634: Financial Red Flags Your Construction Company Can't Afford To Ignore

This Podcast Is Episode 634, And It's About Financial Red Flags Your Construction Company Can't Afford To Ignore

As a construction bookkeeper, I've had a unique vantage point, watching countless projects unfold from the first bid to the final payment. While the hammers and blueprints are the visible signs of progress, it's the numbers behind the scenes that truly tell the story of a company's health. And let me tell you, those numbers often whisper warnings before they start screaming.

 

Small business owners in the construction industry are incredibly busy. You're juggling bids, managing crews, dealing with permits, and ensuring client satisfaction. It's easy for subtle financial warning signs – what I call "red flags" – to get overlooked until they become critical problems. However, ignoring these signals can lead to severe cash flow issues, stalled growth, and even business failure.

 

Based on what I've observed, here are five common financial red flags that you absolutely cannot afford to ignore, along with practical steps you can take to address them.

Red Flag #1: Constant Cash Flow Crises Despite "Profitable" Projects

This is the most puzzling red flag for many owners. You look at your profit and loss statement, and it shows a healthy profit. Yet, your bank account is always running on fumes. You're constantly chasing payments, delaying supplier invoices, or juggling funds to make payroll.

Why it's a problem: Profit is a theoretical measure of what you've earned over a period; cash flow is the actual money moving in and out of your business. In construction, where you often incur significant costs upfront (materials, labor for the first phase) and payments come in installments (often with retainage held back), it's entirely possible to be profitable on paper but cash-poor in reality. This constant stress impacts your ability to take on new projects, negotiate better deals, and even pay your team on time, leading to low morale.

How to fix it:

• Implement Robust Progress Billing: Don't wait until a project is 50% or 100% complete. Structure your contracts to allow for regular progress payments tied to specific milestones (e.g., foundation poured, framing complete, rough-ins finished). This ensures a steady stream of cash.
• Aggressive Accounts Receivable (A/R) Management: Send invoices promptly as soon as milestones are met. Have a polite but firm follow-up process for overdue invoices. Don't be afraid to make phone calls.
• Negotiate Favorable Payment Terms with Suppliers and Subcontractors: While you want to pay your bills on time, try to secure longer payment terms (e.g., Net 30 or Net 45) from your vendors whenever possible. This helps you collect from your clients before your payments are due.
• Manage Retainage Proactively: Thoroughly understand the retainage clauses in your contract. Track how much retainage is outstanding for each project and aggressively pursue its release as soon as the contractual conditions are met. This money is yours; get it!
• Build a Cash Reserve: Even a small percentage of profit set aside each month into a dedicated savings account can create a vital buffer for lean times. Aim for 3-6 months of operating expenses.

Red Flag #2: Consistently Inaccurate Project Estimates (Leading to Underbidding)

Do you frequently find projects ending up significantly over budget, eating into your expected profit margins, or even becoming a loss? Do you often need to inform clients about additional costs? This points directly to issues with your initial estimating process.

Why it's a problem: Inaccurate estimates mean you're consistently underbidding, leaving money on the table, or worse, taking on jobs that will inevitably lose you money. This directly impacts your profitability and, by extension, your cash flow, as you're funding the gap with either the cash from other projects or your capital. It also damages client trust when costs unexpectedly balloon.

How to fix it:

• Implement Detailed Job Costing: This is a non-negotiable requirement. For every project, meticulously track all expenses, including labor hours (with specific tasks), material quantities and costs, subcontractor invoices, equipment rentals, permit fees, and miscellaneous expenses.
• Learn from Past Projects: Conduct a post-mortem analysis after each project. Compare your actual costs to your estimated costs. Where were the discrepancies? Was it materials? Labor hours? Unexpected site conditions? Use these insights to refine your estimating formulas.
• Categorize and Standardize: Develop a comprehensive system of cost codes for materials, labor types, and activities to ensure accurate and consistent tracking of costs. This consistency makes it easier to track and compare data across projects.
• Build in Contingency: Always include a contingency fund (typically 5-15% of the total project cost) in your estimates for unforeseen issues, changes in material prices, or minor scope creep.
• Use Estimating Software: Even simple estimating software can help streamline the process, ensure all line items are considered, and integrate with your accounting system.

Red Flag #3: Uncontrolled Material Waste & Loss

Are materials constantly going missing or getting damaged on site, or are you consistently buying more than what was initially estimated? This is a direct drain on your project's profitability and your company's cash.

Why it's a problem: Every piece of wasted or lost material is money directly out of your pocket. It means you're paying more than you bid, leading to cost overruns. It can also cause project delays while you wait for replacements.

How to fix it:

• • Implement Strict Inventory Control:
  • Secure Storage. Designate secure, organized storage areas on job sites for materials when not in use or overnight.
  • Material Tracking System: For larger projects, consider a simple log or spreadsheet to track materials received and used.
  • Regular Site Cleanliness: A clean, organized job site naturally leads to less waste and makes it easier to spot missing items.
• Careful Material Handling: Train your crew on proper handling and storage techniques for various materials to minimize damage and ensure optimal safety.
• Accurate Take-offs: Ensure your initial material take-offs (the process of determining the quantities of materials needed) are precise to avoid over-ordering or multiple trips to the supplier.
• Return Unused Materials: Establish a process for returning unused, undamaged materials to suppliers for credit, where possible.

Red Flag #4: Inefficient Labor Utilization & Unaccounted Time

Labor is often the most significant cost for a construction company. Suppose your crews are standing around, waiting for materials, traveling excessively between job sites without proper tracking, or simply not as productive as they could be. In that case, your labor costs are likely to be increasing significantly.

Why it's a problem: Every idle hour or misspent minute costs you money. Inefficient labor directly reduces your profit margins and can cause projects to fall behind schedule, leading to client dissatisfaction and potential penalty clauses. Unaccounted time can also lead to compliance issues with wage and hour laws.

How to fix it:

• Accurate Time Tracking: Implement a robust system for tracking employee time. This could include mobile apps with GPS features, biometric time clocks, or even detailed paper timesheets, as long as they are managed in a meticulous manner. Ensure all hours (including travel, breaks, and specific tasks) are accurately recorded.
• Optimize Scheduling & Workflow: Plan daily tasks meticulously. Ensure materials, equipment, and instructions are ready before the crew arrives. Minimize downtime from waiting or searching for tools.
• Cross-Training: Train your crew members on various tasks. This provides flexibility and prevents delays if one skilled worker is absent or busy elsewhere.
• Daily Huddles/Toolbox Talks: Begin each day with a brief meeting to review tasks, identify potential roadblocks, and ensure everyone is aware of their role.
• Regular Performance Reviews: Identify bottlenecks or areas where productivity can be improved. Provide training or reassign tasks as needed.

Red Flag #5: Lack of Financial Visibility & Untimely Reporting

Are your financial reports always weeks or months behind? Do you rely on gut feeling more than actual numbers to make business decisions? Do you only look at your bank balance at the end of the month? This means you're flying blind.

Why it's a problem: Without up-to-date and accurate financial information, you cannot make informed decisions. You won't spot cash flow issues, cost overruns, or unprofitable projects until it's too late. This lack of visibility prevents strategic planning and proactive problem-solving.

How to fix it:

• Invest in Good Accounting Software: QuickBooks Desktop or Online, Foundation Software, or other industry-specific solutions are essential. They automate data entry, generate reports, and track job costs.
• Maintain Clean Books Consistently: Don't let your bookkeeping pile up. Enter invoices, payments, and expenses regularly, ideally on a daily or weekly basis. This provides a real-time picture.
  • Review Key Reports Regularly: Cash Flow Statement - Review it weekly or bi-weekly to track where your money is going and coming from.
  • Job Costing Reports: Review weekly to compare actual costs against your budget for each project.
  • Accounts Receivable Aging Report: Review weekly to see who owes you money and for how long.
• Work Closely with Your Bookkeeper: A good construction bookkeeper isn't just a data entry specialist; they are your financial partner. They can provide valuable insights, flag potential issues, and help you understand your numbers, enabling you to make informed, profitable decisions.

Identifying and addressing these financial red flags isn't about adding more burdens to your plate; it's about building a stronger, more resilient construction business. By taking proactive steps and staying on top of your numbers, you can turn those red flags into green lights for growth and lasting profitability. Don't let hidden financial issues undermine your hard work on the job site – empower yourself with clarity and control.

 

About The Author:

Sharie DeHart, QPA, is the co-founder of Business Consulting And Accounting in Lynnwood, Washington. She is the leading expert in managing outsourced construction bookkeeping and accounting services companies and cash management accounting for small construction companies across the USA. She encourages Contractors and Construction Company Owners to stay current on their tax obligations and offers insights on managing the remaining cash flow to operate and grow their construction company sales and profits so they can put more money in the bank. Call 1-800-361-1770 or [email protected]