Strategic CFO, Bradford Pack, discusses the 7 most common financial challenges faced by construction companies.
With long project times, sizable material orders, and upfront labor costs, the construction industry often faces a variety of financial challenges. Below are some of the top financial challenges and mistakes we see construction companies facing.
1 – Doing Work Without Documentation
One common financial mistake construction companies make is doing additional or changed work without documentation.
The construction industry is very hands-on, meaning a lot of decisions and changes are made on the field based on a quick conversation and a handshake. All too often, that additional work doesn’t get documented through a formal change order before the work is done.
If the change does make it to the office for documentation and invoicing, it’s common for the pricing to have already been negotiated on-site and invoiced without formally crunching numbers. This often results in little to no profit for the extra work. The result of these undocumented changes is an added cost to the contractor that may or may not be billed in the end.
Why it’s an issue: Undocumented changes or changes that have invoiced at a loss can mean reduced profit margins or even a loss on a project.
How to fix it: Construction companies can fix this financial issue with a better set of processes to facilitate mid-project changes. It starts before the project begins with a detailed scope of work and is supported by a detailed change-order process. This process should be designed to allow time for the contractor to put together pricing—instead of shooting from the hip—as well as documenting project changes and sending them to the finance team for invoicing. This document should be signed by both the contractor and customer before the additional work is started.
2 – Invoicing Late & Missing Bank Draws
Many projects have invoice submission deadlines for a monthly draw from the bank. If you miss the deadline, then it may not be until the next month before the invoice can be submitted to the bank and paid.
Why it’s an issue: Just because your invoice hasn’t been paid on time doesn’t mean your workers and vendors are going to wait for their money. If late invoicing has become common practice in your company, you’re likely having to front or float costs until the invoice is paid. This not only increases your financial risk, but also means you have less cash on hand to put back into the company.
How to fix it: Late invoicing is often the result of lax reporting systems, a lack of communication from the field, or an overworked financial department. Consider consulting with an outsourced CFO to determine where systems can be improved for more timely invoicing and optimized cash flow. Many financial issues related to cash flow in construction companies can be resolved by restructuring a few key financial processes. However, if your processes are optimal and you believe the issue lies in an overworked financial staff, you may consider hiring a part-time bookkeeper or financial controller to help balance the workload.
3 – Misunderstanding Costs
One of the most common financial mistakes in the construction industry is not having a clear understanding of costs. A construction company should have comprehensive knowledge of down-to-the-detail costs. This includes not only materials and labor, but equipment and administrative costs as well. Without this understanding, projects may be incorrectly priced, leading to jobs that are ultimately destined to be money losers.
Why it’s an issue: Without in-depth knowledge and processes surrounding costs, you can’t have an educated view of your profit structure. You’re likely bidding some jobs too low, losing out on some projects you’ve bid too high, and may have undiscovered adjustments that, if made, could maximize profits across the board.
How to fix it: The best place to start is to look at your income statement. Are expenses being properly allocated to the associated jobs? Are there any costs that aren’t accounted for? Do you have a method for factoring in expenses such as equipment depreciation, administrative expenses, or property rentals? If you’re not sure where to start, consider consulting with a CFO advisor.