Based off construction insolvency rates (construction accounts for nearly 25% of all Australian business insolvencies each year which is 5 X higher than the national average of all other industries combined), managing cash flow and cash flow forecasting are two of the most difficult and challenging tasks when running a trade or construction-based business.
Whether it’s dealing with customers directly, or being at the mercy of builders, subcontractors, or suppliers… payment terms can often be unforgiving, and it can prove to be very challenging to balance the ins and outflows of cash.
Because of the industry’s very nature, there are so many factors to consider when monitoring, maintaining, and improving cash flow.
And all of these factors make it hard to determine where exactly your money goes, let alone forecast your cash flow (a necessary activity for any successful trade business owner).
So, issues like delays in payments, money owed to you, or failure to collect money add significant strain on your operation, because your costs remain consistent whether you’re collecting money or not.
This is why it is critical that you understand what cash flow is, why it’s important, and how you can best manage it in your own trade business, to ensure healthy profits and longevity in business!
So, what is cash flow?
Let’s start with what cash flow ISN’T…
A lot of contractors make the fatal mistake of confusing cash flow and profit.
Profit and cash are NOT the same thing.
Profit is the difference between what you sell and what it costs you to deliver your products and services (it’s the leftover after all your businesses expenses have been accounted for).
Cash flow on the other hand, is the net amount of cash and cash equivalents flowing in and out of your business at any given period of time.
In order to have healthy cash flow, more money needs to be coming in than it is going out in a business.
Why is it important to have healthy cash flow?
Simple.
Having a negative cash flow (more money going out than coming in) will mean that either your business isn’t profitable and is losing money… or your business has poor timing of income and expenses (it’s all about balance).
That said, having negative cash flow doesn’t automatically just mean that your business is unprofitable.
If your negative cash flow is caused simply by poor timing, then a positive net profit is still possible.
This, however, isn’t always guaranteed.
This is why healthy cash flow is important.
If it’s negative, you likely don’t have cash to support your operations and your business.
If an unexpected expense comes up, you won’t be able to cover it.
Whereas positive cash flow allows you to cover costs without the stress, re-invest in the business, take on different projects, ensure the business is profitable, have a healthy cash buffer and so on…
Is cash flow different in the trade and construction industry?
Operating in the construction industry means operating in chaos… with so much money flowing in and out among every client, contractor, or supply chain.
With so many factors to consider, such as budgeting, paying bills on time, paying cash for assets, and needing to pay employees for labour-intensive work almost weekly, any slight miscalculations or problems can greatly impact cash flow (and your sanity).
In some instances, we’ve worked with clients on payment terms originally at 90 days…
This poses a big problem as a construction company, because you may have needed your client’s payment to pay your subcontractors for their labour, and your suppliers for the materials and heavy equipment prior to receiving payment for the work.
In other instances, clients have originally worked with much smaller payment terms, but have been terrible at collecting money…
Late receipt of payment from your clients can result in your business having to borrow money elsewhere in order to pay suppliers and workers or spend money that actually isn’t yours (this is a dangerous path).
And that’s why it’s important to stay on top of your cash flow, forecast as well as you can, and be proactive with your money flow both ins and out.
Note: If you’re unsure how to plan and prepare for cash flow, Trade Business Accountants can assist you, click here.
How do you improve cash flow?
With so many variables at play, here are 10 ways to improve your trade businesses cash flow:
1. Build better relationships with your clients.
While most clients generally do have the best of intentions, sometimes they can get side-tracked or end up neglecting their payment obligations.
You need to focus on building stronger relationships with your clients to ensure you’re collecting money owed to you in a timely manner, and also, to know whether or not they’re financially capable of paying you the agreed amounts on time.
Note: If it’s larger clients, you should cross-check references from other contractors that have already worked with your potential client prior to engaging them.
2. Make sure that you’re pricing for profit.
The idea that EVERY client is only interested in price is a FALSE belief that contractors often convince themselves of to make up for a lack of effective marketing and selling.
Most people don’t want cheap, they want a bargain.
Price will always be a consideration, but at the end of the day, it’s only ONE consideration.
If you have nothing else to offer than price, that is what your customer will fixate on.
This is important when pricing for profit.
And pricing for profit is something EVERY trade business owner should be doing. You shouldn’t be pricing jobs just to win them and be busy, you should be pricing jobs to win them and MAKE money.
Know your costs, consider all elements of the jobs, and mark up accordingly for a strong and healthy margin.
3. Conserve your cash.
Reserve cash through maximising supplier payment terms for material and equipment and financing (rather than cash purchases) on hand to be able to handle expenses and continue operating effectively.
4. Forecast your cash flow.
Cash flow forecasting means estimating the cash incoming and outgoing across all areas of your business over a period of time.
This will help you estimate the future growth capacity of your company, so that you can plan and budget better for both the short and long term.
To ensure accuracy of the expected future income and expenses, it’s best to monitor your forecast on a monthly basis.
5. Look for the best prices and control building costs.
If you want to be financially efficient and savvy, so that you can save more and spend less, you need to be responsible with how much you spend for your materials and equipment.
This means having conversations with existing and new suppliers (you should feel no obligation to be loyal to any one supplier – they may take advantage of you).
Take the time to canvas and look for great bargains and discounts.
One of our roofing clients contacted another supplier to their usual for a recent project and was able to save $30,000 in materials alone!
Always make sure to compare quality versus price across different sellers of the materials or equipment you need.
And also look for the best deals available, and learn how to negotiate prices and terms where possible… you can negotiate!
6. Plan and take progress claims.
Stage payments are often done every month when an agreed stage of a project has been completed.
Wherever possible, it’s best to plan your payments around every stage, so that subcontractors and suppliers are paid in accordance with progress payments.
7. Be firm when asking for payment.
Delayed payments will lead to cash flow problems (i.e. you may be expecting to receive a payment that you will in turn use to pay bills).
You need to be firm when asking and collecting money because your business and livelihood is dependent on it!
So, have all the documentation ready when payment is due, and submit it to the right people to avoid any delays.
Speak up when you know that the payment is due for completed and signed off work.
And remember, the squeaky wheel gets the oil.
8. Avoid accepting variations when possible.
Variations can seriously mess up the careful planning put into maintaining a positive cash flow.
If you can’t avoid them, make sure to stay on top of all the change orders and insist that clients contribute to the cost UPFRONT – this is the key.
Make the clients sign off on all variations and agree on a date where they can no longer make any changes.
We’ve unfortunately seen many contractors end up on payment plans with the ATO as a result of larger clients not honouring commitments around variations.
9. Create a system around quoting.
Given that there’s a lot of monitoring needed to ensure a positive cash flow, you can’t keep track of all of the prices and data if you don’t have a proper and effective system in place.
You need an effective pricing system (job management software ideally) as this will ensure that you can best estimate and track your profitability before, during, and after a job or project.
This data can also be put into a cash flow spreadsheet, but if you want something more user-friendly and convenient, invest in cash flow software.
10. Be time efficient.
PLAN. PLAN. PLAN.
You need to be organised so that all your work can flow without interruption.
Plan each stage to avoid any delays in work completion, and have the materials ordered early, so that they will be delivered at the right time.
Doing this helps your cash flow, so that no equipment or materials take up space or tie up working capital that you can use more productively.
It will also ensure that delivery of materials will not cause any delays in the construction process (let’s face it, poor planning leads to poor results).
So, in order to make sure that there’s more money flowing in than out, you need to plan ahead and find ways to ensure that you always have cash on hand for future costs and that you’re always paid on time.
If you're an electrician, plumber, painter, carpenter, or any other tradie business owner who is looking for assistance with your tax, accounting, and bookkeeping - click here to learn more!
