Components of Cash Flow Management in Construction: An Expert Guide

by Thomas C Schleifer, Ph.D.

Managing cash flow in the construction business is a complex task that takes professional financial skills, flexibility, and constant focus. The elements of cash flow are all variables that could go for you or against you at any given moment.  Let's look at the fluid nature of each component of cash flow.

#1. Retained Earnings

This initial component relies on the forward planning prowess of the company's owner and the profitability of each job as the company rolls along from infancy to viability. But you can't retain earnings if you don't have any.

  • Competitive Bidding: The competitive nature of the low-bid acquisition system has caused net margins in construction to shrink dramatically over the past half century from a robust 10 to 15 percent down to the 3 or 4 percent that is typical today.
  • Complex Accounting: Construction profit and loss accounting has become quite muddled by the indistinguishable financial complexity of multiple ongoing jobs. Without a five-year profit and loss history it is almost impossible to isolate the profitability of individual construction jobs and clearly identify accurate corporate earnings at any given moment in time.
  • Investment Tendencies: Most privately owned construction companies rarely retain the meager earnings they do generate. The tendency is to invest earnings into fixed assets like a corporate headquarters building or a yard full of expensive equipment.
  • Financial Perceptions: Even financial professionals see a large cash hoard on a construction company's balance sheet as an idle, nonproductive asset that could be put to better use. It is extremely difficult to accurately calculate the working capital capacity of a growing construction company and the importance of a robust retained earnings account to finance their growth.

#2. Front-loading Hopscotch

Frontloading is a common way to cover the unpaid upfront costs of a construction project. However, it must always be done with integrity and with the contractor's eyes wide open. Desperate to manage tricky cash flow needs, contractors often forget the amount they successful front loaded and fail to make allowances for the attendant shortage of capital at the end of the project. This is why they "hopscotch" the front-loaded payment of the next project back to cover the uncovered cash flow of the previous job.

  • Integrity and Awareness: Always front-load with integrity and full awareness of future cash requirements.
  • Hopscotch Payments: Using funds from new projects to cover old ones can create a cycle of dependency and financial instability

#3. Working Capital Line of Credit

The front money requirements in the typical construction contract combined with the scarcity of retained earnings make borrowing the primary source of working capital necessary. Banks typically provide these funds to contractors. The problem is they are rarely sufficient. Bankers often consider all lending asset based and limit the amount of these loans to the value of the collateral. This, of course, would be adequate if the contractors owned the structures they were building for their clients. However, they do not, and most banks default to the tangible net worth of the construction company and its owners to determine the size of a working capital line of credit. The size of the working capital line is, therefore, disconnected from the working capital needs of a growing contractor who is often required to simultaneously finance the up-front costs of multiple projects.

  • Bank Loans: Banks provide working capital based on the value of collateral, typically limiting the loan size.
  • Asset-Based Lending: Construction companies often need more working capital than banks are willing to lend, leading to financing challenges for multiple projects.

#4. Accounts Payable Aging

Typically, construction material suppliers work with credit worthy contractors on a "net thirty days" basis. The ability to extend payment terms out to 45 days or even 60 days is often a critical source of working capital for most contractors. However, this secondary source of working capital is never a sure thing. Favorable payment terms must be negotiated with vendors in advance. It is inappropriate to wait until you need the money and simply delay payment. Suppliers consider this tactic "underhanded" and it will lower your credit rating as a result. They will be less likely to cooperate with your cash needs in the future and charge you increased markups if they do so.

  • Extended Payment Terms: Securing terms beyond the standard 30 days can provide essential working capital.
  • Negotiation Strategy: Always negotiate terms in advance. Delaying payments without prior agreement can harm supplier relationships and credit ratings.

#5. Accurate Billing and Timely Payment

Decades of consulting with contractors of all shapes and sizes has taught me a lesson: contractors are timid when submitting invoices and let owners and their agents dispute proper invoices and pay when they're "good and ready". My post-mortem audits on many contractors who ran out of cash in the middle of a job and and their surety had to intervene revealed that many of them had not billed the job accurately and almost never demanded timely payment. Owners and their agents admitted that they would delay payment to simply let the dust settle and keep a tight leash on the contractor who they believed was "fudging" the invoices anyway. This attitude pervaded the entire industry and does to this day. Contractors must prioritize timely, accurate billing and demand prompt payment as stated in the original construction contract. Any timidity will be seen as an admission of guilt and will delay payment even further.

  • Invoice Submission: Contractors must not be timid in submitting invoices and should insist on prompt payment as per the contract terms.
  • Industry Attitude: The construction industry often delays payments, assuming contractors are inflating invoices. Proactive billing and payment demands can counteract this.

Professional Skill 

Managing cash flow in the construction industry is a highly complex and critical financial management task that must be handled by a professional CFO. Even if you don't feel you need a CFO for accounting data output, hire one just to manage cash flow. Believe me when I tell you that most of the contractors that suddenly failed and had to be turned over to their surety were competent, experienced builders who never took managing cash flow seriously.

  • CFO Importance: Even if a CFO isn’t needed for accounting, their expertise in managing cash flow is invaluable.
  • Case Studies: Many competent contractors have failed due to poor cash flow management. A CFO can help prevent this by ensuring financial stability.

Conclusion Effective cash flow management is essential for the success and growth of any construction business. By understanding and implementing these steps, contractors can navigate the complexities of construction finance and maintain a healthy cash flow.

Dr. Schleifer joined the construction industry at age 16 and has more than 50 years of contracting and consulting experience. He holds a B.S., M.S., and Ph.D. in construction management. Dr. Schleifer’s experience includes serving as foreman, field superintendent, project manager, and vice president of a construction company. To receive Dr. Schleifer's free Weekly Construction Messages, ask questions, or make comments contact: tom@schleifer.com.


How do I get a Surety Bond?

Surety bonds are issued by Merchants Bonding Company (Mutual) through insurance agents. Contact your local insurance agent or use our Find an Agent tool. They will guide you through the process, informing you of what documents and information are needed by the surety (Merchants Bonding Company (Mutual)) to underwrite your bond.

What is a Surety Bond?

A surety bond is a three-party agreement that ensures the fulfillment of a commitment or contract. For instance, the surety (Merchants Bonding Company (Mutual)) may provide a surety bond to a construction company (the principal) which is required by the state (the obligee), ensuring the construction company will perform the duties as outlined in the contract. In bonding the construction company, Merchants assumes the risk should the company default or not fulfill their contract. A surety bond is different from traditional insurance in that the principal is obligated to pay back the surety company on any claims paid out.

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