Construction Finance: What is cash flow and why is cash flow management important?
Updated: Aug 25, 2020
This is part of the series Construction Finance on Construction Cost Accounting website.
Part 1: How to Manage Finance for Small Business Owners
Managing cash flow has never been an easy job. For construction businesses, it’s even worse.
Construction payment takes 83 days on average, according to PWC. (That’s among the longest of any industry in the world.) Especially during this difficult time, slow, late, and partial payments can create cash flow issues for construction businesses. It’s crucial that mid-size and small construction business owners to identify and solve the problems that drain their cash, and build good cash flow management to prevent future issues.
"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.
In this article, we’ll discuss what cash flow is, and what common problems small business owners in construction industry have relating to cash flow management.
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 coming in, and how much, then when money coming 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 essentially to keep since you can project or spot trends of 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 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?
Cash flow management involves looking at current cash flow reports for your construction business, your projections for cash flow trend, and making business decisions based on that information. For example, if you know that you’re going to have $500,000 into your business account, then you plan your business activities around that amount: pay the bills, following debts, etc. But when you don’t have that amount of money, then you have to plan your business activities accordingly.
For small businesses, one of the most important aspects in cash flow management is to avoid extended cash shortages caused by an overly large gap between cash going in and cash going out. You won’t be able to stay in business if you can’t pay your bills for a long time.
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