By James Nielsen,
Esq., CPA, founder and CEO of CreditSuppliers
This is the last in a three-part series of articles on construction financing that Masonry Design has planned with CreditSuppliers.
Construction has been dubbed a high-risk industry by lenders. While anyone working in construction will admit that there are certainly risks associated with being in the business, banks and credit card companies have given the field a bad name.
The reality is that these big companies do not understand the construction industry. Construction doesn’t have the same draw schedules or payment cycles that other industries have. Projects often involve multiple parties who need to be paid before they can pay their subsidiaries. In short, finances can get messy very quickly.
A few recurring challenges for construction pros are cash flow limitations, bad credit, low profit margins and cost overruns. After watching a number of contractors pull themselves out of the recession, it is clear that there are ways to overcome these financial roadblocks. These challenges have a common solution: reliable project financing.
Cash flow limitations
Cash flow is a common problem among contractors, no matter their specialization. The pay-when-paid model is antiquated — it is rare in other industries to see such a payment model. This payment cycle puts financial stress not only on the contractor but also on his suppliers, his employees and the sub-contractors on the project.
In the pay-when-paid model, contractors front project expenses with their own money to satisfy the monetary demands of the other parties working on the project. This practice moves all of the project risk onto the contractor and may limit his ability to start another project until he is paid, which can kick-start a never-ending cycle that will eventually inhibit business growth.
My advice is to utilize financing to increase cash flow. This may seem counter-intuitive, as there are always costs associated with third-party financing. But think about what you’d be able to do if you had the extra capital available to hire another employee who would allow you to work on two projects at once. You’ll make more money in the long run by making investments that push your company to grow.
Poor credit rating
Credit can stem from cash flow. If you do not have the capital available to pay for supplies on time, your credit rating will be impacted. Using financing to increase your cash flow can help you increase your credit. You’ll need to pay off your financing on time in order to reap the credit benefits.
In addition to paying your financing on time, pay suppliers as quickly as possible. You can often negotiate a discounted price for paying in full in a timely manner. Financing can provide a cushion that allows you to make these payments without further straining your working capital.
A higher credit rating can lead to more capital from your financing partners, which allows you to invest more money in growing your business.
Low profit margins
The recession was at its worst almost 10 years ago, but some businesses have yet to fully recover. Certain areas of the country are experiencing high levels of competition for construction projects, which can lead to very low profit margins.
Combat this by spending time perfecting your bidding process. Contractors often cut profit margins down significantly in order to submit a bid that comes in at the lowest cost. While it is a good idea to consider costs when bidding, it is important to take home a profit on a project.
Financing companies often look at your profit margins during the application process. The key is to maintain a steady flow of work in a variety of areas so your company shows a strong profit margin. When it comes time to apply for financing, this will help you win a higher financing limit.
No matter how your budget was prepared, there is always risk of a cost overrun. When a project budget does not account for last-minute changes or potential change orders, there is a chance that the project will be thrown into chaos if a major change is needed. Thoroughly preparing for each project will help you mitigate risk.
A line of project financing can help ease the effects of change orders. More capital allows you to be more flexible when it comes to adjusting for budget and project changes. Factor your financing into each project’s budget and make a list of potential change orders. Your finances should be able to cover the most expensive change order. This process may be unnecessary if a project does not go over budget, but it is important to consider multiple outcomes so you are ready to switch gears if needed.
About the Author
James Nielsen, Esq., CPA is the CEO and founder of CreditSuppliers. Nielsen combined his backgrounds in law, accounting, construction supply and venture capital to found CreditSuppliers, a financing platform that provides project funding to contractors and subcontractors. He earned his B.S. and master’s degrees in accountancy from Brigham Young University. He earned his J.D. at Arizona State University. He is currently a CPA and an active member of the Arizona State Bar.