By Patrick Hogan, CEO, Handle.com
Whether you are a small-time contractor or a large construction business owner, there is one thing that holds true: Cash is king. It is not an exaggeration to say that cash is the lifeblood of any business, and this is even more apparent for construction projects. Having a lot of sales revenue and high profits on paper does not mean you are in a comfortable position, especially if you have low or negative cash flow. Without any reliable cash flow, you will have a challenging time growing your business.
A study conducted by the US Small Business Administration found that about 20 percent of businesses fail in the first year, with only half surviving until their fifth year. Of these business failures, 82 percent cited cash flow problems and around 29 percent said that they simply ran out of cash.
In the construction industry, negative cash flow is a common reason why contractors can become insolvent. If there is not enough positive cash flow, contractors may fail to finish jobs, or will continue work but at a loss. Maintaining positive cash flow is extra challenging for construction businesses because of the nature of the industry. Construction is notorious for having frequent payment issues and a complex and mostly manual billing process. Add to this the high upfront costs and thin profit margins, and it’s even more difficult for contractors to pay what they owe to their own subcontractors and get paid for the work they have done.
The COVID-9 situation further exacerbates the cash flow problems of construction businesses. With some construction projects stopping work temporarily, the flow of cash also comes to a halt. Contractors may have to live off of their cash reserves in order to pay off their business expenses.
The Impact of Cash Flow on Business Decisions
Understanding cash flow is important to a construction company as it identifies trends and gives business owners valuable insights that can be used to make strategic business decisions. Conducting an analysis of your cash flow statement will let you see whether your company generates enough cash to cover current expenses and pay off debts.
Depending on whether your cash flow is positive or negative, you will have to adjust your business strategy. Positive cash flow means you have more cash coming into your business than you are spending. This is the ideal scenario that you want your construction business to be in. On the other hand, negative cash flow means you are operating at a deficit. If you are struggling with collecting your invoices and expanding your business, or unable to do any business due to external factors, such as government-imposed lockdowns, you will experience a negative cash flow.
Cash flow affects your company’s ability to expand. If you have a positive cash flow, then you may decide to purchase a new machine to improve worksite efficiency. It also puts you in a comfortable position to hire more people to increase your work output. In general, the more cash there is that flows into your business, the more freedom, and flexibility you can have to invest in your company’s growth.
On the other hand, having a negative cash flow forces you to exhaust your cash reserves to pay off your payables and operational expenses. You may have to forego business opportunities that come your way in order to keep your company afloat. Plans for capital expenditure will have to be put on hold until your company goes out of the red. And if there is an emergency situation, like the COVID-19 crisis, you will not be able to adapt as quickly.
One thing to note is that a positive cash flow and a negative one are linked to each other. For instance, when you have positive cash flow, you may be confident enough to take on more opportunities and invest in your growth. But once you start with the expansion, you will experience negative cash flow because of the subsequent increase in your expenses. This is a normal trend as long as your cash flow trends back to being positive.
Managing cash flow is a constant balancing act for all businesses. Knowing what aspects of your business generate you more income lets you set up your priorities. On the other hand, discovering inefficiencies in your cash flow can help you decide where to cut costs or focus on collecting unpaid invoices. By understanding how money flows through your business, you will be in a better position to make better business decisions.
About the Author:
Patrick Hogan is the CEO of Handle.com, where they build software that helps contractors, subcontractors, and material suppliers with late payments. Handle.com also provides funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.
