How to Calculate Cash Flow in Construction

A construction company’s financial health greatly depends on a positive cash flow. Without proper cash flow management, it can be difficult to maintain liquidity, pay vendors, fund ongoing projects, or achieve long-term success.  

A 2022 McKinsey study of 500 global construction companies found that, on average, 52% faced delays and 79% dealt with cost overruns, showing that optimal cash flow management in construction can be difficult to achieve. However, by understanding the components of cash flow management and using the right accounting and financial tools, you can more easily manage it and ensure the financial health of your construction company. 

What is Cash Flow in Construction? 

Cash flow refers to the amount of money moving in and out of your business over time. It differs from profit, which is the amount of money your business makes after accounting for its expenses.  

In construction, you can calculate cash flow for individual projects, company-wide, or both. Cash flow plays a critical role in construction, as often, a project’s timeline depends on paying specific trades or vendors in a specific order. For example, you may need funds to pay electrical and plumbing subcontractors before installing drywall and flooring. Without a positive cash flow to pay for ongoing costs, you can face delays and a lower profit margin. 

Components of Cash Flow 

Cash flow consists of two types of flows: inflows and outflows. Inflows represent cash coming into your company and include all revenue and income streams — even progress payments from clients, construction loans, or money from selling company assets. On the other hand, outflows include all aspects that move cash out of your business, such as labor and materials expenses, loan repayments, equipment costs, subcontractor payments, and overhead costs. 

 Calculating Cash Flow  

To properly manage your company’s cash flow, you need to know how it’s calculated. This step involves forecasting your cash inflows and outflows. From there, you can determine your net cash flow. 

Forecasting Cash Inflows 

First, you’ll need to estimate the revenue and income your business expects, whether for a single project or company-wide over a specific period. You’ll also want to include client payment schedules and consider construction-specific elements that can impact your cash inflow, such as retention and change orders. 

Forecasting Cash Outflows 

To determine your total cash outflows, you’ll add all your anticipated expenses together. For construction companies, that means estimating your direct costs, such as labor (including overtime), materials, and equipment. You’ll also need to include Indirect costs from overhead and administrative expenses. Finally, if you have any construction loans, you’ll want to incorporate your monthly repayments or interest into your outflow calculation.  

Net Cash Flow Calculation 

To calculate your net cash flow, simply subtract your total cash outflows from your total cash inflows. The formula looks like this:  

Net Cash Flow = Total Cash Inflows - Total Cash Outflows 

For example, if your company’s cash inflows totaled $500,000 and your total cash outflow was $300,000, your net cash flow equals $200,000. This example has a positive cash flow, when cash inflows exceed outflows. If cash outflows are greater than inflows, you’d have a negative cash flow.  

A positive cash flow is preferred, since it ensures you can cover construction expenses, keep projects moving forward, and pay any bills. If your construction company has a negative cash flow, you may face delays in your projects or have trouble meeting financial obligations on time — all of which impact project profitability and your company’s financial health. 

Tools and Tips for Calculating Accurate Cash Flow 

Using the right tools and techniques makes calculating an accurate cash flow for your construction project easier. Here are a few to try. 

Construction Management Software 

Monitoring cash flow through construction management software, like hh2 and Sage, makes the entire process more efficient and accurate. Features like paperless invoicing and billing help streamline accounts payable and receivable, while data consolidation gives you a comprehensive view of your company, improving cash flow management. Plus, it offers real-time data synchronization and automated calculations, ensuring your cash flow calculations are current and accurate. 

Cash Flow Forecasting Models 

Stay ahead of potential cash flow issues by using forecasting models to predict short- and long-term cash flows, often included in accounting and business intelligence tools. This technique analyzes your cash flow over previous months, quarters, or years to identify trends and predict your cash flow in the future. You can also run scenario analysis to project cash flow under specific conditions or use stress testing to identify vulnerabilities in your cash flow. 

Integration with Accounting Systems 

Accurate cash flow tracking and reporting relies on access to current financial information. Tools that integrate with your existing accounting system allow for a seamless transfer of data. It’s more efficient than transferring financial data manually and reduces human error, so you can be confident that your projections are accurate. 

3 Best Practices for Managing Cash Flow in Construction 

Consider following the best practices outlined below for better cash flow management and business outcomes. 

1. Regular Monitoring and Updates

   Cash flow projections are only effective if they’re current. Make sure you’re making calculations with up-to-date information, and consider leveraging technology so your staff can access real-time data. Your cash flow isn’t static, so you need to regularly review it as your project progresses and make adjustments when needed.  

2. Efficient Billing and Collection Practices

   A slow or inefficient billing and collection process can lead to cash flow problems. To avoid this, send timely invoices once work is completed or specific milestones are met, and don’t be afraid to follow-up on overdue bills. Consider implementing strategies like payment plans or introducing new ways to make payments (such as online bill pay) to encourage on-time payments. You can also reduce the risk of late payment or bad debts by running a credit check on clients before getting into business with them. 

3. Managing Expenditures

   To improve cash flow management, you may need to assess and prioritize your costs, keeping only your most essential expenses (such as labor and materials). By delaying non-critical expenditures, like purchasing new equipment or reducing overhead costs, you can create a more positive net cash flow. You can also negotiate more favorable payment terms with your subcontractors or suppliers to help lower expenditures. 

Common Cash Flow Challenges in Construction 

Even if you follow best practices, you may face cash flow challenges. Identifying them and taking steps to reduce their impact will help you manage your cash flow more effectively.  

Dealing with Payment Delays 

Delays in payments from clients can negatively impact your cash flow. To reduce this problem, assess your billing processes and implement strategies to better manage payments. This step may include ensuring your billing terms are clear to reduce disputes, sending auto-reminders to clients when bills are past due, or offering clients more payment options. You can also consider utilizing credit lines or loans to help bridge gaps in your cash flow and secure your company’s liquidity. 

Handling Project Overruns and Change Orders 

Unforeseen costs from overruns and change orders can have a negative affect on your cash flow. Use historical data from past projects to estimate future project timelines and costs, and adjust your cash flow projections immediately after changes occur for more accurate forecasting.  

Maintaining Sufficient Working Capital 

Ensure you have adequate liquidity to cover your ongoing project costs by calculating your working capital. To do this, subtract your company’s liabilities from your assets. If your assets are much greater than your liabilities, consider building a cash reserve to access cash in case of emergencies or unexpected expenses.  

Make Managing Cash Flow Easy 

Staying on top of your construction company’s cash flow is essential for ensuring its financial health. The right tools, like hh2’s Construction Software, make this process even easier. Book your demo to see how hh2 helps improve visibility into your project's costs and manage cash flow.