How do you measure cash flow in construction?
Managing cash flow in construction can be difficult. Check out these expert insights for how to best maintain balanced finances.
Cash flow is the incoming and outgoing movement of money within a company. Seems simple enough, right?
While managing cash flow may seem straight forward, tracking money can quickly take a wrong turn if you make less than expected on a job or if equipment needs to be replaced. And without the right systems in place, finances can begin to spin out of control making it harder to correct them.
The proper management of cash flow is essential for any business, but it’s the key to success for construction companies. With so many moving parts for every project and multiple jobs happening simultaneously, it’s often a hefty task to maintain balanced cash flow.
So, what are the signs of unbalanced cash flow, and what are the best methods for keeping it on track?
To answer these questions and more, we went straight to an expert. We interviewed Luke Holcomb, the Client Success Manager at Apparatus Contractor Services, LLC, to get his professional opinion on the importance of cash flow and how to successfully manage finances in construction.
Buildertrend: Why’s cash flow so important in construction?
Holcomb: Well, there are three things that can kill a business:
- Profit: If you pay more for your services than you sell them for.
- Volume: Are you doing enough work that the there’s enough gross profit to cover the expenses of running the business?
- Cash Flow: When you have enough profitable jobs to make everything work for the year on paper, but you don’t have the cash when the bills are due.
The key here is to realize what your specialties and talents are as a business owner. Identify when you need someone with expertise. You don’t hire a plumber to build cabinets or vice versa.
Buildertrend: What are some early signs of cash flow problems?
Holcomb: There are some late signs of cash flow problems. By this I mean, if you find yourself in this position, it’s not too late, but it is time for very drastic steps. The classic is “robbing Peter to pay Paul.” If you are getting a deposit from a new customer and using it to pay bills that you incurred for previous customers, you are in trouble.
Spotting early signs of cash flow problems can be a little trickier. Construction is a difficult business to manage cash flow in. When cash enters or leaves the company can change quickly and is affected by many outside variables – some of which you can control and some of which you can’t. This is particularly true when you see shortages in the labor and material markets as you do now.
Because of this, the best way to head off cash flow issues is to make sure you have adequate working capital in your business. There are several ways to analyze this, but one of the easiest would be to compare your working capital to your annual sales. Targets are different for every business, but between 10:1 and 20:1 ratios would be a good place to start. You can then adjust from there depending on your needs. For example, a remodeler probably won’t need as much working capital as a commercial subcontractor.
Even with these safeguards, you must still manage cash flow by not letting your accounts receivable become bloated.
Buildertrend: What are some good cash flow habits or ways to improve cash flow?
Holcomb: This is going to sound overly simplified, but stop spending money. There’s always a new saw, truck, skid steer, telehandler, warehouse, etc. Although these could make things easier and would be fun to own, at the end of the day, they may not be necessary right now. It’s important to look at every asset purchase as an investment. Will you make more profit because you own the asset? If not, it’s a bad idea.
Many people don’t realize that a profit and loss statement doesn’t include the movement of cash for things like asset purchases, owner draws and principal paydown of loans. It’s common to look at the profit and loss and think things are going great without realizing you’ve transferred whatever cash you made into assets or personal funds. The consequence of this is you end up short of cash even though your profit and loss is strong.
Buildertrend: What’s the best way to measure cash flow in construction?
Holcomb: QuickBooks Online offers a cash flow report, and I’ve seen people use programs like Buildertrend to tie income and expenses to milestones to try to get cash flow projections on a project level. You can also use an Excel file and estimate when money will come in and go out.
Buildertrend: How does using online payments improve cash flow?
Holcomb: Well, a dollar today is better than a dollar tomorrow. I’m sure everyone has heard someone claim a check is in the mail when really it isn’t. The time value of money is so important that it has been formalized with a distinction called the internal rate of return. This measures when cash comes into and out of a company to better measure returns on investments, and the return is considered higher when you have it sooner.
At the end of the day, every business is managing investments. You use your existing money and credit to get more money. So, the faster you can turn that over, the more money you can make at any given time.
I was speaking to a client just the other day about how when they started using the Selections feature of Buildertrend, their overall revenue increased by 5%. That is a great example of how an asset like Buildertrend’s construction software is an investment that, when used correctly, means more money in your pocket.
Buildertrend: Can cash flow go negative? If so, what does this mean for a business?
Holcomb: Sure, cash flow is typically measured in periods (this year, quarter, month, etc.). You can always spend more than what you take in during a specified period. We see it a lot, but it’s usually constrained to a day, week or month. We don’t typically see a business lose cash for more than a month.
Think of your cash flow as a well. Water comes in more when it rains, and less when it is dry. You will probably be removing more water from the well when it’s dry. If it is dry for too long, you are going to run out of water.
Buildertrend: How do you forecast cash flow for the future?
Holcomb: This is a big-ticket item. Everyone wants to know what I would call their “cash flow projections.” There is no great tool out there that I’m aware of that will help you forecast cash flow on a company level. My go-to is a well-organized spreadsheet that gets updated frequently. To measure cashflow or anything else in your business, you will need the strong foundation of a good accounting system. This means, entering loans correctly, entering over/under billings and making sure that you have your WIP adjustments completed each month.
Buildertrend has some lesser-known tools that can really speed up these entries. The project-wide WIP reporting feature offers all of the info needed to make over/under billing entries on one page. Instead of going into each project to review the estimated costs and revenue, entering it into a spreadsheet and manually doing the calculations, everything is now available in one spot.
Ready to take the next step toward better managing cash flow in your construction business?
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