Cash is king, and, therefore, is important to construction industry participants, as it is to any business. Managing finances in the construction industry, however, presents some unique challenges. The credit industry has a convoluted payment structure, and most extensions of labor and/or materials to construction projects are done on a credit basis. Further, construction companies must maintain positive cash flow to ensure access to capital, bonding capacity, and to meet contractor qualification criteria. While every new year presents new challenges and opportunities, it’s worth looking back to examine the past year so that the insights learned can be applied to grow business in the future. With the construction economy gaining steam in 2014, looking back can provide valuable information to use going forward.
The Financial Management Problem
[quote style=”right”]42.5% of the receivables of businesses surveyed were past due [/quote]One of the greatest challenges to profitability are challenges associated with a business’s cash flow. In fact, in the United States in general, and in the construction industry in particular, collecting on outstanding invoices is a pressing problem. A 2014 survey found that 42.5% of the receivables of businesses surveyed were past due at the time of the survey. For construction industry participants, two specific issues cause particular difficulty.
Complexity of Payment Procedure: The payment structure in the construction industry is challenging, to say the least. Companies are forced to contend with multiple payment layers, heavy paperwork needs, and frustrating timing challenges. Some parties get paid on credit terms (i.e. suppliers), while others must participate in monthly payment draws subject to pay-if-paid provisions. Further, the parties are required to exchange mountains of paperwork, including confusing lien waivers.
Insolvency with the Buyer: Subcontractor default risk is a real, and a not insignificant fact in the construction industry, and this was especially true in the economic climate of the past year, and the upcoming years. The risk of failure in the construction industry increases with a recovering economy. Research cited in ENR, for example, expects contractor default rates to soar in the years ahead. To further complicate the matter, construction project participants are not at risk with only a single contractor; any of the contractors associated with the project can default, and gum up the payments works for everybody.
How Construction Companies Can Combat Cash Problems
[quote style=”left”]technology platforms have been developed that allow construction industry participants to streamline and optimize their financial management, and financial risk-mitigation procedures.[/quote]Construction industry participants don’t only have unique credit management challenges, however, they also have unique credit management solutions. There are construction industry-specific financial risk-mitigation tools available that specifically address these unique challenges presented in the construction industry. Joint check agreements, for example, can offset the challenge of payment procedure complications, and security rights, like lien and bond claim rights, can virtually eliminate the risk of insolvency (read our Indispensable Guide on Bankruptcy and the Mechanics Lien).
It is foolish to not take advantage of these tools.
These particular solutions and tools available to the construction industry can be convoluted to manage, intricate, and difficult to use. Luckily, technology platforms have been developed that allow construction industry participants to streamline and optimize their financial management, and financial risk-mitigation procedures. This ability turned the corner in 2014, and is poised to dramatically expand in 2015, encompassing not only cloud-based technologies that replace clunky out-of-date in-house platforms and procedures, but also machine-learning / artificial intelligence technology that can optimize processes and lead to making better more efficient decisions.
Use This Knowledge to Grow
Companies rarely look at finance as a revenue or profit generating function. Instead, most companies credit the sales process, or even the performance process, when both the top and bottom line perform well. Unfortunately, this oftentimes even leads to tension between sales professionals and credit, collection, and finance professionals within a single organization. Nevertheless, companies should think carefully about this. CFOs and controllers can generate more profit through intelligent cash management on a project than project mangers.
Managing cash flow really boils down to what tangible things companies can do to get cash faster and keep their own cash longer; and that, in turn, simply refers to the following:
- Billing: Is this technologically optimized?
- Paying Vendors: What are the terms?
- Capital Access: How does access to capital mesh the waiting period on receivables and the payment period on vendor invoices?
- Who Are The Customers? Are the customers solvent, and what steps are being taken to protect against insolvency?
- Construction Cash Realities: Construction participants sometimes have to wait for cash from the owner or lender, or are restricted from collecting – despite their terms – by the terms of the underlying construction contracts. What are the company’s policies with respect to evaluating these risks, and setting forth the parameters of risk the company will accept?
Managing and optimizing the above points with technology, can enable the savvy construction company to leverage these problem areas into growth. Technology is not a necessary evil, but the means to effect a competitive advantage.
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