6 Cash-Flow Strategies for Construction Companies

  • Article

Cash flow is the lifeblood of every business, but it’s especially vital for construction companies that face fluctuating supply costs, supply chain issues and much more. Solid cash management practices can make a difference between success and failure in an industry characterized by razor-thin profit margins.

Healthy cash flow is even more important today in light of the Federal Reserve’s recent interest rate hikes, which have reached their highest levels in more than 15 years — substantially increasing borrowing costs. Suppose, for example, a construction company has drawn $1.5 million on its line of credit. If the interest rate rises from 3% to 8%, the business will see its annual interest expense increase by $75,000.

While credit lines remain a valuable tool for weathering financial shortfalls, taking steps to improve cash flow and minimize dependence on bank credit can greatly benefit construction companies, as well. Here are six cash flow strategies our construction CPAs recommend:

1. Prepare forecasts.

Regularly forecasting cash flow can help you identify potential drains and anticipate problems before they get out of hand. Doing so also enables you to better understand the impact of various activities and practices on cash flow, again allowing you time to make needed adjustments while there’s still time to turn things around.

In addition, forecasting helps you match cash inflows to outflows to the extent possible. For instance, you may be able to negotiate payment terms with your vendors that are designed to coincide closely with receipts from customers.

2. Front-load billings.

Construction contracts often call for progress payments from project owners as specified milestones are reached or as certain phases are completed. Unfortunately, these payment schedules rarely correspond to the contractor’s job-related cash needs.

As you’re no doubt aware, projects typically involve substantial upfront costs for mobilization, labor and supplies. So, if possible, negotiate a front-loaded billing schedule that recognizes your greater need for cash at the beginning of a job.

3. Eliminate or reduce retainage.

Many construction contracts allow the project owner to retain a certain percentage of the total price (usually 5% to 10%) until work has been completed. Because retainage can have a big impact on cash flow, try to negotiate a lower percentage or ask the owner to phase out retainage over the course of the project.

For example, the contract might call for 10% retainage but release half of that amount to you when the job is 50% complete and the remainder when the project reaches 75% completion. In some cases, you may be able to eliminate retainage entirely by providing the owner with other forms of security, such as a letter of credit or performance bond.

4. Stay on top of receivables.

Make sure payment terms are clearly spelled out in your contracts. Have policies, systems and procedures in place to ensure your construction company issues timely invoices. Reinforce with owners that payments are expected on a scheduled basis — don’t wait until a payment is past due to remind them.

Consider offering discounts for early payments if it makes sense from a cash-flow perspective. To help owners pay promptly or even early, provide a wire transfer payment option, which is also more secure.

5. Work with vendors and suppliers.

Vendors and suppliers may offer discounts or more favorable payment terms in exchange for bulk purchases or cash payments. Keep in mind, ordering too many of certain items can consume available cash and increase storage costs.

Also, by coordinating with vendors, you may be able to spread out payables by arranging staggered payment dates. Don’t pay vendors earlier than required unless you’ll receive a discount for doing so.

6. Manage change orders.

Change orders are a fact of life in the construction business. However, if you don’t manage them properly, you’ll risk delayed payment for the additional work — or you may not get paid at all.

Be sure your contracts establish clear terms and procedures for approval and payment of change orders, and that your employees understand and follow those procedures. To avoid cash-flow disruptions, it’s critical to submit the necessary documentation and bill for change orders in a timely and accurate manner.

Additional Consideration

Taxes can also have a big impact on cash flow, so it’s important for construction businesses to regularly reevaluate their tax accounting methods. In some cases, changing accounting methods may provide an opportunity to defer taxes — thereby improving cash flow.

Changes made by the Tax Cuts and Jobs Act allow construction companies with average gross receipts of $30 million or less (as indexed for inflation for 2024), as well as certain other businesses with higher gross receipts, to use the cash method of accounting for tax purposes.

Eligible companies currently using the accrual method may be able to defer taxes by switching to the cash method.

These same businesses may also qualify to use the completed contract method rather than the percentage-of-completion method to account for jobs expected to be completed within two years. Under the completed contract method, income generally isn’t reported until the contract is substantially complete.

Here to Guide You

Although profitability is the ultimate goal of every business, healthy cash flow is just as important. Even a construction company that’s highly profitable on paper can fail if it lacks the cash it needs to complete current projects and competitively bid on new ones.

Doeren Mayhew’s dedicated construction CPAs specialize in working with construction companies to evaluate their current financial position and implement cash-flow strategies tailored to their business.

Ready to put this brain power to work?

Contact Our Pros

Subscribe for more VIEWPoints