Construction companies often operate on razor-thin margins, making financial management crucial in ensuring success. However, many businesses in the industry are not as conscientious with their finances as they are in meeting client expectations, sometimes even compromising profitability and taking losses on projects. The fundamental goal of any business is to make money. To do that, you need to pay attention to your finances and avoid these pitfalls that befall many construction businesses.
Poor cash management
Many construction companies suffer from poor cash flow. One of the biggest pitfalls under cash flow problems is having insufficient cash reserves. In construction, where most projects have longer payment cycles and businesses are often expected to front many of the costs for projects to commence and progress, having sufficient cash reserves is prudent. Of course, this exposes the company to considerable financial risk, though it is a regular practice.
To work around the risks, it’s wise for companies to establish requiring a significant deposit at the onset of the project. It’s best to get at least half of the project cost down in the beginning. Some clients might balk at this and look elsewhere, yet many will be open to this arrangement because it simplifies things on their part. Part of being able to require significant cash-down from clients is improving your vetting process and ensuring the financial viability of clients and their projects.
You need to avoid having to dip into the cash runway of another project to fund another one, mainly because this puts both projects at risk.
Regular and timely invoicing is key to getting paid on time. Many construction businesses fail to send timely invoices, causing delays in the payment process or even project progress.
Timely invoicing and establishing a cadence of frequent invoicing, especially in bigger projects, enable both parties to identify and resolve questions and disputes early on. Late invoicing already causes late payments. If there are disputes on late invoices, payment cycles are even more prolonged.
Many clients might also have date-based pay cycles, and late invoicing can cause you to miss their payment schedule, forcing you to front cash that might put you in a tight spot. Yet, your vendors and workers must be paid on time to preserve morale and productivity. Suppose you’re getting paid late due to late invoicing. In that case, you might need to make unnecessary poor cash decisions to cover time-sensitive payments you must make, like loans or delaying vendor payments, which corrode relationships.
Failure to preserve lien rights
Late payments and even delinquent clients are unfortunately common in the business. Fortunately, states have laws in place to promote prompt payment and protect construction businesses, professionals, and suppliers from non-payment and financial loss. However, to benefit from the rights granted by these lien laws, contractors and suppliers often have the responsibility of filing the necessary notices. In many cases, failure to file these notices results in the loss of your right to recover payments via mechanics liens.
Mechanics liens work by placing a hold on the property where you furnished work or materials. If the client fails to pay, the court may order a foreclosure sale to pay unpaid contractors and vendors on the project.
Mechanics liens are powerful in protecting your right to payments. Ensuring your right to file them must be part of your workflow for all projects. The required preliminary notices are typically time-sensitive, and delivering them late may cause part or all of your work to be unprotected.
For example, the preliminary notice in California must be filed within the first 20 days of work or materials delivery to have the right to file a lien in case you go unpaid. Sending the notice late will result in part of your work being ineligible for lien protection. Automating this process through lien management software is a sound investment, primarily if you deal with multiple projects located in different counties and states.
Knowing is half the battle
These are just some of the financial pitfalls you need to watch out for as a construction business owner. Many choose to avoid the hard truths and the seemingly cumbersome aspect of finance, but paying attention and putting the necessary processes in place will save you from costly mistakes and decisions.
About the Author:
Patrick Hogan is the CEO of Handle.com, where they build software that helps contractors, subcontractors, and material suppliers with filing documents like preliminary notices to avoid late payments. Handle.com also provides funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.