Construction companies often experience financial problems at one point or another. Many operate with tight cash flows and are not always prepared to handle the cash fluctuations that sometimes occur during the course of business.
In the best case, tight cash flows make your business susceptible to financial problems that prevent it from reaching its full potential. In the worst case, tight cash flows may affect your ability to stay in business altogether. Therefore, improving your cash flow is critical to the success of your business.
Address Internal Issues
Audit your operations to ensure they are as efficient as possible. This task is fairly complex, so consider working with a professional, such as a CPA. Areas to review include overhead expenses, receivables and inventory.
Overhead expenses should be reduced or eliminated where possible, but handle this matter carefully. Drastic cuts could have unintended consequences and could affect your ability to work with clients.
Determine how quickly your clients are paying. Many companies get into financial trouble simply because accounts receivable invoices remain outstanding for too long.
This problem is common with large commercial clients, who often take 60 days or more to pay. Negotiate better payment terms with clients and consider offering early payment discounts if possible.
If you carry inventory, ensure that your stock is at an optimal level. Having too much money tied up in slow-moving inventory affects your cash flow, while having too little inventory impacts your ability to handle projects efficiently.
Maintain Your Margins
The construction industry is extremely competitive. Many construction business owners try to price their services as low as possible so they can win new business. While this strategy is valid, as long as you have a clear idea of your actual costs and are making a reasonable profit, many owners don't have a good idea of actual project costs.
This lack of understanding leads to prices that are set too low. Ultimately, profit margins suffer and the company is exposed to the risk of loss. Work with your accounting department to determine your all-in cost for a project. Then, price accordingly for a minimally acceptable profit.
Negotiate Better Terms
Another key to improving cash flow is to negotiate the longest possible payment terms with suppliers. Most construction executives approach this matter the wrong way. They call suppliers and demand longer payment terms, and when suppliers don't meet the demands, they threaten to leave. This approach may result in better terms from some suppliers, but it could also damage a number of relationships.
A better approach is to give suppliers a good reason to provide you with longer terms. Begin by paying invoices a little early. While this may seem counterintuitive, paying early improves your credit profile and worth with vendors. They value clients who pay early, which gives you negotiating power.
Once you have built a record of paying early for a few months, call your vendor and negotiate a longer payment term. Refer them to your track record as a client who pays invoices early.
Most vendors will agree to extend your term, at least a little. If you still think that your vendor can provide better terms, repeat the process. Obviously, use this tactic only if you can afford to pay a little early.
Build a Cash Reserve
Every business should have a cash reserve to help manage shortages. Building a reserve is sometimes difficult, but it must be done. Without a cash reserve, your business is at the mercy of cash flow fluctuations.
Building a cash reserve involves trade-offs. A small reserve frees cash and allows growth, but it also exposes you to cash flow problems. A large reserve, on the other hand, stockpiles cash and keeps your business safe. However, this security comes at the expense of growth.
Consult with your finance team or accountant to determine a viable reserve size and a plan to achieve it. Some owners feel comfortable keeping a reserve sufficient to cover expenses for one month, while others prefer higher amounts. Use your own judgment to balance the drawbacks and benefits of a larger reserve.
Supplement with Financing
If your company does not have a cash reserve, or if the reserve is too small, consider using financing early on. This requires frank consideration because financing has costs. However, obtaining financing after you have encountered cash flow problems is nearly impossible. Due to the importance and ramifications of this decision, consult a CPA to determine the best course of action.
Small companies should consider getting financing through the Small Business Administration (SBA) Microloan program. This program provides up to $50,000 (the amount varies by state) of financing to new and growing businesses. Microloans do not have the requirements of conventional loans and are accessible to many business owners. Furthermore, Microloans are usually bundled with financial training and management advice. These extras can be valuable for many owners.
If a Microloan is too small for your company, consider a regular SBA 7(a) loan. These loans are easier to get than conventional bank loans and lines of credit. However, you still have to undergo the complete underwriting process and your business must be well-managed.
Another alternative to complement your cash reserve is to finance your construction invoices with a factoring program. Factoring can help construction companies that have cash flow problems resulting from commercial clients that take too long to pay invoices. The program finances slow-paying invoices, which gives you liquidity to cover expenses while you wait.
Improving your cash flow requires perseverance and discipline. Depending on your specific situation, cash flow improvement can take weeks, months or longer. The results, however, are worth it. Your business will be able to withstand financial challenges and to capitalize on new growth opportunities.