Improving cash flow management: A guide for construction firms

Poor cash flow management is one of the biggest causes of insolvencies for US construction firms.

But while you might feel helpless when clients don’t pay, there are steps you can take to proactively manage risks and keep control of the health of your construction business.

Read this guide from Sage to find out how to protect your firm from cash flow issues.

Here’s what we’ll cover

Cashflow in construction: The pros and cons

There’s almost $2 trillion-worth of construction work on the table for US firms right now, with investment pouring in to infrastructure, renewable energy, and commercial projects.

It sounds great in theory—but in reality, it’s only exciting if your clients pay on time, and you can protect yourself from cash flow problems.

In parallel to increasing work orders is an increasing number of bankruptcies in 2024—driven by challenges that just won’t go away—like inflation, labor shortages, supply chain disruptions, and rising interest rates.

Couple that with evergreen challenges like delayed payments, cost over-runs, under-pricing, high fixed costs, and economic downturns, and you’ve got a combination that can put the financial security of your business at risk.

Strategies for managing cash flow

The good news is you can protect yourself from financial issues at every stage of the construction lifecycle.

Here are 8 top tips to help you get ahead:

1. To bid or not to bid? You decide

A critical first step is to decide whether you really want to win specific new work opportunities in the first place.

While numbers look great on paper, the old adage still rings true—turnover is vanity and profit is sanity.

In an industry notorious for low margins, take time to think whether you could cope financially were something to go wrong with a contract. It’s all too easy for “hiccups” to turn profits into losses.

At the same time, resist any pressure to get involved with the all-too-common practice of “underbidding” or competing for work just to follow in the footsteps of your peers—even when the numbers don’t add up.

2. Manage high fixed costs

With skills shortages across the globe, construction labor costs are on the rise.

And that’s on top of inflation, which continues to drive up the cost of equipment, and materials.

Be cautious about taking on new permanent staff and long-term financial agreements, because any unexpected downturns in work could cause costs to outstrip income, and cause financial distress.

3. Implement robust contracts

The key to great financial management is to ensure that your clients pay on time.

Sounds simple, but construction projects often involve multiple stakeholders, as well as extended payment cycles, which can leave you without the necessary liquidity to cover ongoing expenses.

Whatever the project, make sure you draw up a robust contract with crystal clear payment terms and schedules outlining the frequency of payments and any specific milestones which must be achieved to receive the money.

This is particularly important for contracts involving elements of retention—where a portion of the payment is held back until specific stages are completed, to ensure satisfactory delivery.

Finally, be sure to include penalties for any late payments from clients to deter clients from harming your finances.

But remember, you also have a role to play in maintaining best practice within industry.

It’s a small world in construction, and reputation matters.

So make sure you practice what you preach and pay your contractors according to agreed terms, too.

It’s helpful to be known as a company that’s good to do business with.

4. Proactively identify and manage potential cost over-runs

Some people say that totally unforeseen events no longer exist because issues are now so common that we should expect them as standard.

For example, we regularly see supply chain issues—such as those linked to initiatives like the “Build America, Buy America Act,” which mandates that highly sought-after materials be domestically produced.

And then there’s the regular freak weather events, failed deliveries, and challenges linked to labor or skills shortages.

Without foresight and careful management, these issues can turn profits into losses and create a domino effect that could end in insolvency.

Make sure you build in contingencies to cover operational hiccups—like setting money aside to deal with things like “no shows” by specialist subcontractors.

5. Don’t forget the day-to-day

It’s all too easy for seemingly minor expenses to add up and compound into serious overspends over a year.

Don’t get caught out, be vigilant on all expenses, as well as issuing and processing your invoices.

6. Keep an eye on the big picture

While the market is booming right now, nothing lasts forever, and we live in unpredictable times.

Keep an eye on news of any impending economic challenges like recessions which can signal potential reductions in demand for construction services.

To be forewarned is to be forearmed.

7. Manage debtors

The 1982 Prompt Payment Act was implemented to ensure that subcontractors are paid fairly and on time for their work while allowing the main contractor to maintain oversight and control over the project’s quality and progress.

Nevertheless, issues still happen.

Prevention is often better than cure in managing debtors, so avoid potential issues by taking note of warning signs—like subcontractors consistently presenting delays with sourcing materials, providing appropriate staffing, or delivering work on time.

When problems do arise further down the line, it can get more difficult. When a client refuses to pay you, get ready to be firm to recoup the money you’re owed.

Maintain fair relationships by following your agreed dispute resolution process—and if that fails, don’t be afraid to escalate to the small claims courts.

They usually take care of disputes involving up to around $25,000, but this differs by state.

8. Establish a line of credit

For many construction firms, it makes sense to have a “back up” credit line to cover any short term squeezes on cash.

Speak to your bank and financial institutions about whether you could access a low interest loan to use in the event of major problems.

That way, you could avoid the risk of tying up all your cash on one-off expenditures that don’t generate a return.

Manage cashflow for growth, not “business as usual”

The “horror stories” of poor cashflow management are well-documented.

But what’s discussed less frequently is the missed opportunity cost of staying behind the curve.

Managing finances is an essential discipline and shouldn’t be considered as a competitive advantage.

But if your competitors get armed with accurate, efficient, and real time data, and you don’t, you’re going to be playing catch up for a long time, rather than getting ahead.

Advanced companies are moving their finances online, freeing up time to spend on value-add activities.

They’re busy connecting and integrating all relevant applications like SalesForce, for complete visibility of all transactions across their organizations.

Do you really want to be left chasing pieces of paper?

The problem: Construction still relies on paper systems

Rabbet’s 2023 Construction Payments Report found it costs $273 billion to carry forward the fees and costs associated with slow payments.

In addition, it found that nearly 14% of total construction costs could be eliminated with faster, more reliable payments to contractors.

But according to pymnts.com, 75% of Companies Still Use Paper Checks—which shows that industry is still reliant on legacy processes and infrastructure.

Using paper-based systems to manage finances can lead to several significant risks, including:

1. Incorrect data and errors

Paper-based systems rely on manual effort, where it’s easy for human error in areas like data entry and miscalculations.

These mistakes then inform inaccurate records—with a domino effect that your financial records are wrong.

2. Wasting time and resources

There is an immediate cost in terms of time, labor, and money of carrying out low-value and administrative manual tasks.

Not only that but in the long term, it reduces productivity and results, while potentially delaying critical financial decisions.

3. Poor flexibility

Modern construction firms are agile, working seamlessly across multiple sites and offices.

But with paper systems, based at a single location, you’re restricting people from working in a remote, decentralized or flexible way, which slows down operations.

4. Poor security

By definition it’s hard to get a truly secure system for paper records, putting your essential documents at risk from fire and water damage as well as theft and data breaches.

5. Limited business insight to drive growth

Why make it even harder than it needs to be to complete audits?

No one wants to spend more time than they need to sifting through physical records to find relevant information.

Especially when you could avoid this by using a software-based system.

6. Out of date information

Paper based systems can’t update themselves  so you’re always going to be on the back foot, inputting data and making decisions retrospectively.

7. Environmental harm

As a business, it’s really not a good look to be reliant on deforestation and large amounts of waste associated with paper systems.

Not only that but storing paper can be expensive compared to digital solutions.

Advantages of using software-based systems

Using cloud-based accounting systems for financial management enhances accuracy, efficiency, security, sustainability, and strategic decision-making.

You can manage risks any time, anywhere, securely.

So, it’s perhaps no surprise that, according to pymnts.com, around 30% of construction businesses are aiming to use digital technologies to speed payments.

Here are 7 ways software systems can help construction companies to manage the flow of cash:

1. Maximize accuracy

Design out the potential for human error by using systems that automate calculations and data entry processes.

This will result in more accurate cash flow data, reducing any potential discrepancies that can arise from manual handling.

2. Get real time data and insights

Get on the front foot with real-time updates and analytics about your transactions, which will help you respond quickly and effectively to financial challenges.

With advanced software systems, specifically designed for the construction industry, you’ll also get advanced reporting and analytics tools which help you to identify patterns, predict future access to funds, and make data-driven decisions to drive business growth.

3. Save time and money

Focus on more strategic activity by automating routine management tasks like invoicing, payments, and reconciliations.

4. Maximize security

Protect your business intelligence via sophisticated security measures like encryption, user authentication, and access controls.

A far cry from the basic—and arguably, inadequate—traditional methods like locked filing cabinets and offices.

5. Simplify the audit process

With all documentation stored online, you can simply download records to create a robust audit trail that complies with regulatory requirements.

6. Support business growth

It’s easy to scale software systems so you can cope with extra business.

You can also integrate other relevant applications used within your business such as payroll and sales systems to create a single, accurate source of data across your business.

7. Environmental benefits

Be a leader, not a dinosaur, on protecting the environment.

Now’s the time to get rid of paper, and the need for expensive storage, once and for all.

Final thoughts

The US construction industry is not a place for the faint-hearted—with huge risks as well as opportunities ahead.

It’s going through change that will decide winners and losers—so the big question is: will you choose growth and success, or is it business as usual?