Cash flow is the heartbeat of any small business. Managing cash flow for construction businesses is uniquely challenging. In this article on construction cash flow, we break it all down for you.
Long build and lead times often mean construction is one of the slowest-paying industries.
The coronavirus pandemic has also seen many projects delayed and up to 150,000 small and medium firms could lose 20% of cash flow due to the new VAT reverse charge.
Read on to find out what you can do now to control your cash flow and boost growth in your construction business. Here’s what the article covers:
How does cash flow work in construction?
Put simply, construction cash flow is the movement of money in and out of your business. It dictates whether you have funds available to spend on critical aspects such as labour and materials.
For many businesses, cash flow – or the lack of it – can mean the difference between success and failure.
Most construction firms run cash flow reports for their organisation and/or each project they are working on.
They use data to understand income and outgoings margins, and profitability over a set period of time, or assess the financial health of their business.
Get one step ahead: Create a cash flow projection
The most advanced construction firms plan ahead by creating longer-term construction cash flow projections.
By predicting future income, costs and day-to-day transactions, these firms can identify and mitigate potential cash flow problems more easily and put steps in place to better maintain construction cash flow.
Future cash flow projection reports generally covers three types of activity:
- Operating activities: This includes your income from sales, minus the cost of goods sold, labour expenses, and other costs of doing business. To calculate your net cash flow, look at your projected sales and other income, and take away projected payments to suppliers, subcontractors, payroll and business expenses.
- Investing activities: This relates to the purchase of fixed assets such as vehicles. To work out net cash flow, look at the sums you plan to spend on fixed assets, and take away any income you will receive from the sale of similar equipment.
- Financing activities: This includes aspects such as paying debt, dividends or issuing stock. Look at any income you expect to receive and take away any payments for servicing debts, such as leases, or dividends to shareholders.
Regularly tracking and analysing activity in each of these categories will allow you to calculate projected net cash flow over a longer period of time.
You’ll be able to compare performance to expectation, spot trends, and identify the areas in which you are likely to lose or make money as quickly as possible.
No forecast can ever be 100% accurate, so treat yours as a working document, which should be updated and adapted continually as new information becomes available.
In addition, always include insight from your previous years’ cash forecasts to maximise reliability – because the best indicator of future performance is historical performance.
10 ways to improve construction cash flow
The UK construction sector is highly complex and subject to significant potential risks. By using a cash flow forecast, you can protect yourself from potential problems.
These 10 top tips will help you too:
1. Work collaboratively with clients to agree workable contracts, timelines, and payment terms that work for both parties
Together, agree how and when you will be paid. According to RICS, there are pros and cons of different payment options. The payment types are:
- Stage payments, made at pre-set times
- Milestone payments, made upon completion of agreed aspects
- Payments against an activity schedule
- Payments related to the valuation of works done on site to date.
Choose which works best to support cash flow within your business.
Any contracts should also include clear wording on any financial penalties of you failing to meet key performance indicators (KPIs), and details of dispute resolution, to prevent legal action with potentially sky-high bills that could put your finances in jeopardy.
2. Carry out due diligence on potential clients
Consider using a credit agency to investigate the financial position of clients and make sure they are able to pay – ahead of doing business.
An expert agency can also help you to chase late payments.
3. Train your team on cash flow management
Communicate with your whole team that it’s in everyone’s interests to keep your business financially healthy.
Set a shared goal of reducing costs and maximising income, particularly among quantity surveyors, project, and site managers who can influence financial decision-making.
You could even introduce incentive packages based on cash flow performance.
4. Spring clean your finances
There’s never been a better time to audit all of your income and outgoings.
Take the opportunity to negotiate lower prices, deals and agreements, and stop paying unnecessary subscriptions to maximise cash flow.
5. Get a robust accounting system
Use an accounting system that’s ready to process transactions specific to the construction industry straight away.
And a cloud-based solution will mean you can manage your business admin anywhere and on any device, including a mobile phone or tablet.
Wherever possible, this should include elements of automation to ‘design out’ potential mistakes, and autocomplete repetitive actions within your business.
Account for all allowable expenses as these can actually add up in your favour.
6. Get the right accountant
You may wish to consider working with an accountant specialising in the construction sector.
7. Get organised
Eliminate avoidable delays by using proper processes, systems and admin tools. Get payment upfront for major outlay on materials or labour to reduce your risk.
Invoice clients in advance of works, offer payment incentives and restructure terms with non-payers to speed up cash flow.
Process change orders quickly when projects require more time, money, or resource than expected. Make it easy for people to pay you by supporting electronic payments.
And if a client stops paying, stop working as soon as you can to nip potential issues in the bud.
This will all ensure that your business is paid faster, which increases construction cash flow and allows capital to be used for day-to-day operations and growth.
8. Don’t overspend your liquid cash
Consider using finance, not cash, to buy expensive supplies and materials.
You will pay interest and charges, but you’ll have plenty of cash to continue operating. You might even be able to classify some fees as allowable business expenses.
9. Stay on top of accounting changes
Don’t be caught out by changes to regulations, such as the VAT reverse charge, where companies in the supply chain may need to contribute 20% more towards the payment of VAT.
Or new CIS rules, such as those that come into force in April 2021.
10. Know your rights
Thankfully, many large clients and main contractors now recognise that suppliers are an extension of their business.
Most have adopted fair payment practices, the Construction Supply Chain Payment Charter, and project bank accounts amid pressure from the government to pay fairly.
In addition, there are several remedies for late payment. Know when to escalate issues of non-payment to get further support.
The importance of cash flow in construction
For many businesses, it can be easy to confuse cash flow and profit. But without care, even highly profitable businesses can go to the wall because of cash flow issues.
Construction is an interconnected industry where one issue affects all. Companies of all sizes have a shared responsibility to pay suppliers on time and help prevent financial distress.
By following this guidance, you can help to maintain the resilience of companies of all sizes within the supply chain.
Tackling the Construction Industry Scheme with Sage Accounting
Learn about the Construction Industry Scheme and your legal responsibilities, and find out about the new VAT reverse charge for construction.
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