Cash flow is a common challenge faced by small businesses. It’s particularly tough for small construction companies — those with 20 or fewer employees — which typically have a difficult time making sure their income and expenses align.
It’s great if a small construction company can get an initial deposit and have a clear progress payment schedule. But then they have to wrestle with immediate and ongoing expenses associated with each job that can be difficult to manage. To top it off, many small firms don’t have a full-time person managing their construction finances.
I’m familiar with these small business challenges on a personal level. My father once ran his own construction company. Growing up, I came to know many people in the business and their struggles with financing.
My father, Henry DeNicola, is now retired. But from 1989 to 2015, he ran Excell Builders. The small construction firm had about 15 full-time employees at one point and completed a variety of residential and commercial projects in the San Francisco Bay Area.
Here’s an interesting and, to me, impressive fact about my father’s career as a small business owner: he ran his construction firm without ever taking out a loan.
Now, that doesn’t make my dad unique, and self-financing isn’t the only way, or even necessarily the best way, to run a construction company. But his experience provided important insights into what it takes to be successful in the construction industry.
Construction finance tips to help your business
1. Create a Plan Before You Start
Planning is important for any small business. It is critical for small business owners in the construction industry. There are simply so many moving parts in construction that you need to map out a strategy before getting started. And each of those moving parts can entail major expenses if there’s any type of unexpected development that causes a delay or setback.
“Proper pre-construction planning is arguably the most critical project phase any owner can undertake,” says Brandon Hurd, managing director at Hurd Construction Management, a general contractor and construction management company. “Unqualified schedules, scopes, specifications, and particularly budgets are recipes for legal and financial disasters.”
“A solid footing and foundation is necessary for any project to endure the project lifecycle and series of changes likely to occur whether by owner request, construction codes, or other local regulatory requirements.”
2. Know When Each of Your Expenses Will Hit
Construction costs are generally separated into hard costs and soft costs. Hard costs are anything that’s directly related to the physical construction, including materials and labor. Soft costs are everything else — including permitting, engineers, taxes, insurance, fees, and interest on loans. They may even include ongoing expenses, such as maintenance or insurance after a project is completed.
Both hard costs and soft costs could come due at various points throughout a project. Knowing when each you’ll have to actually pay each expense could be the difference between a smooth job and getting caught short-handed in the middle.
Here’s one example of a hard cost: “Your subcontractors may ask for a deposit to kick off — maybe the plumber needs to order supplies,” says Nicole Landau president of Landau Consulting Solutions, who offers outsourced CFO and accounting services to construction companies.
“A good and appreciated general contractor imposes on themselves rigid criteria of paying subcontractors without delay,” says DeNicola. Therefore, the hard-cost for labor might be an immediate concern when you start a job. “But your expenditures for materials (another hard cost) can be arranged to be delayed for a period of time.”
Soft-expenses, such as premiums for insurance policies, can take a big bite out of your budget if you pay them annually. However, some of these soft expenses might be overlooked during job-specific planning. “When you’re doing your cash flow, make sure those are filled out and projected,” says Landau.
3. Always Budget a Contingency Fund
Just like with any small business, things can go wrong for a construction firm. But again, you need to keep in mind that mistakes in construction can be costlier than in other industries.
“There will be times when something goes wrong, and there should be a line item in your budget or estimate to cover that,” says Landau. If you’re taking out a loan to finance a job, the lender may require you have a contingency fund. In some cases, it will actually hold onto the money and only disburse it to cover the cost of an emergency or change order.
If you’re self-financing, you’ll need an initial fund to get started and pull from during an emergency. That’s what my dad did. “Most of the clients didn’t pay until 30-, 60-, or 90-days later,” he told me. “Once I was established, I could weather ups and downs… Many of my jobs were for in the $300,000 to $1 million range and I was comfortable if I had $50,000. That would put me through the rough spots.”
4. Ask For Deposits
State or local laws may limit how much of a deposit you can accept, but generally, you can receive a deposit along with progress payments for your work. Getting a deposit can be crucial for managing cash-flow during the early parts of the job, but some business owners are hesitant to ask.
“One of my clients was asking me daily for the cash balance as they were floating day-to-day. He didn’t want to ask his clients for a lot of money upfront, but once he changed his mindset of getting a larger deposit his cash flow was much more manageable,” says Landau. “He is now able to pay vendors faster. Most importantly, he is once again confident in his business.”
5. Resist the Temptation to Overspend Early
While the deposit can help you cover costs, try not to go overboard at the onset. This is a point my dad stressed: “Contractors get a check for a lot of money, and somehow that translates into them thinking they have a lot of money. They miss all the costs that are associated with the payment.”
If you’ve already forecast your weekly, monthly, or longer-term cash flows for the project (and your overall business), it could be easier to avoid a cash crunch later. “When I got money, I always looked at what I had to spend the money on in the future and what I had already spent money on,” dad told me. “I never got to the point where I had to spend money I didn’t have.”
6. Use a Separate Account for Each Job
Glenn Amerson, president of FGC, Inc., a Florida-based general contractor, says using separate checking accounts helps him stay on top of his finances. “When you have one bank account with all of your jobs’ payables and profits coming in and out, overspending happens,” says Amerson. “Each project needs to have a separate checking account, so you’re not mixing and matching money.”
Separating the finances for each job helps him allocate the money from a progress payment to the subcontractors, overhead, and profit for that job. You could create a similar system on paper while keeping your money in a single account. Either way, Amerson says, “the key is to make sure you have enough money in the pot for payables.”
7. Find Creative Cash-Flow Management Opportunities
Although he didn’t take out loans or draw on a line of credit, my father did take a creative approach to finance some of his expenses. For example, he lined up the timing on credit accounts from suppliers and his business credit cards.
Here’s how he explains it: “You can acquire materials on April 2nd. The bill from the supplier will arrive on May 1st and is usually due by May 30th. You can pay it with a credit card on May 28th. The bill from the credit card will arrive on June 27 and will be due by July 24th. That is almost 4 months after you acquired the materials.”
The details and arrangement can vary depending on the supplier, your terms with suppliers, and whether you have a large enough credit limit on your business cards to carry the expense. If you’ve built business credit, you may be able to get even longer terms with suppliers to spread out your payments. But it can also be risky. Mistimed expenses, clients paying late, or a lack of backup funding could leave you with high-interest credit card debt.
Factoring your invoices could be another option. When you work with a factor, you can receive an advance on 85 to 90 percent of your outstanding invoice amounts. You’ll then get the rest of your invoice amount, minus the factor’s fees when your client pays the invoice.
8. Understand Your Books Before Looking for Financing
If you’re not self-financing your jobs, you’ll need to look for funding from one or more outside sources. Bank loans, particularly from local banks that understand the area, may offer construction loans, but you could also look for funding from construction-specific lenders, private groups, lending exchanges, and state or federal programs, according to a report by the Korte Company.
“It’s not a bad thing to shop around and diversify your portfolio with different banks,” says Landau. However, you’ll want to clearly and accurately present your business’s financial situation and be prepared to answer lenders’ questions.
“Digging into the balance sheet is going to be very important,” says Landau. “Either have someone in-house that can understand it, or outsource the work to someone who can clean it up before you go to the bank.” Based on her experience, she says construction companies can get a line of credit based on cash flows and projections, but being able to present your entire financial picture is helpful.
9. Nurture Your Banking Relationships
It can take months or years to secure financing for a large job. Even if you’re working on a smaller scale, or already have your financing lined up, you may want to keep an open dialogue with different banks and lenders.
“Maintaining banking relationships is really important,” says Landau. If you hit a snag and need extra money, having a relationship in place could be important to quickly securing financing. Or, if you’re tapped out and get the opportunity to bid on a great job, knowing you can get financing could be the difference between being able to bid with confidence or having to pass.
10. Know That Your Personal Finances May Be on the Line
When your business takes out a loan to finance a project, you (and your partners or financing group) will likely have to sign a personal guarantee for the loan. Meaning, although the project and loan may be in the business entity’s name, you agree to repay the loan from your personal assets if the project doesn’t go as planned.
Additionally, you and your partners may have to open your books and give the lenders an overview of all your assets and liabilities to secure a loan.
11. Consider Outsourcing Some of The Financial Work
My father readily admits that he’s “a person who became a businessman,” rather than someone who desired to be a businessman. And he built his business so that he didn’t have to be especially involved with the financing world.
Many construction companies need to rely on financing if they want to succeed. It’s part of their plan or a requirement for managing their cash flow. However, that doesn’t mean the owner wants to — or has the time to — take on the financial management tasks
Hurd says you might be able to benefit from hiring a construction manager early on. “For a nominal amount of money they can provide you objective data and opinions for analyzing if you’re financially ready to undertake your project.”
Bringing in someone with financial expertise could also help you secure funding. “If the business owner is doing the sales and a lot of the behind-the-scenes work, it can be beneficial to have someone who speaks the banking language,” adds Landau. “The expert can present different data and may be able to get a larger line of credit with better rates.”
This post originally ran on the BlueVine blog here and is published here with permission from BlueVine.
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