How to Calculate Construction Company Cash Flow

No matter what kind of company you are running, cash flow is a constant concern. After all, paying bills is an important consideration for everyone, and paying bills requires cold, hard cash. Even borrowed cash affects your bank balance at some point. As cash enters and leaves your bank accounts, it is counted in the company cash flow. Let’s look at how cash flow is thought about, how it is calculated, and how it is important.

Cash Flow, explained

In a nutshell, cash flow is the amount of money that enters and leaves a bank account over a given time period. Depending on your choices, it can be calculated on a daily, weekly, monthly, quarterly, and annual basis. No matter how you measure it, however, the calculation methods need to be consistent. Cash flow is frequently represented in different types of reports generated by accounting software. It is also used to help banks and other financial institutions measure the ability of a company to pay its bills.

More specifically, cash flow is expressed as a positive, neutral, or negative number. When there is more money coming into a bank account over the reporting period than leaves it, cash flow is positive. If more money goes out than comes in, then cash flow is negative. Having just as much money leave as comes in results in flat cash flow.

Finally, let’s look at how cash flow can change over time. It is possible for cash flow to be negative during a single time period, positive later on, and neutral for a larger time period. In addition, cash flow can vary within different bank accounts for business entity or individual. This means that cash flow is a relatively changeable part of an entity’s financials. Nonetheless, cash flow is critical for all businesses, and any negative cash flow needs to be addressed promptly.

Cash Flow vs Profit and Loss

Another consideration with cash flow is that it is different from profit and loss numbers. That’s because profit or loss is the end result over a period of time, while cash flow only monitors the amount of money available for immediate use at any given time. This is true, because positive cash flow can be achieved through borrowing a lot of money, even if there’s no money left at the end of a project or reporting period. Borrowed money needs to be repaid with fresh cash, but before this happens it boosts the amount of money that’s available.

On the other hand, profits represent money that’s a more permanent part of cash flow. Until and unless the money is spent on expansion, investment, or other things like investor returns, profit doesn’t need to leave the bank account. Profit, likewise, can be kept for a long time if necessary. It can also be used to solve negative cash flow during lean times, such as a recession or when there are invoice collection issues.

Let’s look at this from the standpoint of negative cash flow or an operating loss. Negative cash flow can be caused by a construction company spending more money than it’s getting from a client, while also not borrowing money or withdrawing it from savings. On the other hand, the negative cash flow can be turned into a profit. This might happen if the client suddenly pays, an investment is made that allows for increased income, or a large debt payment results in less debt down the road.

Negative profit, also called an operating loss, differs from negative cash flow in that the loss is permanent. Typically, we don’t expect lost money to be recouped, though there are rare situations where this can happen. For instance, if a customer goes bankrupt because they’ve borrowed too much money, then you might get some cash back from the trustee. Or, you might get lost money through the sale of a home after a mechanic’s lien is placed. However, these moneys are usually just added to the current P&L or cash flow figures. They don’t really change the past, though they might alter the taxation picture for the year in which they occur.

Calculating Cash Flow for a Project

Now that we understand what cash flow is, what it is not, and how these numbers can change, let’s look at actual calculations. In construction companies, cash flow is usually considered both at a project level and a corporate level. This helps to identify areas in which the company is profitable, and how to tweak cash management strategies. That might include borrowing, billing, or other options.

Typically, a small to medium sized construction company doesn’t have a different bank account for each project. Instead, they’ll have a general operating account, a savings facility, and sometimes a payroll account. Larger companies might have divisions, each with their own set of accounts. This means that cash flow for a project can’t be gauged just by looking at the bank statements every month. Instead, the inflows and outflows need to be associated with each project.

The easiest way to do this is through project management software. Here, you’ll enter each bill, overall expense, money borrowed, and customer payment into the specific project ledger. If a bill represents expenses spread out over multiple projects, then the project “share” should be charged to the project “account.” One of the bigger examples of this is with overhead. Renting out your business premises, hiring the bookkeeper, paying down debt, and maintaining equipment are something you’ll do each month regardless of what projects are running. You should be including this “share” of the overhead in the estimate for each project. The beauty of project management software is that much of this work is automated, and they’ll even give you cashflow reports.

Another way to calculate cash flow for individual projects is by using spreadsheets. In this case, you enter each expense related to the project, as well as the actual cash received in connection with the project. This can involve borrowed money or the financing of your materials purchases. Likewise, expenses include loan repayments. There are several examples of spreadsheet setups for this purpose on the Internet. As with the project management software approach, you’ll need to enter the project’s share of overhead costs into the expense side to get accurate results.

Finally, let’s talk about taxes. If you’re trying to determine if a project is profitable, or if it has long-term positive cash flow, you need to deduct a share of the taxes. Here, we mostly mean the business-level income taxes, which will be paid later on. In other words, this is cash which will remain in your account for months after the final client payment. However, it’s money you’ll need to pay out later, so you need to take it into account with planning.

Calculating Cash Flow for a Whole Company

For a whole-company cash flow report, you will consider all types of cash inflows, as well as all outflows. Cash flow calculations are deceptively simple: cash in, minus cash out. However, as with project-based cash flow reports, you must include everything. Unlike project-based reports, these numbers encompass everything in the company.

To that end, calculating the cash flow for a construction company requires looking at the corporate balance sheet. Let’s assume a monthly report for illustration purposes. Over the course of a month, you will have the following expenses: materials purchases, office rent/mortgage, vehicle lease/purchase, payroll, maintenance, subcontractor invoices, credit card or installment payments, and (frequently) taxes or fees to a government entity. At the same time, you may get loan proceeds, fresh charges on the credit card, client interval payments, rent from a subtenant, project deposits, and withdrawals from savings.

Once the inflows and outflows have been completely added up, you can get an overall cash flow number. This will be positive, negative, or neutral. The important thing to remember is that cash flow is expressed in terms of all cash that comes in, minus all cash that goes out. It doesn’t matter if the money is borrowed, brought in from savings, or a result of paid client invoices. Likewise, cash out for these purposes counts loan payments and taxes, not just project-specific expenses.

Let’s turn this theory into a bunch of numbers. Most construction companies, unless they’re just starting out, has more than one project running at the same time. Therefore, there will be expenses and payments related to each project, plus the overhead. For the sake of argument, we will assume that the transactions for January looks like this:

What does this table show us? For one thing, it shows that you can have negative cash flow on some items, while also maintaining positive cash flow overall. Some items here, like the investments, are pure negative sides. However, most items have both inflows and outflows of some sort. In addition, I’m assuming for the sake of argument that the investment cost is coming out of that month’s income, which is rarely the case. Often, this will be a cashflow neutral item, because the money comes out of corporate savings. Alternatively, the cash can be loan proceeds, a form of income I also omitted. A share of this would later be added to the debt payment section for various projects. Why? Because in construction businesses the investments are typically geared towards operational efficiency. Or, they might allow for expansion, which will increase income over time.

Here’s the bottom line. Because cash flow measures only the money coming in and going out, without considering the source of the money, it mainly measures the extent to which your company can pay its bills. In addition, cash flow reports help a business see where a company is losing money, and where it is especially profitable. For instance, the rental income in the above table is a relatively low-cost income source. Only overhead and taxes come out of that sum of money, where overhead includes maintenance and management expenses. In addition, the income from rentals kept cash flow from turning negative because of the investment. Of course, an investment will likely not be made every month.

How Cash Flow for Construction Differs from Other Company Types

In construction, keeping cash flow in the black requires more effort than it does for many other industries, and there are several reasons for this. First, construction is an expensive business. It requires that companies expend a lot of money on materials, many of which are purchased before work can even begin. Plus, there’s the overhead cost of maintaining bulldozers and other equipment, which must be done consistently even if they aren’t being used. All of this costs a lot of money upfront.

Similarly, labor costs are often incurred before that first client payment. Unless you require a down payment, that is. In most jurisdictions, you have to pay employees and the payroll expenses on a consistent basis. Worse, construction clients have a bad reputation for paying very slowly. As a result, many construction companies have significant negative cash flow early on in a project. Often, they stay in the red for each project until right at the end.

At the end of the day, the difficulties surrounding construction cash flow underlines two things: the importance of knowing which projects have positive cashflow, and prompt billing. There are many ways to bill clients, and several techniques to boost timely payment. Each of these strategies help to keep cash flow more consistent, though it’s difficult to have positive cash flow at all times. At the end of the day, it’s critical to ensure that your strategies result in overall profitability for your company in the long term.