What is Cash Flow and Why is Cash Flow Important?
Updated: Aug 7
Managing cash flow has never been an easy job. For construction businesses, it’s even worse.
This industry faces a unique set of challenges as evidenced by PWC's statistics, which reveal that construction payments typically take as long as 83 days - one of the longest payment cycles worldwide. In an unpredictable business landscape, delays in payment, partial payments, or missed payments can put significant pressure on a construction company's cash flow. Therefore, for small and medium-sized construction enterprises, identifying and rectifying any issues affecting cash resources and implementing robust cash flow management strategies is crucial to prevent future complications.
"Despite the fact that cash is the lifeblood of a business -- the fuel that keeps the engine running -- most business owners don't truly have a handle on their cash flow," says Philip Campbell, a CPA and former chief financial officer in several companies and author of Never Run Out of Cash (Grow & Succeed Publishing 2004).
Poor cash-flow management is causing more business failures today than ever before.
The repercussions of ineffective cash flow management are resulting in a record number of business failures today. In this article, we delve into the nuances of cash flow and the cash flow challenges frequently encountered by small construction business owners.
What is cash flow?
Simply put, cash flow is money coming in and out of your business’ wallet. When you look at cash flow, you look at when money comes in, and how much, then when money comes out, and how much.
Money can funnel into your business through accounts receivables, sales, etc., while money can leave your business through accounts payable, monthly expenses, salaries, etc. As a business owner, you should track it weekly, monthly, or at the very least, quarterly.
A contractor’s cash flow statement is an analysis of all cash activities in a given period (usually one month). The period can be in the past or a prediction for the future. Past reports are essential to keep since you can project or spot trends in future report amounts.
Cash Flow vs. Profit
Cash flow is different from profit. "There is a secret that very few business owners have discovered (and the accounting community has not done a good job revealing): knowing whether you earned a profit (or created a loss) is not the same as knowing what happened to your cash," Campbell says. "Profit, as defined by the rules of accounting, is simply revenue minus expenses. Invoicing a customer for products or services you sold to them creates revenue. Actually collecting the money on that invoice is what creates cash."
A positive cash flow – when money coming in is more than money coming out – is what is needed to generate profits. You need enough cash to pay for your employees and suppliers so that you can make products. Then when products are sold is when profit is generated. Vice versa, no cash means no products, then no profits. So you really need to structure your business to have positive cash flow if you want your small business to grow and increase profits.
Why is cash flow management important?
Understanding the role of cash flow in business is fundamental, and it's particularly crucial in industries with intricate financial dynamics such as construction. Cash flow, in reality, holds the pulse of your business. Below, we delve into why cash flow deserves your undivided attention:
Business Survival: Sustaining a positive cash flow can be synonymous with business survival. It ensures your company can settle its short-term obligations, such as salaries, utilities, and payments to suppliers, thereby safeguarding your business's solvency.
Getting Your Business to Grow: When you handle your cash flow well, you can build up a fund that you can put back into your business. This could include exploring new projects, initiating marketing campaigns, or even acquisitions – all of which are conducive to business growth.
Attracting Investments: Investors and lenders are more likely to give money to businesses that show they can handle their cash flow well. Steady, positive cash flow is a sign that a business is financially stable and has growth potential. This makes it less risky to invest or give money to that business.
Weathering Storms: A well-managed cash flow serves as a financial cushion during challenging times, helping your business withstand unforeseen disruptions to your income streams. There could be a drop in the economy, a crisis in a business, or a global disease.
Access to Credit: If you have a good handle on your cash flow, you can offer credit terms to clients you can count on. This could increase sales and strengthen relationships with clients. At the same time, it lets you take advantage of credit options from your suppliers, which helps you get the most out of your operating capital.
Guiding Strategic Decisions: Understanding cash flow patterns can offer valuable insights for strategic decision-making. It helps you figure out when you'll be short on cash or have too much, so you can plan your operations properly. It also helps figure out if big investments are possible or if there are places where costs could be cut.
Recognizing the Need to Improve Your Cash Flow
As a business owner, monitoring your finances, especially your cash flow, is a fundamental responsibility. Here are some indicators that suggest it might be time to boost your cash flow:
When it's becoming challenging to meet payroll regularly.
When your business habitually delays bill payments.
When your business operates in overdraft persistently.
When lack of funds is causing you to decline growth opportunities.
When your cash flow forecast predicts an upcoming cash crunch.
When your revenues heavily depend on a single client.
When there's a discrepancy between increasing profits and stagnant or decreasing cash flow.
When business growth is being hampered due to inadequate cash flow.
If you're quick to recognize these signs and act promptly by adopting the right strategies, you can not only better your cash flow but also keep your business in good financial shape.
Learn more: 7 Common Cash Flow Problems and How to Manage Them
Strategies to Improve Cash Flow Management in Construction
Managing cash flow effectively can be a challenging task, particularly for those in the construction industry. It necessitates careful monitoring of incoming and outgoing payments, strategic planning, and accurate forecasting. Here are some strategies for construction business owners to enhance their cash flow management:
Implement Prompt Invoicing: The sooner you invoice, the sooner you are likely to get paid. Do not wait till month-end to send invoices.
Establish Clear Payment Terms: Ensure your clients know when payments are due. Send reminders as the due date approaches.
Regular Cash Flow Reviews: Make it a practice to review your cash flow statements regularly to detect potential problems early.
Leverage Cash Flow Management Software: Various tools can help you track and manage your cash flow more effectively.
Learn more: 20 Proven Strategies to Improve Cash Flow in the Construction Industry
As a busy construction business owner, you may find it difficult to manage these responsibilities while handling day-to-day operational tasks. That's where our services at CCA can help. We specialize in bookkeeping services specifically designed for the construction industry.
Our team at CCA understands the unique cash flow challenges faced by construction businesses and is well-equipped to handle them. By choosing CCA's services, you not only save time and effort but also ensure your cash flow is managed with precision, paving the way for business growth and profitability.
Get in touch with us today to learn how we can help you streamline your cash flow management.
Conclusion
Getting the cash flow right is very important for your construction business. If you manage it well, your business can be very successful. If not, your business could fail.
At CCA, we offer special services to help manage your cash flow. This can help your construction business do well and stand strong against the competition. Let us join you in your journey to make your business strong and successful.