Cash management is the act of organizing, planning, controlling the collection, investment, and disbursement of cash. In the construction industry, it is crucial to keep an eye on your company’s cash flow as well as the cash flow on your major projects. For that reason, acquiring a comprehensive knowledge of this process is essential to successfully manage a construction company. Successful cash management polices begin at the project level.
From the start to the completion of the construction project, it is important for management to be effective in terms of how they manage the cash to adequately fund project expenses, and to navigate the project to profitability. In each of the following stages of the construction project life cycle, decisions are made, actions are taken, and business practices are implemented that will ultimately determine your company’s ability to manage profitability and positive cash flow. Understanding the importance of cash management to a construction company, as well as the basic cash management fundamentals through the project life will allow you to improve your confidence when working with project managers, vendors, subcontractors, and owners.
The construction life cycle can be broken down into 5 sections with different attributes impacting the cash flow of the project and of the company as a whole:
1. Pre-Bid and Bid
Decisions made in this phase will impact Accounts Receivable, Work in process, Accounts Payable based on contract terms, and company business practices, and will ultimately determine project cash flow and profitability. Therefore, Credit Review of the potential customer and Contract Review of key contract provisions should be considered by the project or cash manager during this phase. It is important to develop a thorough understanding of key provisions that could impact project cash flow and profitability such as the payment provisions and financial record keeping requirements.
2. Contract Award
Once the contract is awarded, the company should perform a more intensive review and negation of terms within the contract in order to obtain more favorable terms to facilitate desired cash flows. Provisions to consider:
- Timing of payments
- Method of payments
- Penalty provision for not adhering to payment requirements
- Reporting and documentation requirements
- Allowable contract costs
- Performance penalty provisions
- Retention Terms
During the planning of the project, management should discuss the work paper flow. This can be done by establishing a Performance and Billing Schedule before the construction begins. This will put the owner on notice as what to expect. It is based on a schedule of values consistent with the company’s management and accounting systems which shows month by month the expected project to be put in place and what will be billed for. In addition to that, a Pre-construction meeting should be considered as it allows all involved parties to meet, discuss the project overview, and discuss reporting and documentation requirements.
4. Contract Performance
During this phase, all involved parties are working together in order to complete the project. This phase also encompasses the activities that will have either a positive or a negative impact on cash flow. The following processes impact cash flow most significantly:
- Contract Performance – Deliver of the project in accordance with plan and following performance and billing schedules will enhance cash flow.
- Contract Costing – Follow the schedule of values. Organization and minimization of errors is key. Also, successful negotiation with vendors and subcontracts may result in cost savings.
- Contract Billing – Bill in accordance with contract terms.
- Payment Tracking – Pay in accordance with contract terms
- Collection and Posting – Ensure the project manager assists in this process.
5. Contract Close Out
This last section of the project life cycle can be hazardous to cash flow in regards to collecting the final payment. Generally, if there are problems in regards to collecting payment, it originates from the fact that the customer is unsatisfied with the product or the management in charge during the project. Therefore, the company must seek to satisfy the customer by way of completing the project to their satisfaction level and in accordance with contract documents.
Though the above may seem rather simple and straight forward, construction companies often find themselves deviating from the basic fundamentals of cash management for a variety of reasons. The cash mangers ability to keep your construction company focused on the above fundamentals will be beneficial to the cash flow of the company as a whole. If you would like to discuss the cash management of your Company please contact one of the construction professionals here at Aronson for assistance and some insight into your company’s specific needs.