Strategies to Manage cash flow for a construction company during a Recession

Updated: 18/06/2024

Executive Summary:

Table of Contents

• BENEFITS OF MAINTAINING CONSISTENT CASH FLOW
• APPLICATIONS OF CASH FLOW IN CONSTRUCTION
• CURRENT EVENTS
• WHAT DOES THE FUTURE HOLD FOR CONSTRUCTION?
• COMMON CASH FLOW ISSUES FOR CONSTRUCTION COMPANIES
• WHAT’S THE PLAN?
• IDENTIFYING EARLY SIGNS OF CASH FLOW PROBLEMS
• UNDERSTANDING THE CYNICAL NATURE OF CASH FLOW
• TIPS TO IMPROVE CASH FLOW MANAGEMENT
• WHAT CAN CONTRACTORS DO TO PROTECT THE CASH FLOW FOR A CONSTRUCTION COMPANY DURING THE DOWNTURN?
• WHAT IS FREE ISSUING?
• WHAT IS GOOD DESIGN MANAGEMENT?
• HOW CAN CONTRACTORS DIVERSIFY + WIN NEW BUSINESS?

Effective cash flow for construction company management is crucial for them to navigate economic downturns and maintain operational stability. Cash flow projection reports serve as strategic roadmaps for financial decision-making, helping to identify potential cash flow issues early and ensuring the availability of adequate funds.

Defining Cash Flow and Projection Reports: The cash flow for a construction company refers to the movement of money coming in and going out. Managing the cash flow for construction company accounting ensures the availability of funds, which is essential for procuring materials and labour without interruptions to the project schedule.

A cash flow projection report forecasts the cash outflow on a construction project over a certain period, estimating when and how much money will be needed. These reports help in planning and strategizing, allowing all project stakeholders to anticipate future financial obligations and prepare accordingly.

BENEFITS OF MAINTAINING CONSISTENT CASH FLOW

Maintaining a positive cash flow for a construction company is essential for the operational efficiency and financial health of construction projects.

Top Benefits:

1. Cash flow for construction company to Pay for Labor and Materials: Ensures timely procurement and payment for essential project resources.
2. Improved Financial Planning and Forecasting: Enables accurate planning and resource allocation.
3. Stronger Relationships with Stakeholders: Timely payments build trust and reliability with subcontractors and suppliers.
4. Credibility with Lenders: Consistent cash flow for a construction company improves the likelihood of securing financing.
5. More Operational Efficiency: Efficient cash flow management supports smooth project execution and growth.

Applications of Cash Flow in Construction:

• Cash Flow Statements: Formal financial documents that track the flow of cash in and out of the business over a specific period.
• Cash Position: The amount of cash that a company has on hand at any given moment. Monitoring cash position is crucial for construction firms to ensure liquidity for daily operations and unexpected expenses.

Current events:

Currently, the construction industry is facing significant headwinds.

Painfully long lead times, expensive materials, cost-constrained clients, and a recession make the hard job of construction even harder.

Data from Credit Safe shows that the total number of UK company insolvencies for 2022 rose by 27,219. This represents a 37% increase compared to the same period in 2021.

Construction companies represent ~17% of these insolvencies; that’s 4831 construction businesses.

WHAT DOES THE FUTURE HOLD FOR CONSTRUCTION?

The truth is no one knows the future, but there is some guidance to help assist in commercial decision-making.

2022: Despite the uptick in insolvencies, 2022 saw construction output increase by 5.6% (compared to 2021). This rise was driven by new work (+3.8%) and repair and maintenance work (+8.5%).

2023: The Construction Products Association (CPA) initially predicted that construction output will decrease by 4.7%. Decline in construction output. However, as the year progressed, the forecast was downgraded multiple times, reflecting a more severe contraction. By spring 2023, the CPA projected a 6.4% decline, and by summer, this had been further adjusted to a 7.0% decline. The primary drivers for this downturn included sharp falls in private new housing and repair, maintenance, and improvement (RM&I) sectors, exacerbated by economic challenges such as high interest rates and falling real incomes. Additionally, delays in major infrastructure projects contributed to the negative outlook.

2024: The CPA also predicts that construction output will recover by 0.6% in 2024. However, subsequent revisions have slightly adjusted this figure. The summer 2023 forecast expected a 0.7% growth, while the autumn 2023 forecast revised this to a marginal fall of 0.3%. By winter 2023/24, the expectation was for a 2.0% rise in 2025, influenced by anticipated economic recovery and falling interest rates, which should ease challenges in the housing and RM&I sectors.

2025: The Construction Products Association (CPA) forecasts a modest recovery in the UK construction sector starting in 2025. After a challenging period marked by significant contractions, construction output is expected to rise by 2.1% in 2025. This recovery is anticipated to be driven by stronger UK economic growth, real wage increases, and lower mortgage rates. In particular, the private housing sector, which faced severe declines, is projected to see a 5.0% growth as mortgage approvals and property transactions begin to rise. The private housing repair, maintenance, and improvement (RMI) sector is also expected to recover, with output rising by 3.0%, supported by energy-efficiency retrofits and solar photovoltaic installations​.

2026: The CPA predicts further growth in 2026, with construction output increasing by 3.6%. This growth will likely be supported by a continued economic recovery and potentially lower interest rates, which should bolster confidence across various construction sectors. The infrastructure sector, in particular, is expected to benefit from ongoing major projects such as HS2, Hinkley Point C, and additional initiatives like offshore wind farms and National Grid upgrades. However, the forecast for 2026 carries greater uncertainty, especially considering the potential impact of a new government following the general election in 2024. Changes in public sector spending plans and infrastructure project deliveries could significantly influence the construction industry‘s performance.

COMMON CASH FLOW ISSUES FOR CONSTRUCTION COMPANIES

Construction companies often face cash flow challenges due to the nature of their work and payment cycles.

Common Issues:

• Delayed Payments: Clients often delay payments, creating cash flow gaps.
• High Upfront Costs: Covering upfront project costs can strain cash reserves.
• Supply Chain Disruptions: Sudden price increases or material shortages can impact cash flow.
• Overhead Expenses: Managing high operating costs requires careful cash flow management.
• Project Delays: Delays can lead to late payments and additional expenses, affecting cash flow.

By addressing these issues proactively, construction companies can maintain a healthier cash flow.

WHAT’S THE PLAN?

The outlook is challenging but not catastrophic. As we move through 2024, the strategy for most construction businesses in 2025 will focus on leveraging the anticipated economic recovery. This will involve making strategic investments, improving operational efficiency, and staying adaptable to policy changes and market conditions. Identifying early warning signs and implementing key strategies, such as calculating ideal working capital, sending invoices promptly, incentivizing early payments, and accepting electronic payments, will be crucial for maintaining a healthy cash flow for a construction company and positioning businesses for growth

IDENTIFYING EARLY SIGNS OF CASH FLOW PROBLEMS

Construction companies must be vigilant in identifying early signs of cash flow problems to avoid project disruptions and financial strain.

Early Warning Signs:

• Slow Payments from Clients: Delays in client payments can significantly impact cash flow for a construction company, leading to potential cash shortages.
• Material and Equipment Shortages: Shortages can delay project timelines and increase costs, straining cash reserves.
• Overhead Expenses: High overhead costs, such as rent and utilities, can deplete cash reserves quickly.
• Inaccurate Budgeting: Poor budgeting can lead to unexpected expenses and cash flow issues.

By monitoring these signs, construction companies can take proactive measures to mitigate cash flow issues.

Understanding the Cyclical Nature of Cash Flow:

Understanding the cyclical nature of cash flow is essential for construction project management. Cash flows typically follow a pattern throughout the project’s lifecycle, from the initial phase to the post-construction phase. Anticipating these cycles helps in budgeting, financial planning, and resource allocation.

Best Practices for Cash Flow Projection Reports:

1. Gather Expertise in Schedule and Budget: Projections should be prepared by individuals with a thorough understanding of both the project schedule and budget.
2. Create a Layered Approach to Reports: Generating reports at various levels provides nuanced financial insights, aiding in strategic planning and resource allocation.
3. Regularly Update Reports: Continuously updating projections ensures alignment with the evolving project scope and schedule.
4. Use Integrated Project Management Systems: Implementing such systems enhances efficiency and accuracy in cash flow projection reports.
5. Track Cash Flow Forecasting Variance: Regular comparison of forecasted cash flow with actual figures helps maintain projection accuracy.

Align Cash Flow Projections with the Schedule of Values: Ensuring that projections align seamlessly with the schedule of values helps in accurately determining future cash flow requirements. Timely adjustments in projections reflecting changes in project scope ensure an accurate depiction of the project’s financial health.

TIPS TO IMPROVE CASH FLOW MANAGEMENT

Implementing effective strategies can help construction companies maintain a healthy cash flow.

Key Strategies:

1. Calculate Ideal Working Capital: Determine the working capital needed to cover short-term expenses.
2. Send Invoices Promptly: Expedite the billing process to ensure timely payments.
3. Incentivize Early Payments: Offer discounts for early payments to improve cash flow.
4. Market Smarter, Not Harder: Focus on cost-effective marketing strategies to attract more clients.
5. Gain Better Visibility to Cash Cycle: Use accounting software to track and manage cash flow accurately.
6. Accept Electronic Payments: Streamline payment processes with online payment options to speed up cash inflows.

 

WHAT CAN CONTRACTORS DO TO PROTECT THE CASH FLOW FOR A CONSTRUCTION COMPANY DURING THE DOWNTURN?

Despite the UK technically avoiding a recession, 2023 & 2204 both may still feel like one.

By all accounts, neither 2023 or 2024 have been anythig like 2008 and will be further distinguished by the fact that goods, services and energy will remain expensive despite a decline in demand.

This means that traditional ‘belt-tightening’ and cost cutting won’t work. At least not in isolation.

There are many innovative ways to manage cash flow for construction a company that can reduce cashflow bottlenecks, reduce cost and position themselves to grow faster than ever in 2024.

We’ve identified three areas/practices which can help contractors achieve this.

• Free Issuing
• Good Design Management
• Diversify + Win New Business

WHAT IS FREE ISSUING?

‘Free issuing’ refers to building components or materials supplied by the client to the contractor to install.

HOW DOES FREE ISSUING HELP DURING A RECESSION?

We will fully explore this practice in future blogs, but there are several benefits to free issuing:

• It reduces pressure on the contractor’s cash flow.
• It focuses on the client.
• It reduces procurement, programme and lead time risk for the contractor.
• It can create a new revenue opportunity.

WHAT IS GOOD DESIGN MANAGEMENT?

Not to be confused with CDM (although they are interconnected). Good Design Management, from a contractor’s perspective, starts during the tender stage and is the most cost-effective way of reducing construction risk, and unintended construction costs.

Put simply; design management means managing the design process in a way that reduces risk to the project and contractor. It takes many forms but tends to focus on the following areas:

• Site risk: Managing how the design of the project interacts with a particular site.
• Procurement risk: This covers everything from subcontractor selection to specification.
• Construction risk: This covers everything from constructability to third-party agreements and health and safety.
• Change control: This is the management of post-contract design changes (common during a recession).

HOW DOES GOOD DESIGN MANAGEMENT HELP DURING A RECESSION?

A significant proportion of additional construction cost is created by poor design management. The ability to manage the design and its associated risk pays dividends in several ways:

• Contractors are able to avoid ‘problem projects’ that are likely to overrun and possibly cost you money.
• Contractors are able to win more tenders by demonstrating mastery of the project information.
  FYI: We wrote a 4-part blog series on how to gain an edge during the tender process, here.
• React more quickly to changes in the client’s investment/development strategy, e.g., extreme value engineering, or programme acceleration.

HOW CAN CONTRACTORS DIVERSIFY + WIN NEW BUSINESS?

The answer is a shift from new build to repair and maintenance.

The Office of National Statistics (ONS) has shown that last year’s 5.6% increase in construction output was driven by growth in repair and maintenance work, up 8.5%.

New work only increased by 3.8%. 

Excluding 2021, this was is the largest annual growth for R+M (repair and maintenance) since records began.

The ONS graph below shows that since 2020 R+M has been growing as a proportion of all construction work.

A more detailed analysis (ONS table 1 below) shows that the majority of the R+M growth is taking place in private housing (+21.4%) and non-housing (+19.6).

The ONS defines Repair and Maintenance as:

“work, which is either repairing something which is broken, or maintaining it to an existing standard. For housing output, this includes repairs, maintenance, improvements, house/ flat conversions, extensions, alterations and redecoration of existing housing. For non-housing, this includes repairs, maintenance and redecoration on existing buildings, which are not housing, such as schools, offices, roads, shops.”

Granular data on the exact characteristics of the repair work is elusive, but there is a strong probability that the growth in R+M can be attributed to:

• The £300BN Energy Efficiency Upgrade/ Retrofit Revolution. We wrote a blog series on how contractors can take advantage of this generation opportunity, here.
• Office landlords converting existing offices into homes, due to low occupancy. Data from the Department for Levelling Up, Housing and Communities showed that 2,119 bids were made in 2021 to use permitted development rights to convert offices into homes.
• People working from home are investing the money they would have spent on commuting and leisure into adding value to their homes. This trend started in 2020 (due to covid) and has continued. In 2020, covid forced the UK public to save an additional £140Bn.

HOW DOES DIVERSIFYING AND WINNING NEW BUSINESS HELP DURING A RECESSION?

Recessionary and inflationary environments change consumer and commercial spending habits. People cut back and focus on essentials, but they don’t stop.

Subsequent recessions have shown that demand for repair and maintenance work increases as demand for new build work declines. 2024 is no different.

Repositioning your construction business to take advantage of this shift will keep the cash flowing during the lean times and supercharge revenue growth during recovery and boom.

HOW IS C-LINK HELPING CONTRACTORS COPE WITH THE DOWNTURN?

C-Link is working with leading construction businesses to streamline their most resource-intensive, time-consuming activity, estimation and sub-contract tendering.

On average C-Link is saving main contractors up to 900 man-hours per project. (300 man hours during competitive tender and 600 man hours during sub-contractor tendering and management.)

If you’d like to discuss how C-Link can help you do the same drop us a note here.

If you’re not ready but if you’re intrigued, why not check out our platform?

About Martin Prince-Parrott

Martin is an ESG Real Estate Developer and former Award-Winning Architect. He’s spent the last decade designing and developing a billion-pounds worth of mixed-use institutional-scale real estate. He’s worked with and for market-leading companies such as Gensler, Microsoft, Barratt Homes, Legal & General and Barclays Bank.