Cash flow poses a common challenge for small businesses, particularly those in the construction sector with 20 or fewer employees. These companies often struggle to synchronize their income with expenses.

Securing an initial deposit and establishing a clear progress payment schedule is advantageous. However, managing immediate and ongoing expenses for each project can be daunting. Compounding this, many small construction firms lack dedicated financial management personnel.

Construction Finance Tips To Help Your Business

1. Establish a Plan Before Commencing

Planning stands as a cornerstone for any small business, especially within the construction sector. Given the multitude of variables in construction, strategizing beforehand is paramount. Each element involved can potentially incur significant expenses if unexpected issues arise, leading to delays or setbacks.

According to Brandon Hurd, managing director at Hurd Construction Management, a general contractor and construction management company, "Proper pre-construction planning is arguably the most critical project phase any owner can undertake. Unqualified schedules, scopes, specifications, and particularly budgets are recipes for legal and financial disasters."

He emphasizes, "A solid footing and foundation are necessary for any project to endure the project lifecycle and series of changes likely to occur whether by owner request, construction codes, or other local regulatory requirements."

2. Track Timing of Expenses

Construction expenses typically fall into two categories: hard costs and soft costs. Hard costs directly pertain to physical construction, encompassing materials and labor. Soft costs, on the other hand, encompass everything else, from permitting and engineering to taxes, insurance, fees, and loan interests. They may even extend to ongoing expenses like maintenance or post-project insurance.

Both hard and soft costs can manifest at different stages throughout a project. Understanding the timing of each expense can mean the distinction between seamless operations and encountering financial constraints midway.

For instance, Nicole Landau, president of Landau Consulting Solutions, which provides outsourced CFO and accounting services to construction firms, illustrates a hard cost scenario: "Your subcontractors may request a deposit to initiate work — perhaps the plumber needs to procure supplies."

Henry DeNicola highlights the importance of prompt subcontractor payment: "A reputable general contractor adheres to strict timelines for subcontractor payments." Therefore, labor-related hard costs might demand immediate attention at project commencement, while material expenses, another hard cost, can potentially be deferred.

Soft expenses like insurance premiums can significantly impact budgets if paid annually. Yet, these expenses might be overlooked during project-specific planning. Landau advises, "When projecting cash flow, ensure these are factored in and forecasted." If you have any concern About Business Insurance, Click Here for Free Quote.

3. Allocate for Contingencies

Similar to any small business, unforeseen challenges can arise for construction firms. However, it's crucial to recognize that errors in construction can incur higher costs compared to other industries.

"There will be instances where things go awry, necessitating a budgetary allocation to address them," Landau advises. If you're relying on a loan to fund a project, lenders may stipulate the inclusion of a contingency fund. In some instances, they may retain funds and only release them to cover emergencies or change orders.

4. Secure Deposits

While state or local regulations may impose limits on deposit amounts, generally, you can receive deposits along with progress payments for your work. Obtaining a deposit is vital for managing cash flow early in a project, yet some entrepreneurs may hesitate to request it.

Landau recounts a client's experience: "One of my clients was constantly monitoring their cash balance, operating on a day-to-day basis. Initially reluctant to request significant upfront payments from clients, a shift in mindset towards securing larger deposits significantly improved cash flow management." As a result, the client could expedite vendor payments and regain confidence in their business operations.

5. Exercise Restraint in Early Expenditure

While a deposit can aid in covering initial costs, it's crucial not to splurge prematurely. Contractors receive substantial payments, which may lead them to believe they have ample funds. However, they often overlook associated expenses.

By forecasting weekly, monthly, or long-term cash flows for both the project and overall business, it becomes easier to avoid cash shortages later on. 

6. Utilize Separate Accounts for Each Project

Segregating finances for individual projects enables efficient allocation of funds for subcontractors, overhead, and project-specific profits. While a similar system can be established on paper while using a single account, Amerson underscores the importance of ensuring adequate funds for payables.

7. Explore Innovative Cash Flow Management Tactics

The specifics and feasibility depend on supplier terms, credit card limits, and business credit status. Establishing favorable terms with suppliers or leveraging business credit can potentially extend payment windows further, albeit with associated risks. Mismanaged expenses, delayed client payments, or insufficient backup funds may lead to accruing high-interest credit card debt.

Another avenue to consider is invoice factoring. Collaborating with a factor allows for an advance of 85 to 90 percent on outstanding invoice amounts, with the remainder, minus factor fees, disbursed upon client payment.

8. Master Your Financial Records Before Seeking Financing

When not self-financing projects, seeking external funding becomes necessary. While local banks familiar with the area may offer construction loans, other options include construction-specific lenders, private groups, lending exchanges, and state or federal programs, as outlined in a report by the Korte Company.

Exploring various banking options and diversifying your portfolio isn't a bad idea. However, it's essential to present your business's financial status clearly and accurately, ready to address lenders' inquiries.

9. Cultivate Strong Banking Relationships

Securing financing for sizable projects can be a lengthy process, spanning months or even years. Even for smaller ventures or those with existing funding arrangements, maintaining open communication with various banks and lenders is advisable.

Maintaining solid banking relationships is paramount. Should unexpected financial needs arise or lucrative bidding opportunities emerge, having established relationships can expedite the financing process. Whether seeking additional funds or seizing promising opportunities, reliable banking connections can make all the difference.

10. Acknowledge Personal Financial Risks

Securing financing for a project often entails signing a personal guarantee for the loan, involving you, your partners, or financing group. This commitment means that despite the project and loan being under the business entity's name, you agree to personally repay the loan from your assets if the project encounters difficulties.

Furthermore, lenders may require you and your partners to disclose all assets and liabilities to secure the loan, underscoring the intertwining of personal and business financial responsibilities.

In conclusion, navigating the financial landscape of a small construction business demands careful planning, strategic foresight, and a nuanced understanding of cash flow management. From creating comprehensive plans before commencing projects to nurturing strong banking relationships, each step is integral to sustaining financial health and ensuring long-term success. 

However, it's crucial to recognize the personal financial risks involved, particularly when securing loans or signing personal guarantees. By mastering these principles and fostering prudent financial practices, small construction businesses can effectively mitigate challenges and thrive in a dynamic industry landscape.