What Payment Priorities Tell You About Your Construction Cash Flow
When a project is nearing the finish line, cash flow turns into a flood. Subcontractors, inspection fees, final deliveries of (expensive) fixtures and finish materials…it all comes due at once.
Should you prioritize payments or just pay invoices as they come in? Accountants who specialize in real estate and construction say that it’s smart to have a structured approach.
First, don’t confuse cash flow with profits, says Aaron Partridge, a shareholder with the construction practice of Doeren Mayhew, a Troy, Michigan-based accounting firm. Money in the bank is not the same as money you get to keep when all the bills are settled.
It’s too easy to let the final payment for one job ride, as you postpone a last visit to complete the punch list, because you’ve moved on to the demanding start of another project. “Contractors get in trouble when they front-load payments, and don’t track outstanding bills,” says Partridge.
Partridge recommends “staying in front of the client in terms of cash flow. Start with 30 percent or 50 percent down, and maintain your cash flow ahead of the customer. By the time the job is complete, you want about 90 percent of the payment complete. You don’t want to be fully complete with the job with the customer owing you 70 percent.”
And be sure to overlay each project’s projected cash flow with your company’s cash flow. Plan to pay insurance premiums, quarterly taxes, marketing costs, vehicle maintenance and other predictable expenses when big project bills are not due.
If you have invested in capital equipment, ask your accountant about depreciation and other write-offs that can minimize quarterly tax payments and free up cash. It’s also smart to analyze cash flow patterns (by year and type of project) and review your findings with your accountant to see where small adjustments can smooth out fund availability.
As projects progress, invoice promptly so you aren’t pressing customers for payment on the spot. It’s tempting to let the paperwork ride, but customers appreciate prompt billing as well to help them manage their own cash flow.
Final payments often are delayed because of holdups with occupancy permits and addressing touch-ups and making small fixes. Compile a punch list and review it with the customer at each point in the billing cycle so that small items don’t accumulate. A lengthy punch list can involve costly visits from subcontractors, scheduling headaches and even small, high-cost orders of additional or replacement materials. Each item on the list delays the conclusion of the job and the final bill.
When it’s time to cut checks, start with vendors that offer early-payment discounts, says Stephen Nelson, a Redmond, Washington CPA with his own firm, flag vendors that offer an early-payment discount. That saves you money, of course (and note how that early-payment discount puts them at the top of your list: Could early-payment discounts do the same for you with your customers?).
Nelson says that the point of payment is a moment of truth with vendor and subcontractor relationships. Nobody wants to be penalized by someone else’s cash crunch and prompt payment builds loyalty and referrals.
The opposite is also true, delayed payments and excuses erode credibility and undermine your reputation with each affected subcontractor and supplier – and probably their circles of influence too.
“If you can’t pay bills when they’re coming due, then by definition you’re undercapitalized,” says Nelson. If you chronically find yourself running short of cash, “think about downsizing your business,” advises Nelson.
Joanne Cleaver is a widely published freelance business author, writer and former deputy business/real estate editor of the Milwaukee Journal Sentinel. She and her husband have renovated three historic homes.