Construction Cash Flow | Nav

Cash flow is the cash coming into and going out of your construction business during a specific period — and managing it well is necessary for your long-term success. A healthy cash inflow and outflow shows you have the ability to collect from customers and enough cash to cover your expenses, which is especially important in the construction industry. Often, you need to bid on the next big project even before you get paid for your last project, which makes managing a construction company’s cash flow vital.

The ultimate goal of managing your cash flow is to generate positive cash flow over the long term. That’s necessary to be able to pay your suppliers and give employees a paycheck. If you have a negative cash flow, there are methods you can use to manage it better.

In this article, we cover the importance of cash flow in construction loans, how to calculate cash flow, and techniques for managing your cash flow better. 

The Importance of Construction Cash Flow in Construction Loans

Having a healthy cash flow is essential to any business. But in the construction industry, it’s especially vital — especially when you go to apply for construction loans or other small business loans. Construction businesses often have to pay for the materials and labor for a project well before they expect to send out any invoices, so they may turn to loans. 

Commercial construction loans are difficult to get approved for because you are receiving funding for something that doesn’t yet exist. The lender will need to take a close look at your business’s financial documents to make sure you are profitable and will be able to deliver on the job. So managing cash flow ensures you can avoid late payments and prove to the banks that your financial situation is stable enough for them to lend to you.

To get a construction loan, you’ll also likely need to supply:

  • Personal and business credit (read this for more on how to establish business credit)
  • Proven experience with building as a general contractor
  • A large down payment, up to 30%
  • Project appraisal

The payment schedule on a construction loan usually kicks into gear once you complete the project. In the meantime, you usually only pay interest on what you have borrowed.

Construction Cash Flow Example

Here is an example of cash flow on a construction project that might help you better understand the importance of managing cash flow.

Example

Bid price: $90,000

Monthly payment: $30,000

Project length: three months

Cash Flow Example Month 1 Month 2 Month 3
Cash In $30,000 $30,000 $30,000
Cash Out
Materials and supplies $40,000 $5,000 $0
Overhead $5,000 $5,000 $5,000
Total Cash Out $50,000 $10,000 $5,000
Cash Flow Positive or Negative ($20,000) $0 $25,000

The job costs more in the first month because of the materials and supplies needed. There’s a negative cash flow during month one because of this. In month two, your expenditures slow down, but since you were in the negative, you don’t have positive cash flow. In the final month, you begin to see a positive cash flow because your expenses have been paid.

Construction Cash Flow Calculation

It’s important for contractors and subcontractors to figure out your business’s cash flow so you have insight into how you’re doing financially. You can calculate cash flow by following these steps:

1. Create separate categories

Separate your inflows and outflows of cash coming from three categories:

  • Operating activities
  • Investing activities
  • Financing activities

You’ll calculate each of these categories individually. Next it’s on to the math.

2. Find your operating cash flow

Operating cash flow is your customer payments minus operating expenses, like rent, labor, and materials. This calculation only includes cash-based items, like services completed and products sold. 

Use this equation to calculate operating cash flow:

Operating cash flow = total cash coming in for sales – cash paid for operating expenses

3. Find your investing cash flow

Investing cash flow is the cash coming in and going out for longer-term capital investments like stocks, bonds, property, equipment, or the acquisition of another business. 

To calculate investing cash flow, simply add up all of the items mentioned above. 

4. Find your financing cash flow

Financing cash flow is any funding you get from lenders, owners, or investors. So if you take out a loan, this would calculate into your financing cash flow.  

To calculate financing cash flow, add together all of your business’s financing items.

5. Generate a cash flow statement

Add the solutions to the three calculations above to your business’s beginning cash for the period to add into your cash flow statement. We give more details about the cash flow statement in the next section.

What Is a Construction Cash Flow Document?

A cash flow statement or construction cash flow document can help you understand your construction business’s cash flow position at the end of the period. To project cash flow, you can create a cash flow projection (or a cash flow forecast) that foresees any potential future cash flow issues. This projection should help give you time to pivot and avoid issues with your bottom line in the coming months and years.

Keep in mind that negative cash flow over a short period of time isn’t necessarily an indicator of trouble. Instead, it could mean that you are making big investments that will grow your business. You’ll want to focus more on long-term cash flow rather than short-term since sustained negative cash flow can be problematic. 

Typical Construction Cash Flow Problems

When it comes to cash flow management in the construction industry, there are several common issues you might run into: 

  • You pay your bills too quickly. It might sound like a good idea to pay a bill right away so you’re not late, but that can leave you strapped for cash in the meantime. 
  • You don’t ask customers to pay anything upfront. You might be required to pay for items before a new project begins, so not having any sort of payment written into the construction contract from your customer can make it difficult to afford.
  • You’re slow to send out invoices. You don’t send your invoices to your customers as soon as the job is done, which creates a delay in the beginning of the payment process.
  • Your customers are slow to pay. On the other hand, you might send out your invoices right away but your customers take 90 days to pay you. Delayed payments might mean months of not having cash in your pocket to put toward another project. Non-payment is also a problem.
  • You didn’t budget for retainage. Retainage is when a customer holds back 5% to 10% of the total construction costs until the project is complete, so failing to budget for this can create a hole in your cash flow.
  • You don’t manage change orders properly. Any adjustments to the work after the project has started requires a change order, and your project manager needs to manage the changes in your budget to make sure you get paid for everything.

How to Improve Construction Cash Flow

In construction management, it can be difficult to keep track of all your finances and cash flow. If you’re looking to get out of the negative, there are a few things you can do. Distributing your costs, staying on top of your outgoing invoices, and setting up electronic payments from customers can all help.

Also, try progress invoicing. This system allows you to invoice for work as you complete it, which helps you avoid overbilling or underbilling (or invoicing for the majority of the project at the beginning or the end). Put it in the payment terms that you’ll send invoices as you make progress. Additionally, business credit cards can improve cash flow — and some even provide a 0% APR for a period of time so you aren’t paying interest for the first months.

Instead of paying off a bill right away, pushing the payment back closer to the due date can lessen your gaps in cash flow. And asking customers to put down money upfront can help ease the strain of having to pay for all of the expenditures out of pocket.

Finally, if you have slow-paying customers, try to be more picky about who you’ll work with. Perform credit checks on current or potential customers to see if they have a history of making late payments. This research can save you headaches down the road.

Lenders Depend on Construction Cash Flow Documents

Having the right documentation in place before you apply for business startup loans is essential. Construction cash flow documents are no different. But if a construction loan doesn’t fit your business right now, there are many other options that may be open to you.
For example, you could consider a line of credit or a short-term loan. These are more flexible options that typically allow you to spend on any of your business needs. Create a free account (or update an existing account) with Nav to find the best possible funding options for your construction business today.

This article was originally written on June 29, 2022.

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