With pandemic assistance coming to an end—such as the Paycheck Protection Program (PPP) and Employee Retention Tax Credit (ERC credit)—that boosted cash flow for many construction companies since 2020, cash management strategies need to be revisited and refreshed to ensure your company takes the right steps to improve liquidity and strengthen its bottom line.
Paying attention to cash flow is especially important as the pressures of inflation affect wages and material costs, the market’s volatility, and supply chain issues.
Cash Flow and Revenue
Projecting cash flow in the construction industry can be especially complicated because, unlike many industries, cash flow doesn’t always follow revenue recognition. As revenue is recognized over time, most often measured by the percentage of the job that’s complete, revenue is recognized ratably as a project progresses.
However, if you’re able to invoice for more than the work completed—referred to as overbilling—or, alternatively, only able to invoice for a portion of the work completed—referred to as underbilling—your cash flow will be out of sync with your revenue recognized. As a result, it’s important to understand both the revenue recognition and related cash flow needs of each project.
Where Does Operations Cash Flow Typically Get Trapped?
Construction companies often see business cash flow trapped in several areas:
- Billing discrepancies. Ensure that the project teams capture and provide accurate information to help finance teams bill timely and to identify out of scope work.
- Unprocessed change orders. In most cases, costs related to unprocessed change orders can’t be billed until all parties sign change orders. Helping project teams manage and resolve unprocessed change orders in a proactive and efficient manner can help expedite the company’s change requests and its ability to bill and collect for those items.
- Claims. Similar to unprocessed change orders, proactively managing and settling claims early can help improve cash flow and avoid the costs associated with a long, drawn-out negotiation.
- Accounts receivable. Overlooking timely collection hurts liquidity.
- Retentions. Companies sometimes forget to bill for retention. Provide billing notices to bill and recoup retention amounts as soon as eligible.
- Inventory and other assets. Supply chain volatility can lead to inventory arriving before it can be installed, driving up storage costs. Additionally, certain inventory may require down payments ahead of arrival or installation; try to map your contract schedule in a way that permits advanced billing.
- Accelerated debt amortization. Repaying debt sooner than contractually obligated could result in an unnecessary decrease in cash that may be more important that the reduced interest cost.
How Do You Create Positive Operational Cash Flow?
Take the following steps to proactively boost your cash flow.
Plan for the Unexpected
Though it’s impossible to predict unexpected events, having potential solutions in place as a safeguard could help cushion their financial impact.
Contract provisions around unforeseen events should be considered during the drafting phase.
Enhance Organization-Wide Communication
Many aspects related to cash flow management in construction are dependent on a project’s operations, but operation and financial components of a company are often segregated.
Open lines of communication and strong working relationships between finance and operations teams are important to keep them in step and prepared for the unexpected.
Effective communication of job progress on the operations side can help identify potential cash drains, or to ensure that jobs can be billed appropriately.
This may require assessing company functions from a comprehensive perspective to fix any issues and maintain a strong operational culture.
Conduct Regular Forecasts
The more closely finance and operations work together, the more accurate regular cash flow forecasts can be, making it more manageable to use time and resources efficiently.
Tracking which jobs have positive cash flow and which jobs need more attention can help the bottom line.
Measure Performance and Identify Improvement Areas via KPIs
Successful companies build an innovation-driven, improvement-oriented culture. Tracking relevant key performance indicators (KPI) can assist in decision-making, help you set strategic objectives, and allow you to evaluate your business processes in real-time.
Invest in data analytics technology that can create user-friendly dashboards that make KPIs easy to track and interpret. Construction companies aren’t traditionally early adopters of technology, but these tools can help management drive timely and informed decision-making to improve the bottom line and cash flow.
What KPIs Should Construction Companies Track Related to Cash Flow?
Potential KPIs to include:
- Project timelines linked to financial data. Overlaying project timelines can help compare demand for talent and supplies and be used for budgeting. Where and when will your cash flow needs be the greatest?
- Effective equipment management and special use opportunities. Focus on how to avoid idle equipment and leverage its full potential on contracts throughout the company. Is there opportunity to increase profitability through effective equipment management to avoid excessive equipment short-term rentals as well as keeping owned or long-term leased equipment from sitting idle?
- Current ratio. Are you using your working capital efficiently?
- Financial ratios and working capital. Proactively implement strong billing processes. What does your current liquidity look like?
- Under-billings. Which projects have work done that hasn’t been billed?
- Days in accounts receivables (AR) or AR turnover. Are you proactive in managing receivables? Which bills haven’t been collected?
Construction companies may also want to track KPIs that are often more closely associated with project management. Establishing and monitoring project management KPIs can help improve the bottom line and cash flow.
Potential KPIs to track include the following.
Leadership is responsible for setting safety as the highest priority and upholding the expectation that safety is taken seriously by everyone involved. Accidents happen when hazards go unreported or unidentified. A reporting process that identifies hazards to mitigate or even eliminate them not only protects your employees, but also increases productivity and trust as well as avoids costly accidents.
Further, an effective safety program should always link back to education and training for your employees.
- What is your overall safety or incident rating?
- How many accidents have there been per job site and what’s their severity?
- How many safety meetings or trainings have there been?
- Has there been a decrease in accidents since a consistent safety program has been in place?
Measuring quality can be tricky as these metrics may change depending on the type of project. Quality metrics usually also involve internal quality metrics such as timeline and budget, and external quality metrics such as client satisfaction. But quality metrics are essential for decreasing the time wasted on reworks or changes.
- What is the total number of project defects, and how much time is required to address them?
- What is the cost of rework efforts?
- What is the first-time pass rate of inspections and how many re-inspections are required overall?
- How satisfied is your customer with the progress reports and ratings?
- Does the finalized product fit the originally outlined purpose and specifications of the project?
Performance, Productivity, and Workforce Efficiency
It’s important to understand how your team spends their time and effort to ensure deadlines are met. Carefully tracking performance and productivity can help you discern if you need to allocate additional resources to the job or take some away to increase efficiency and meet project goals.
- What is the average project revenue per hour worked?
- What is the average percentage of employee downtime?
- What is your employee turnover rate?
Recent factors caused by the pandemic increased construction material shortages and price volatility, forcing many contractors to rethink their inventory management infrastructure. In uncertain times, it’s important to effectively track material supply to ensure project deadlines are met. Tracking metrics around material supply can also help you determine if you need to look for new suppliers or storage sites.
- What common materials do you have on hand, and what do you need to pre-order for future jobs?
- What is the average timeline of delivery for necessary materials, and what costs are involved for shipping, storage, and substitutions?
- What is the percentage of defective or incorrect deliveries?
How Can You Connect KPIs to Business Insights?
It’s not enough to gather the data; you must interpret it, too. The goal is to implement an intuitive, easy-to-use financial and operational dashboard that draws the user towards what’s important—selecting a few actionable KPIs is more effective than listing all interesting performance indicators.
Budget managers should feel empowered to answer their own queries through use of data visualizations and dashboards KPIs should be viewed in context:
- Performance over time
- Short- and long-term forecasts
- Underlying data that influences decisions
- In-depth analysis with finance leaders—without creating a data deluge
Evaluating KPIs and Measuring Progress
Once you identify KPIs and benchmarks and develop some comparable scenarios and intel, the real value building begins by analyzing what actions will create measurable change in your cash flow management approach.
While every construction organization is different, some common macro-level areas of focus include measurables that enhance profitability through revenue and cost intelligence, reductions in organizational risk through capital management, and the increase of profitable growth.
What to Do in the Event of a Cash Flow Deficit
When cash is in short supply, don’t wait for the situation to resolve itself. Companies need to act quickly and look for places where cash has been trapped.
Steps to Improve Cash Flow Management
- An off-cycle invoice might need to go out
- Ineffective change order management should be resolved
- Progress on a job must be communicated effectively
Maintaining a strong relationship with your bank is also important should you need to draw on a line of credit to resolve the problem.
Don’t be afraid to have tough meetings and hold your team accountable if problems arise in specific areas. This may require a cultural and operational mindset shift within the company to address recurring issues.
We’re Here to Help
The impacts of the COVID-19 pandemic have been tough for many businesses. Explore additional construction business consulting resources like how to implement new technology, how to access additional tax benefits, and more.
For more questions about cash flow management, contact your Moss Adams professional or visit our Construction Practice.