I’m starving for cash!!
~What a construction company would say,
if it could talk
“Growth Eats Cash” is one of the most enduring sayings in business, and that’s because it’s true. Business growth doesn’t just happen, it needs to be fueled. And the fuel is cash. While the growth eats cash truism holds for just about any business in any industry, the complexities of managing cash flow in the construction industry make growth for construction firms particularly challenging.
Good News / Bad News for Construction
First the Good News:
Market forces, economic trends, expected growth, and a massive pipeline of much-needed, large-scale construction projects all point to one conclusion: the construction industry is poised for significant, sustained growth. This means that, if you’re in the construction business, congratulations, you have a huge opportunity before you to take advantage of the coming industry expansion and grow your business in a way that hasn’t been possible since long before the most recent recession. That’s the good news.
And Now for the Bad News:
Construction businesses are more likely to fail in a growing economy than in a declining economy. How likely, you ask? For subcontractors, the answer is three times more likely, according to Thomas Schleifer, PhD, of the Del E. Webb School of Construction.
Seems crazy, doesn’t it? Businesses are supposed to fail in an economic downturn, not during an expansion. How is it possible that a growing economy is somehow more of a survival threat to construction businesses than a declining one?
How is this Possible?
Let’s take a moment to clarify a very important issue: what causes a company (any company) to fail? The simplest, and most common, reason why a company fails is because that company ran out of cash. And running out of cash is an easy problem to have in the construction business, because it takes a huge amount of cash for a construction firm just to fund its normal operations. There are lots of reasons for this, but 3 of the most significant drivers of the construction cash crunch are:
- Floating project/job costs up front is expected
Your cash starts going out the door on a new project/job immediately
- Slow-payment is pervasive
The cash coming in the door from your customers is slow to arrive
- Retainage, change orders, and underbillings are prevalent
Construction-only practices like these all serve to further complicate the collection of construction payments which has a negative impact on cash flow
In other words, before a construction business owner can worry about the cash needed to fund growth, he has to worry about the cash that his business is already eating. Putting it another way: construction businesses already eat cash, and a construction business is always starving.
Why Do Construction Companies Need So Much Cash for Normal Operations?
In order to illustrate the cash-starved nature of the construction business, imagine the following scenario: A subcontractor has an opportunity to grow by taking on a new project in addition to the existing project load. This is going to be a 6 month project with a contract value of $332,000 – not bad. But let’s take a closer look at the cash that subcontractor is going to need just to keep the project moving forward…
- $332,000 contract value
- 6 month project/job timeline
- Retainage – 10%, balance coming in last customer payment
- Labor cost – 15%, paid weekly
- Direct overhead – 7%, paid weekly
That bad, huh?
Yes, it really is that bad. Just think about how your average project/job unfolds in the real world. The costs and expenses of a new project don’t wait for your customer’s payments to roll in. Payroll? Can’t wait on that! Overhead? It’s going to be difficult to work if your electricity is cut off and you don’t have any fuel in your work trucks and machinery!
When you throw in the added burden of retainage, it’s very likely that a contractor, sub, or sub-sub to be cash flow negative for a significant portion of a project/job timeline. In fact, it’s not unusual for the negative cash flow to last for the entire duration of the project, only moving into the black when the final project payment (which includes the retainage) is received. And if your labor costs, your overhead, or the project retainage are higher than normal, then the depth and the duration of your cash crunch is only going to increase.
What Can You Do?
Look, the construction industry ain’t for the faint of heart, and everyone reading this post knows it. You need a ton of cash just to survive, and if you’re thinking about growing, then you’re going to need access to more.
But one way to increase your access to cash is to decrease your cash needs. Take a look at the table above and notice the difference between getting paid at 30 days and getting paid at 90. Look closely at the amount of cash needed to fund a project. It takes 6 times more cash – $199,000 compared to $33,000 – to fund a project/job where it takes the customer 90 days to pay than it does to fund a project where the customer pays in 30 days.
One of the main benefits of securing your payments by using the zlien platform is that your customers will pay you more quickly. And getting your customers to pay you more quickly could be the difference that allows you to have the cash you’re going to need to grow. We’d love to show you how – get in touch with us to find out more.