Mastering Cash Flow: Essential Tips for Construction Companies - Part 2

In Part 1 of this series, we explored the critical role that effective cash flow management plays in ensuring the financial stability of construction companies. We discussed the importance of tracking key financial ratios, optimizing the Schedule of Values, and streamlining billing processes to avoid cash flow bottlenecks. If cash flow isn’t properly managed, even the most profitable construction companies can find themselves facing severe financial distress. In Part 2, we will take a deeper dive into the tangible benefits of mastering cash flow management by looking at real-world scenarios where businesses have turned potential crises into opportunities for growth.

Example #1 – Improving Days Sales Outstanding

In this example, we explore how a $50 million specialty contractor could significantly improve its cash flow by reducing its Days Sales Outstanding (DSO) by 10 days. DSO is a key metric that measures the average number of days it takes for a company to collect payments after revenues have been earned. High DSO indicates delayed cash inflows, which can strain working capital and limit the contractor's ability to reinvest in operations. Reducing the DSO, even by a small margin, can unlock substantial cash for the business.

In this example, by reducing the DSO by just 10 days, the contractor frees up $1.37 million in cash that had previously been tied up in receivables. This demonstrates how small improvements in cash flow management can have a substantial impact on a company's liquidity and financial strength. By unlocking these funds, the company can better support its growth, enhance operational stability, and create a stronger financial foundation for the future.

Example #2 – Distribution Timing

Scenario:

XYZ Construction, Inc. had 30 ongoing projects of varying sizes and durations, with multiple start and end dates. While the company was generating strong revenue, managing cash flow across such a large portfolio of projects was complex. The company’s owner wanted to take a $500,000 distribution but was concerned about timing, given the cash flow fluctuations associated with managing a large number of projects. To address this, XYZ Construction used a nine-month cash flow forecast, breaking down cash inflows and outflows for each project to ensure the distribution wouldn’t disrupt liquidity.

Key Considerations in the Forecast:

• Project Staggering: The projects were at different phases of their lifecycles. Early-stage projects typically required heavy investment, with significant upfront costs such as equipment rentals, mobilization, and initial labor. Mid-stage projects saw more balanced cash flows, as billing cycles were more aligned with the progress of work. Projects nearing completion were particularly challenging because payments could be delayed due to retainage or final billing, meaning that although work was nearly done, cash inflows slowed down significantly.
• Retainage and Final Payments: For projects nearing completion, a percentage of payment was withheld as retainage. While the work was almost finished, the company would not receive full payment until the project was closed out, and all contractual obligations were met.
• Vendor and Subcontractor Payments: Payment terms with vendors and subcontractors varied across the projects, adding further complexity. Some vendors required upfront payment, while others operated on 30- or 60-day terms.
• Managing Overhead and Fixed Costs: In addition to direct project costs, XYZ Construction had ongoing overhead expenses, such as office rent, administrative salaries, and insurance premiums, that needed to be factored into the forecast. These fixed costs added another layer of pressure on cash flow, especially during periods when large projects were winding down, and inflows were temporarily reduced.

A nine-month cash flow forecast helped identify a period of cash surplus, signaling the optimal time for the owner to take the distribution without jeopardizing operations. The forecast also allowed the company to prepare for cash flow dips during various project completion phases, ensuring liquidity. By forecasting cash inflows and outflows across their projects, XYZ Construction successfully timed a distribution while maintaining financial stability, demonstrating the importance of proactive cash flow management.

We can help

For more information on strategies to not only prevent cash flow issues but also position your construction company for sustainable growth and long-term success, contact our team below.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.

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