There are several pitfalls in cash flow management that can be fatal to your construction business.
This article was contributed by Patrick Hogan, CEO of Handle.
Cash flow is one of the most important things to manage in your day-to-day operations. After all, it is cash that keeps you afloat, funds your growth, and enables you to keep employees happy. Poor cash flow management is one of the main reasons for business failure, particularly in the construction industry. Because of lengthy periods between billing and collection and other unpredictable factors related to contractors, suppliers, and the weather, construction cash flow management can be a huge challenge for the inexperienced.
There are several pitfalls in cash flow management that can be fatal to your construction business. Let’s take a look at the most common mistakes in construction cash flow management.
1. Failing to have emergency reserves
There are a lot of things that can happen unexpectedly. You can lose one of your biggest clients. Contractors can back out. Projects can be delayed indefinitely. The construction industry relies on a lot of estimates and forecasts and inaccuracies and deviations can result in unexpected expenses. Rainy days are inevitable and all cash flow managers need to be prepared to face them.
Seasonality is one of the biggest reasons why construction businesses need emergency reserves. There will be peak seasons and slow times that can cause fluctuations in expenses and revenue. Not to mention different weather conditions that affect the start and duration of a project, including delays.
Having a percentage of your current cash reserved for emergencies provides you with a cushion when the unexpected comes. This can be difficult, especially if you are working on scaling your business up, but it is better to be safe than sorry. If you can’t keep cash aside, consider looking into short-term loans. However, keeping a cash reserve is still your best bet so start building yours today.
2. Failing to check the client’s history
One of the most common causes of cash flow troubles for construction businesses is granting customers credit without due diligence. The industry is mired with payment delays and nonpayment so it is important to check a client’s history to minimize these risks.
Before closing the deal with a client, investigate the customer’s financial history, especially that part regarding their ability to pay creditors. One way you can do this is by asking for references from a supplier that the company has worked with in the past. Do a quick phone call to these references, asking whether the potential customer has a history of timely payments or not. You may also use court records and notices of liens that are available publicly to gauge the client’s credit-worthiness.
3. Failing to protect payment rights
Don’t think that writing off your receivables as bad debts is the only option available to you in case of delinquent accounts. There are legal remedies available to you for these instances, such as the mechanics lien, which gives you a legal claim against the property you worked on–but to be able to exercise them, you need to protect your payment rights.
Fortunately, the federal law is explicit in stating what you need to do: send a preliminary notice to your clients. Preliminary notices, sometimes called pre-liens or notice to owners depending on the state, are not demand letters, they’re simply a document required by law to preserve your right to file a lien in case of payment issues.
4. Sloppy accounts receivable management
Customers are notorious for extending payment periods, especially if you are too passive in billing and collecting. Sending late invoices or letting your receivables age past their due dates spells huge trouble for your cash flow. If you are not proactive in managing your receivables, you won’t have enough cash to fund your growth, make payments on time, and compensate your employees.
Hit your accounting books and check customer accounts that are overdue. Start making calls and follow-up emails to collect your receivables before they turn delinquent. Moving forward, include a billing schedule so your clients know when to expect the invoice to arrive. Always follow the schedule so that you are prioritized.
Even though many businesses continue to work through the lengthy process of paying vendors with paper checks, transitioning to electronic payments, which facilitate payments more expediently, can mitigate the risk of past-due receivables impacting your own ability to pay your vendors on time
All business owners experience cash flow woes. By being aware of these common construction cash flow management pitfalls, you will be able to prepare your business to withstand these challenges and keep it afloat.