The construction industry comes with a number of financial challenges. This is due to upfront labor costs, long project timelines, and a lot of materials. Despite the lucrative nature of construction, many financial challenges can impact your company’s bottom line. Below you will find the top 7 common financial mistakes of construction companies.
Top 7 Common Financial Mistakes of Construction Companies
1. Failing to Document:
The construction industry is by nature very hands-on. Even though the industry involves a lot of hard labor, the formalities of business are still necessary. This includes documenting everything. One common financial mistake construction companies make is failing to document additional work, changes in plans, and extra costs. Even though many of these changes are discussed verbally, it is imperative to put everything in writing. Doing this regularly can create a lot of extra work and impact your projected profits.
Avoid this mistake by creating effective project processes to ensure documentation is second nature to everyone involved. Begin with a detailed scope of work and require any change to be made in writing and signed by both parties. This can easily address the issue and ensure you maintain all of your profits.
2. Late Invoices and Monthly Draws
Construction projects often have invoice submission deadlines for the monthly draw from the bank. Missing this deadline can result in having to wait until the next month to receive payment. This results in having to front certain costs, which can increase the risk of financial issues.
Avoid this issue by creating a scheduled system for invoicing and monthly draws. If you cannot optimize this process, consider outsourcing some of your financial tasks. Indevia affordable outsourced accounting solutions can help you stay on schedule and save you the headache of late invoicing every month.
3. Issues with Costs
The construction field has a variety of different costs. Labor, materials, equipment, and administrative staff are just a few of the costs to complete a project. A construction company should have a clear idea of the costs in great detail. Without this, you could lose a lot of money and risk the overall profit projections.
Avoid losing money due to a failure of understanding the details of the construction project. Depending on the size of the construction company, you’ll need staff skilled in accounting and finance. A skilled accounting firm can help form processes that work for your company and ensure your finances are organized and up-to-date.
4. Improper Cost Allocation
Most construction companies are working on multiple projects at once. This can be a lot to juggle financially, but it is possible. Many construction companies misallocate costs which impacts each project’s profit margins. Oftentimes companies will have overall profitability. However, each individual project may not be profitable. Ensuring that each project remains profitable can improve your overall bottom line.
Avoid this by hiring the staff necessary to ensure each project and your overall profits align with your company’s financial goals. It is worth the investment to hire a team skilled in bookkeeping for construction companies. Not only are they skilled in finance, but they are also aware of the unique challenges of the construction industry.
5. Issues with Fixed Costs in Bid Contracts
Due to market fluctuations, many contractors add the ability to adjust material prices in the contract. This is due to the volatile market fluctuations that have been very clear recently. Sometimes bid contracts will have fixed costs without the flexibility to account for market changes. This can result in major financial issues depending on the initial budget.
Avoid this mistake by including language in your service contracts that allow for flexibility based on the market. You can also include a clause that states that market changes regarding the pricing of materials will be invoiced to the customer.
6. Lack of Cash Reserve
Since construction companies have to front all of their labor and material expenses, a large cash reserve is necessary to maintain financial stability. Sometimes it can even take up to a year to see any form of payment for a construction project. This requires a large cash reserve and many companies fail to account for how much they actually need.
There are a couple of ways to address this issue. Many contractors ask for a 25-50% deposit before starting a project. This can help reduce the amount your construction company covers upfront. Another option is to negotiate with vendors. You can try and extend the billing cycle, or negotiate paying once the project is complete. Work with your financial team on finding a strategy that can help curb company cash issues.
7. Messy Financials and Front-Loading
Front-loading occurs when construction companies use money received by one client to pay for the costs of another. This can get really messy very quickly. This can often happen due to an issue with the amount of cash reserve.
Avoid this mistake by planning the project out in advance. Work closely with a financial professional to ensure that all costs are accounted for and that you can take on other projects without having to mix project payments and funding.