing your accounts receivables is to make sure you understand your lien rights and timing requirements for filing. Many states limit the amount of time from the date of invoicing to when you can file a lien. If your team isn’t aware of the deadline, you could be forfeiting your lien rights and losing your best leverage if a customer hasn’t paid.

Best practice #3: Understand the dynamics of your borrowing base.

If cash is king, credit is queen in the construction business. That makes it critical to have a good relationship with banks that operate within the industry. Many banks don’t, so it’s in your best interests to identify and cultivate close relationships with the banks in your area that are comfortable with lending to construction companies.

A best practice for cash flow management is to make sure your team understands the dynamics of your borrowing base for your line of credit (LOC) and where your business stands at all times. Your borrowing base limits the amount of cash you can borrow against your LOC and is calculated on the collateral being used, such as accounts receivables and assets.

For example, your business might have a $5 million LOC, but you may not have the full $5 million available to use if your collateral value is less than the LOC. One reason your available credit can be less than you thought is that you haven’t accounted for retainage. Most banks are unwilling to lend on retainage, which reduces your borrowing base.

Best practice #4: Keep the finance and the construction teams coordinated.

Mobilizing a big job is cash intensive. Can you pay that large invoice to mobilize a job or do you have to delay the start of construction? In a competitive industry like this one, you can’t afford downtime.

That’s why short-term and long-term financial forecasting and modeling are critical. You need to know what your cash flow requirements will be for this week, next week and beyond.

The only way to accurately forecast and model is to understand what’s happening with each construction project. Your finance team must be in continuous contact with the construction team to know what got sold, when it will start and what the cash flow requirements will be. Often each team is operating on assumptions without communicating and coordinating with each other.

Here’s an example of why this is so important. A construction company increased the size of the projects it sold, going from an average size of $1 million to projects averaging $5 million. But as project sizes grew, no one was making sure that the cash needed to mobilize these much larger projects was also available. Suddenly, there wasn’t enough money to mobilize the jobs the company had sold and still cover payroll, equipment leases and other costs. The business nearly went under, surviving only through the painful process of selling the owner’s personal assets.

Best practice #5: Give your team the right tools for the job.

There’s a saying in the construction industry that having the right tools is 90% of the job. This goes for your finance team as well. Just as you would never send your employees to a job site without the proper tools for the work, neither should you expect your finance team to do their job well without the proper technology.

It takes more than a calculator or a spreadsheet to accurately and consistently project cash flow to understand your company’s current cash position, expectations on cash outflows, and availability and borrowing capacity on lines of credit and loans. Modern software can help your finance team operate more efficiently, accurately track and model your cash flow situation, put business performance data at your fingertips, and much more.

Investing in accounting and finance software that streamlines the Schedule of Value, cash forecasting and analysis, project budgeting and other core functions can help your team keep the business viable and ready for growth.

You need a solid cash flow management foundation to keep your projects on budget and moving forward. Here’s a blueprint to help your construction business avoid cash flow pitfalls and thrive: