In our work with clients and financial institutions we all too often see where the opportunities, driven by the start of recovery, present dangers to organisations in the construction sector. The understandable desire to “get back to work” creates scenarios where businesses take on more than their cash facilities can cope with and run into difficulties.
The key to maintaining and maximising recovery is to focus on possibly one of the greatest challenges the construction industry continuously faces — cash flow management.
A few common pitfalls that can deplete and thus strain cash flow include:
- Timing delays, such as making payments to employees, subcontractors or suppliers before receiving money from the customer for work done or the time between raising invoices to and receiving payment from the customer;
- Not having robust controls and/or standard procedures over how project activities trigger billing on an accurate and timely basis;
- Not actively managing cash, from expediting collections to management of the supply chain and staffing costs.
Below are three possible solutions to these problems:
Cash flow forecast
Cash flow forecasts are, by definition, forecasts, and as such will rarely match actual outcomes exactly. However, to achieve optimum results, the cash flow forecast, after factoring in timing differences for payments and receipts, should run almost parallel to the project management of the work. This will provide a clearer picture of when the peaks and troughs of workload should coincide with the peaks and troughs of the project’s cash flow.
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Taking the time to plan things as accurately as possible at the beginning will not only improve the project’s chances of running smoothly, but also highlight potential stress points in the project’s cash flow, which will help you manage the risks.
Alternative financing options
There are a number of alternative financing options provided by third parties that, even after fees, can be less expensive than taking out a commercial loan. Some of the most commonly used financing options are:
- Invoice financing The invoice financier buys the debt owed to a company by their customer once an invoice has been raised.
- The financier makes typically about 85% of the value of the invoice available upfront and then pays the balance, less any charges (fees and interest) once they have collected the full amount directly from the customer.
- Invoice discounting Similar to invoice financing but rather than collecting the outstanding debts from customers, the financier instead lends money against the value of the invoices raised to customers.
Once the debt is received from customers the amount borrowed from the financier is repaid. - (Early) settlement discount Customers are incentivised to pay earlier than or within usual credit terms by receiving a discount off the total invoice amount from the supplier.
- Supply chain finance Typically used when dealing with customers that are larger companies with typically higher credit ratings. A bank is notified by the customer once an invoice from the supplier has been approved for payment. The bank then offers up to 100% of the invoice value to the supplier at lower interest rates than a commercial loan, with the assurance that the company will pay the invoice amount direct to the bank.
An effective order to cash process
Due to the long durations of construction projects, where possible contracts should be structured with staged payments. So rather than waiting until the end of a completed project for the entire payment, smaller incremental payments should be charged once each stage/specified activity of a project has been completed. As a result, the communication between billing and project management must be clear and efficient.
Even with a steady supply of profitable projects there is still a danger of becoming insolvent unless cash flow is managed effectively. It may be cliche but the saying “failure to plan is a plan to fail” could not be more pertinent than in construction.
By Steve Mortimer, an associate director in the performance improvement team at Grant Thornton UK