Transcript:
An issue a lot of construction owners run into is that they’re financing their customers’ projects without realizing it.
For example, say your client’s draws are based on milestones, like the completion of drywall or electrical. You might be able to get a draw at that point. But if it takes you 60 days to reach and complete that milestone so it becomes a deliverable you can bill your customer for, then for those 60 days you’re providing free financing. You’re covering payroll, vendors, and subcontractors on your own.
That can lead to a lot of headaches if the cash coming in isn’t enough to pay your people. Vendors and subs start saying they won’t deliver more material or take on more jobs until you pay. As you know, that can create a huge bottleneck in the growth of your business.
As a home builder, even if you have a buyer for a property you’re developing, the cash inflow may not arrive as quickly as you’d like. Meanwhile, cash is going out for materials, subcontractors, payroll, overhead, and bidding other jobs. That timing gap between the cash you receive from customers and the cash you spend can come from the terms of the agreement you entered with the buyer, or it can come from the timeliness of your internal operations.
You might have completed a milestone that gives your business the right to invoice the customer. But if you don’t have systems in place to capture job costs promptly from credit cards, vendors, suppliers, accounts payable, and everywhere else, you might not be capturing all the costs you should be billing to your customer. So even though the milestone is finished, you might not bill it for another week, two weeks, or a month, depending on the efficiency of your operations. In the meantime, your business isn’t receiving the cash it needs to keep operating.
Another delay that can keep your company from receiving funds on time is incomplete supporting documentation. Many lenders require support for the costs that were paid out, whether that’s a materials purchase or a subcontractor invoice, before the buyer’s draw can be released from their loan. If your systems aren’t accurately capturing that documentation and you’re collecting it after the fact, instead of having it 100% ready the moment the milestone is complete, you’re delaying your draw package. That delays your company’s receipt of funds, and once again, you’re providing free financing to the buyer.
A couple of ways to manage and track this gap are through reports like your accounts receivable aging report and your work in progress (WIP) report. Your team should be reviewing these at least once a week. That way, your leadership team can take the necessary action to either upgrade your processes so the problem doesn’t keep happening, or put controls in place to ensure your project managers are following the processes your company has established.
Other areas to monitor are your budget vs. actual reporting and your WIP reporting. These let you track when costs are exceeding estimates. That can be a sign that a project manager made a verbal agreement with the buyer and the change order hasn’t been fully submitted or processed. If that’s the case, your back office isn’t capturing that cost during billing. It may get captured later, but in the meantime, your team is financing that cost at 0%.
A few ways to reduce the free financing you’re providing: first, you can update your contracts so there are more frequent milestones and more specific terms around the costs you know are going out.
