Think of cash flow from the basic contractual level: You do the work, send the invoice, and wait for the payment to arrive according to the 30-day or other expected timeframe. Meanwhile, you keep on working and spending cash out of your own pocket. But what happens when, for one reason or another, the project manager delays sending an invoice? Now your cash flow cycle is extended, with the potential for cascading effects. But how do you measure the impact? In this article, we’ll explore how contractors can use the S-curve model to calculate cash flow, and the cost of delays, in construction project management.
Communication problems hinder cash flow management
Having the right internal infrastructure to properly manage cash flow and billing isn’t limited to the systems that produce the information. Internal controls and timely communication between project management and accounting are just as important.
Smaller contractors in particular are often led by owners and managers with a limited background in accounting, and a small accounting team.
In the case of larger contractors, challenges may arise from precisely the opposite situation. While they have a structured and sizable back office, they often find that lack of cross-department communication can cause delays and inefficiencies in areas such as change orders, billing, and collections.
The S-curve: Visualizing project cash flow for faster decision-making
To prevent the situation from getting out of hand, it’s important to be aware of such delays, and respond to them, as quickly as possible. Having a visual representation of the job costs and AR invoicing can help you do exactly that, enabling stakeholders to make better and faster decisions. Tracking project performance over time visually can be solved in the form of a line graph with an S-curve.
An S-curve is a simple yet versatile data visualization which shows the progression of a construction project in any time interval: daily, weekly, or monthly.
The reason this graph is called an S-curve is because projects start slowly, ramp up during project delivery in the middle, then slowly end as the project closes out, forming the “S” shape. This model can track and compare specific metrics over time, like production progress against the planned schedule, actual versus budgeted costs, or costs against project progress.
A cash flow S-curve will show the timing and movement of cash as the project progresses with the actual timing when payment is due.
In this article, we are exploring the use of an S-curve to analyze project cash flow, but this framework can actually be used to visualize almost any aspect of a construction project. If you want to see other uses in action, check out this YouTube tutorial on building an S-curve to model cash flow forecasts from Spencer Burton, a real estate investment director in Dallas, TX.
Example of S-curve for project cash flow
Here is an example of an S-curve showing a month-over-month view of project costs, billings, and receipts on a construction project:
Red Line: Actual job cost spending trend line
Black Line: Contractor invoices submitted (flat line indicates no invoice was sent)
Green Line: Payments received
White Space Between Black & Green: Cost the company is carrying
On a construction project, the gap between invoices and payments is expected to be wider due to industry-specific factors like retainage, since that money is withheld until a future date. If you continue the S-curve model out until retained funds are collected, you should see the invoice and payment lines meet again.
The S-curve can be used as a learning tool for teaching, and as a training opportunity for construction PMs and any other users, with a focus on helping them better understand project financing. Having this curve will show the direct impact of missing an invoice, calculating cost burdens, and understanding the dollar amount of financials charged against the line of credit.
Profit erosion happens very subtly over the course of a project. As a result, aligning the data the PMs and accounting department view will make sure “the squeaky wheel gets the grease” to safeguard the profit margin.
As noted by Dr. John Killingsworth, a construction management professor at Colorado State University, your PMs should be proactively working with your accounting team on improving AR aging.
“Cash is more expensive than a line of credit,” Killingsworth says. “If the return-on-asset is north of 10% vs a line of credit at 5%, you’re missing out on the opportunity cost of using cash to expand into new markets, grow the business, and develop into a stronger organization.”
3 cash flow lessons in S-curve modeling
Balancing job costs against cash flow is a neverending battle for many construction businesses. The S-curve model provides several lessons that contractors can apply in general to improve their cash position.
Regardless of how small the PM thinks the invoice is in relation to the contract, inconsistency can create more significant problems for the company. Overlooking smaller invoices thinking, “I’ll just wait for next month,” can de-emphasize the importance of cash flow.
Getting into a habit of consistency will create a more efficient billing cycle. When project owners receive the invoices at the same time of month they’ll develop the habit of timely and consistent payment.
Consistently following up on invoices should be a best practice at the company. Start by asking simple questions like “Did you receive it? Does it meet the standards?” and “When are you coming to the jobsite?” This makes sure that other stakeholders know you’re there for them. You need to have those conversations to ensure transparency and steady improvement.
Use S-curve models to put construction cash flow to the test
By starting with something as simple as an S-curve, you can set in motion a virtuous cycle in which you assess your current billing practices, advise PMs and other project stakeholders to adjust their behavior, and, ultimately, roll out tools, systems and best practices that raise standards and drive higher project and company performance.
The post Using the S-curve Model to Track Construction Project Cash Flow appeared first on Levelset.