5 Common Financial Management Mistakes In The Construction Industry

 

 

 

 

1. Not understanding your costs and how to allocate them

Understanding and allocating costs for a building project is the starting point for any quotation, estimate plus agreed changes as the work progresses and without knowing your costs in detail, working out your profit margins becomes impossible. Incorrect pricing cannot be easily corrected on the job as you have a contract and negotiations with a client to consider. A starting point for gaining an in-depth look at costs and having control of your profit structure is to look at your three main financial statements

  • Balance sheet: your business’s financial position at a moment in time.

  • Profit and loss, or income statement: which shows your financial performance within a particular period.

  • Cash flow statement: Recording money coming and going out for a particular period — like your bank statement, but with insights into patterns and/or problems.

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Taking time out to fully understand these documents gives you an insight into whether your profit structure is sufficient to rely on and whether you are properly allocating expenses to associated jobs. 

For example, are you taking into consideration expenses such as equipment depreciation, administration expenses, rents, and leases?  Costs for each project should be meticulously accounted for to be able to analyse profits. Without paying attention to allocation of costs you may not be able to work out if the whole contract has been profitable. This is based on data and your understanding of that data and how it is applied. If you are not sure where to start, consider asking your accountant for some help and guidance. 

 

2. Working without documents

While this does not sound like a financial management mistake, it is fundamental to establishing the parameters for your costs and profits.

From your point of view as the contractor, the document should;

  • Include detailed scope of work,

  • Gives you time to work out your pricing and

  • Schedules expected payments and how invoicing will happen.

  • It provides a formal process for documenting changes as the work progresses to ensure additional work is costed accurately and carries the same profit margin as the rest of the job.

  • It will set out your guarantee as to workmanship and set the standards for the contract. 

  • It should also include what happens when material costs increase during the work, and a good contingency coverage.  Missing these details can result in the business bearing the costs. 

  • The contract or agreement should include a guarantee and warranties on the work, plus

  • Liability insurances

  • It set the standard expected from both parties – a matter of good faith and the worth of this is the references you receive and the ‘word of mouth’ marketing for your company which comes from a good client experience. Ensure that you also have the right clauses so that your business gets paid.

From the client’s point of view:

  • It provides a structure, 

  • a payment schedule 

  • a progress schedule 

  • a reference point when things do not go to plan

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3. Invoicing Late

Making sure your invoices are sent as close to the schedule as possible is a good way to reduce financial risk, plus getting invoices paid without undue delay.  Late invoicing impacts your payments to your employees and suppliers, who cannot wait until the invoice has been met for their payments to proceed.  Timely invoicing just needs restructuring to a good processing system and is a straightforward way to improve cash flow in your business and reduce any financial risks.

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4. Holding insufficient cash reserves

By the nature of the construction industry, you will have to meet labour and material costs for the first few months of a job, or more often for longer.  This means your cash reserves must be sufficient otherwise alternative means of raising cash have to be sought. Delayed payments and loan costs can result in a risky environment, this should be avoided if possible.  Minimising delay in payment is another reason to avoid late invoicing but a better solution is to request a deposit on a project at the starting point.  If this is a formal arrangement in the documentation, most clients are happy to release 25% at least for start-up costs.

 

5. ‘Robbing Peter to Pay Paul’

Use of money from one project for costs incurred on another is the result of not paying attention to project planning and quoting.  It can often occur when one project is delayed for some reason and another is started halfway through, so that income is applied to expenses for the second job, while the first languishes.  This can result in neither job progressing and at the risk are not only the projects but also your client relationships.  The solution to this problem starts in the preparation of your quotation or estimate, by implementing a rolling forecast which should ensure that invoices early in the job correlate to work achieved and later in the job reflect a contingency to manage and eliminate the need to ‘rob Peter to pay Paul’.

 

Remember:  In any industry, but particularly the Construction Industry, there is always room to learn a better approach and when you share your concerns with a business professional such as an accountant or a business advisor, they will help you implement better systems, and make strategic adjustments to maximise profits, while reducing business risks.

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