Cash flow is the lifeblood of any construction business. Without sufficient cash to cover expenses, even the most promising ventures can fail. In the construction industry, managing cash flow is particularly challenging. Many construction business owners are honest, hardworking individuals who genuinely strive to pay their subcontractors, vendors, and material suppliers promptly. However, good intentions can sometimes lead to undisciplined payment practices that jeopardize the financial health of the business.
To maintain peace of mind, many construction business owners prioritize paying those who are the loudest, the most overdue, or those with whom they have the most substantial relationships. While this approach may offer short-term relief, it often drains all available cash, leaving the business vulnerable.
When materials are sold or services are provided for a specific customer, the risk of nonpayment should remain with the customer—not the contractor. If contractors use their limited cash flow to pay vendors or subcontractors before receiving payment from the customer, they risk being unable to fund other critical expenses or projects. This risk creates a precarious financial situation that can threaten the stability of the entire business.
Strategies to Increase Cash Flow
Maintaining positive cash flow in the construction industry requires deliberate strategies to manage expenses and protect revenue. Below are three essential approaches that can safeguard the financial stability of your business.
Adopt a “Pay When Paid” Policy
The cornerstone of effective cash flow management is to implement a “pay when paid” policy. This policy means withholding payment to subcontractors or material suppliers until payment has been received from the customer. By aligning your outgoing payments with your incoming cash flow, you can avoid spending money you don’t yet have, reducing the risk of financial strain.
Utilize and Protect Mechanics Lien Rights
Every state provides lien laws to protect contractors, and these laws are critical for securing payment. For example, in Utah, contractors must file a pre-lien notice with the State Construction Registry within 10 days of starting a project to preserve the right to lien the property if the customer fails to pay.
This process protects not only contractors but also material vendors and subcontractors, who can file their own pre-liens. By shifting the payment liability to the customer rather than the contractor, lien rights act as a vital safeguard for cash flow.
Establish a Clear Payment Allocation System
Once payment is received, a disciplined approach to allocation is essential. Start by setting aside funds for materials, labor, and subcontractors, as these amounts belong to those parties. After meeting these obligations:
- Use the remaining funds to cover selling, general, and administrative expenses.
- Pay yourself a profit.
- Address any loans or debts.
This structured payment strategy ensures that financial responsibilities are met without compromising operational cash flow.
Tools and Techniques
Effective cash flow management often requires leveraging the right tools to anticipate challenges and bridge gaps. Here are two highly effective tools we recommend for construction businesses to maintain financial stability.
13-Week Cash Flow Projection
A 13-week cash flow projection is a straightforward yet powerful planning tool. By analyzing expenses on a week-by-week basis over the next three months, you can gain a clear picture of your financial outlook.
To use this tool, begin by entering your current bank account balance at the start of the week. The projection will then calculate your cash flow for each subsequent week based on anticipated income and expenses. This forward-looking approach allows you to spot potential shortfalls early and make informed decisions to manage your cash effectively.
Leveraging a Line of Credit or Financing Options
For businesses experiencing tight cash flow, a line of credit or a business credit card can be a valuable resource. Unlike traditional loans, these financing tools provide flexibility, allowing you to make interest-only payments until customer payments are received.
Once you’re paid, you can use the incoming funds to pay off the credit line or credit card balance, maintaining financial stability without overextending your resources. While we don’t typically recommend straight loans for capital, these revolving credit options are ideal for short-term cash flow management.
For example, an SBA Express line of credit is a great option. With an SBA Express line, you only pay interest on the amount you’ve drawn. If you have a $50,000 line of credit but have only used $10,000, you’re only paying interest on that $10,000. It’s an excellent way to manage cash flow without overspending on interest.
Planning and Prevention
Documented procedures are an essential part of managing cash flow effectively. They provide clear guidelines for handling financial situations while maintaining professionalism and protecting relationships.
When a subcontractor requests payment, having a well-defined policy helps you respond consistently and professionally. Instead of navigating an uncomfortable personal conversation, you can refer to the company’s established procedures. For instance, you might explain:
“Our company policy states that we cannot issue payments until we’ve been paid by the customer. Unfortunately, we haven’t received payment yet.”
This approach shifts the responsibility from you to the policy, reducing the potential for conflict while reinforcing your commitment to fair and transparent practices.
Partnering for Success
Bringing in professional financial help is a pivotal step for growing construction businesses. We recommend hiring an accountant or consultant when your revenue reaches around $200,000. At this point, your business likely has the financial capacity to support this investment and the complexity to benefit from expert guidance.
We emphasize the word “investment” because hiring a financial professional should directly contribute to your bottom line. A skilled accountant or consultant will not only help you manage cash flow and reduce waste but also identify opportunities to save or generate revenue.
In fact, we operate under a straightforward principle: we only work with clients when the money we help them save or create exceeds the cost of our services. This principle ensures that our support is always a net positive for your business.
Conclusion
For any business, especially in the construction industry, cash flow isn’t just important—it’s everything. The common phrase “cash is king” captures this sentiment, but we prefer Mark Cuban’s take: “Cash flow is king.”
Without consistent cash flow, even a profitable business can struggle to pay its bills, meet payroll, or fund new projects. Prioritizing cash flow ensures you have the resources to keep your business running smoothly and resiliently, no matter the challenges.
Make cash flow your number one focus, and you’ll set the foundation for sustainable growth and success. Explore solutions to keep your business thriving. Take control of your cash flow management today!
