In the construction business, cash flow is one of the most important elements for the success of any project. This is a key indicator that allows financial managers, cost controllers, and project management roles to monitor how accounting books and numbers are evolving in real-time.
Essentially, cash flow refers to how much money is coming in and going out of a company, as well as the speed at which that money flows. One of the main objectives of finance teams in construction companies is to achieve the right alignment between cash flow and the project schedule.
To achieve this goal, it is necessary to have a detailed plan that defines specific dates for making payments and collections. Additionally, it is important to consider the delivery deadlines for materials and labor, as well as important project milestones such as the completion of certain phases or the delivery of key elements.
In this article, we will discuss how professionals responsible for financial management in construction projects can make sure that the cash flow process evolves in a positive way.
Definition of Payment Schedule in Construction Projects
In construction project management, planning and monitoring of payments require very special care. The payment schedule is a timeline that defines payment dates to suppliers, subcontractors, and employees based on the project’s progress.
It is essential to have a well-detailed payment plan that specifies when payments will be made and how much will be paid at each stage of the project. The payment plan should also include any retentions that need to be held back until specific milestones are met or specific tasks are completed.
One of the main topics of concern when establishing a Payment Plan are how to schedule construction work certificates and upfront payments. These are documents issued by the project manager that indicate the status of the construction at a given moment. These certifications detail the progress made in the project and the percentage of completion. Payments to suppliers, subcontractors, and the in-house workforce are determined through certifications, which establish how much should be paid based on the progress made in the project.
How the payment schedule will develop should be previously discussed and agreed upon with all stakeholders involved in the project. When and how much is to be paid should be agreed upon at each stage of the project. It should also include any retentions to be held back until certain milestones are met or specific tasks are completed.
It is important to consider that the payment schedule should be flexible and subject to changes based on variations in the project’s progress and market conditions.
Policies for Advances and Retentions in Construction Projects
Upfront payments and retention policies in construction projects are quite common in the construction and building industry. Their objective is to guarantee contract compliance and mitigate financial risks.
When paying upfront is required, it means that the client is going to pay before the start of the project, in order to cover initial costs and make sure that the project canl be carried out. How much the client must pay in advance? It should be high enough to cover the initial costs but not excessively high, so it does not create a financial burden on the contractor.
On the other hand, retention is how much money will be withheld from the final payment to the contractor, in order to ensure compliance with specific requirements, such as quality control and proper delivery of technical documents. The retention percentage should be reasonable and clearly defined in the contract to avoid misunderstandings and conflicts.
Through financial management software solutions for construction projects, retention percentages to be applied can be established, as well as the timing and how are retentions payments to be released. In addition to this, an ERP platform helps to manage and track all money retentions, ensuring that they are paid at the appropriate time and form and are correctly reflected in the project’s financial statements.
Cash Flow Sensitivity Analysis in Construction
Cash flow sensitivity analysis in construction is a useful tool for evaluating the potential scenarios that could affect the income and costs of a construction project. Conducting this type of analysis helps to identify any risks and opportunities of the project. This is essential for making well-formed financial decisions.
Some of the factors to consider when conducting a cash flow sensitivity analysis include:
- Construction project overall time duration
- Fluctuations in construction material prices
- Changes in market demand
- Delays in the delivery of required materials or equipment
It is important to consider both internal and external factors that can affect the project’s cash flow.
To conduct an accurate sensitivity analysis, it is essential to have reliable and up-to-date cash flow data. Information on direct costs, overhead expenses, as well as income, and delayed or upfront payments, need to be collected. This way, different scenarios can be evaluated accurately for better financial decision-making.
Optimization of Capital Utilization in Construction Projects
Optimizing the utilization of capital in construction projects involves identifying and cutting unnecessary expenses, finding more efficient ways to carry out tasks, properly managing advances, and reducing payment time frames.
There are several methodologies for identifying and cutting unnecessary expenses in a construction company. Some of the most common ones include:
- Value-added analysis: focuses on identifying which processes or activities add value to the company and which ones do not.
- Benchmarking: involves comparing the costs, processes, tasks, and strategies of the company with those of similar companies in the same industry.
- Budget reviewing: this aims to identify areas where the company can reduce its costs without affecting the quality of products or services offered.
- Lean manufacturing: This methodology focuses on eliminating waste and optimizing production line processes.
It is recommended that all relevant employees from different levels of the company are involved in this process. This is highly important for identifying and cutting unnecessary expenses and ensuring that sustainable and lasting changes are implemented.
Financial Indicators to Evaluate Cash Flow in Construction
Some of the main financial indicators used to evaluate cash flow in construction include:
- Net present value (NPV): a financial indicator used to evaluate the profitability of an investment.
- Internal rate of return (IRR): measures the profitability of an investment over time and is used to determine if a project is financially viable.
- Payback period and net profit margin: The net profit margin is the percentage of profit remaining after all expenses have been deducted.
Some examples of specific financial indicators for construction include:
- Project profitability
- Working capital efficiency
- The success rate of sales proposals.
Good cash flow control allows project managers to make timely and effective decisions to keep the project’s finances in good condition and ensure its continuity. For this, it is essential to have a team of highly trained finance managers for construction projects.
If you would like to learn more about financial management, check out BrickControl’s comprehensive construction management features, such as accounting integration and construction project analysis.
