It’s easy to define construction cash flow. Cash flows in when you collect payments on jobs. Cash flows out when you pay your suppliers, subs, employees, and overhead expenses. Like every business, a construction-related business must have more cash flowing in than flowing out, or the business owner will be scrambling to pay bills.
Positive cash flow is critical for long-term survival for every business. A homeowner posted this question on our website that illustrates what can happen when a construction business fails:
I am starting the process of a kitchen remodel and am soooooo confused about all this mark up and overhead stuff. I have priced out all the individual pieces (cabinets, countertops, flooring, even electrical and plumbing). I know that I am paying for the contractor to organize and execute the project. I am paying for their knowledge and craftmanship…… My question is……will there be transparency in all the budgeting? Will I expect to see what they paid for the cabinets and what I am being charged? I know that contractors charge a certain percentage up but is that off of the at cost charges they get say on cabinets?? I have to say this is very confusing. Should I be able to ask for receipts from each item purchased from a vendor or from subcontractor work?
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I should have prefaced this with we had a contractor quit a recent project with it about %80 done. He just packed and left, sending us an email that said “This is to inform you that we have been asked to stop work on all projects”. Then came to find out many of the suppliers and subs were not paid (lumber supply, electric, painter, plumber). We contacted a lawyer but were told it would cost us more to fight than it was worth. We ended up making deals with several of them to reduce their charges because they knew we had gotten screwed. I don’t want to make the same mistake twice, but I don’t want to be a penny pinching pain in the ars for our next contractor either. Any suggestions or good sources for the home owner would be appreciated.
When a homeowner selects their contractor based on price, that contractor almost always doesn’t have enough money in the job to pay their suppliers and subs, let alone meet payroll and pay themselves for physically working on the job. That’s a construction cash flow problem. To make up the deficit they use funds from the next job to pay bills on past and current jobs. When the stream of available cash finally dries up, the last client loses. This homeowner was the last client.
I told the homeowner that their contractor likely left the job because they were in debt because they didn’t charge enough for their work. I also gently said that they were asking the questions a “penny pinching pain in the arse” would ask.
It’s always painful to hear about a contractor who suddenly leaves a job and walks away from their bills. I believe most construction-related business owners fall into four categories:
A-list contractors run their business like a business. They’ve learned how to estimate their work. They know to how to calculate the markup their business needs to survive, and they use that markup every time. They recognize when a client might be a problem, like those clients looking for the lowest price, and they let another contractor who doesn’t know better take those jobs.
Their contract is detailed enough to protect both them and their client. They won’t make changes without a change work order. They do what they promise: starting and finishing jobs on time, communicating with clients in good times and bad, and paying their bills on time so their clients don’t have to worry about liens.
Construction cash flow is seldom a problem for A-list contractors because their price is what they need to pay for all job costs, cover their overhead, and set aside a reasonable profit.
B-list contractors operate like a business most of the time. They do many things right but still fall into the trap of lowering their price when pressured. They trust customers to do the right thing, so they don’t always get signed change work orders before making a change and sometimes that bites them. Their contracts aren’t detailed, and their payment schedules are often poorly structured leaving them with occasional cash flow problems (ie, not enough money in the bank to pay their bills).
Many B-list contractors, when they get tired of losing money or getting taken advantage of, tighten up their business practices and become A-list contractors.
There are more A and B-list contractors today than 20 years ago when our book Markup & Profit; A Contractor’s Guide was first published. Our goal has been to see more contractors succeed. We’re making great progress, but there are still way too many C- and D-list contractors around.
C-list contractors run their business like a hobby, sometimes making a living, sometimes losing money. They want to run an honest business. They want to quote a fair price to their clients, but they don’t know how to estimate the work and they have no idea what their markup should be. Because they aren’t confident in the price they quote, when a homeowner begins to push for a low price, they give in. They focus on what is fair to the homeowner, not what is fair to their business.
Cash flow is always an issue with C-list contractors. If they’re married, their spouse’s income is a necessary means of support because the business income isn’t dependable.
D-list contractors are the ones you read about in the news. They are either con artists or complete flakes. I’m convinced these are a very small minority of contractors even though they get the most attention.
C-list and D-list contractors almost always are the lowest priced contractors. My guess is that this homeowner hired a C-list contractor, someone who knew how to do the work and wanted to do the right thing, but they didn’t know how to price their work and it all caught up with them.
Many C-list contractors find help and learn how to estimate their work and calculate their price. They change their business practices and become A- or B-list contractors. Their cash flow improves when they stop trying to be the lowest price contractor and instead work with clients who understand the importance of hiring a quality contractor who will stay in business. If they don’t, they eventually go out of business, almost always deep in debt.
Pricing jobs correctly is the first step to positive cash flow. Calculate the markup you need based on your overhead expenses and your profit needs. Estimate the cost you’ll incur to build that job, then apply your markup to that estimated cost and that’s the correct sales price. That price will provide enough money to pay all bills for that job, as well as your overhead and profit needs.
The industry is different today than it was twenty years ago, and so are our clients. Many building owners are beginning to realize that contractors aren’t hired hands; they’re professionals who are providing a service and deserve to be paid accordingly.
When you find a prospective client who’s fussing about how much you’ll be paid or how you price your work, walk away. You need to make a fair profit on every job. If your client wants to decide how much profit is fair, or if they insist on being educated on the details of your business finances, let another contractor take the job. Operate like an A-list contractor. If you need help, let us know.
Related Articles:
- Building a Successful Construction Business
- Calculating Markup
- Why Do You Need a Written Construction Contract?
- Use the Right Payment Schedule
- Change Work Orders
- A Minimum Price
- Making the Numbers Work in Construction
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations.
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