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Why Profits Don’t Translate to Positive Cash Flow in Construction

Cash Flow or Profit – what you want the most

I worked with many contractors and subcontractors and have seen them struggling for cash despite positive profits on the balance sheet, that’s true.

Profit is good but when you gradually shift your focus toward cash in the bank, you are surprised to see that cash didn’t grow as much as you expected it should.

How is this possible? How can you make good profits but so little liquidity? Where has the cash gone?

This is where the blame game starts.

The Blame Game of Unhealthy Cash Flow in Construction Industry

In an ideal scenario, good profits mean positive cash flow. However, this is not the case for construction companies like yours.

The positive profits on the books fail to translate into healthy cash flow mainly due to accounting errors, incorrectly quoted work, changing scope of projects, high wages, long payment terms on invoices, and expenses often paid before the invoices are issued.

These scenarios are too familiar for you. Let’s have a better understanding of why profits don’t equal cash flow with the story of Mr. Jack, a seasoned contractor and owner of ABC Construction.

Renowned for his keen eye for detail and innovative abilities, Mr. Jack steered multiple projects on time and within budget yet found himself in a perplexing situation as cash was just always stagnant.

“Having positive cash flow was my number one priority, said Mr. Jack.” “Upon scrutiny, I could not see significant fluctuations in material costs or changes in overheads. Also, all projects showed good profits in books.”

On closer observation, it was found that un-reflected cash items like amortization expense, deferred income taxes, and impairments, coupled with inaccurate quotation and sudden changes in the scope of a project were depleting cash reserves.

After drilling down further, it was noticed that the variances are due to the timing difference between revenue and expenses in financial statements and the actual collection of payments. At times, expenses and revenue are recorded in books before he receives or pays. Also, the cost estimation and budgeting process was inconsistent.

All this boils down to one – robust cash flow management practices. This can make the difference between success and failure of your construction business.

Are you ready to see the full picture?

Cash is King: Key Tips to Optimize Cash Flow Management in Construction

Your cash flow is influenced by project milestones, completion stages, contractual agreements, and more. Here are the key tips that help you better manage cash flow.

Gain Access to Cash Flow Projection Reports

Projection reports are imperative due to the nature of project-based work. With this, you can better forecast and plan for cash flow fluctuations at every stage of projects, holding on reserves for unwanted situations. This will give you better clarity of when expenses and receipts are due, so you can plan and ensure adequate liquidity.

Monitor and Control Project Costs

No matter the size of your company, you need to keep project costs in check to ensure healthy cash flow. With rigorous cost tracking systems, you can identify potential cost overruns beforehand and timely implement corrective actions. For this, you need to accurately update expenses daily, regularly review project budgets, and look for ways to reduce costs.

Include Favorable Payment Clause in Contracts

Being a game of give and take, the contract clause must focus on payment terms dictating how long your customers have to pay invoices.

“A contract should really be a tool to help everyone in the construction industry; it doesn’t have to be this monster document that you just hold your nose, sign, and hope for the best.”

Karalynn Cromeens, The Cromeens Law Firm

Structure progress payments are in your company’s best interest as they help you to maintain a positive cash flow as the project progresses. You need to work with suppliers to negotiate extended payment terms to align with your customer receipts and cash inflow, enabling you to build strong relationships with customers and suppliers.

Effective Invoice Management

You would already be trying to create more efficiency in the processes, including invoicing and payment collection. By clearly outlining project milestones, payments terms, and workflow, you can fast track billing cycle and keep everyone involved accountable.

You need to record invoices promptly and consistently conduct 3-way reconciliation. This approach enables you to ensure timely payments, avoid over and under billing, and that your cash flow remains healthy.

Efficiently Manage Retainage

At times, your customers may withhold paying some percentage of the total contract until project completion. This can directly impact cash flow if you don’t promptly understand the retainage terms in your contract, creating challenges in paying suppliers, subcontractors, and employees.

By negotiating lower retainage rates, requesting partial payment, or fixing timings of retainage releases, you can improve cash flow during and after projects.

Profit may paint a rosy picture of success, but you need to continuously fill your cash coffers to fund new projects, pay expenses, including materials, labor and operating costs, and ultimately grow and scale at pace. By understanding the nuances of cash flow management and considering these key tips, you can mitigate financial risks, improve liquidity, and pave the way for a brighter tomorrow in the construction industry.

By John Bugh

John Bugh is Chief Revenue Officer for Pacific Accounting and Business Services (PABS), responsible for the strategic direction, planning, vision, growth, and performance of the company’s marketing, branding, and revenue streams.

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