Managing construction finance is probably one of the most challenging things a contractor or Developer can do in their business. There is an entire industry based solely on bookkeeping and accounting for construction. And many contractors are struggling to manage it themselves because their expertise is in building and not in the financial part. That is why I developed this quick guide to highlight some important strategies to handle construction finances.
Plan your project
The first thing you have to do before even considering construction finance having a strategic plan for your project from the beginning. This starts with having an accurate construction estimate and a good project management team.
The most critical part of managing your construction finance is going to be preparing accurate budgets and estimates. We highly recommend you use digital takeoff software to estimate the quantities and then use a spreadsheet with pricing, or use a reputable construction estimating services company to handle your estimating.
Design your project as to specific as possible before starting
As mentioned above, make sure your Architect creates the most detailed drawings possible finalizing those permit drawings. If you are the General Contractor or the Subcontractor, make sure you read through all the plans and highlight any inconsistencies and issues you find to the Architect before starting. It becomes a mess when you need to ask for more money later on and they don’t have it in their budget. Again, this will mess up your financial plan.
The difficult part of the construction is coming up with the money to finance the project. If you are the developer, you might need to get a commercial bank loan or residential bank loan. If you are a General Contractor or Subcontractor you might need to get some capital from a credit line.
There are small loans available with government programs like the SBA so take a look at them.
Credit lines are a great method to fund your project in between payments. If you are in the commercial side of construction, many General Contractors and Developers do not pay anything upfront. So, you must have funds to cover labor and materials for usually up to 90 days. A credit line essentially is a revolving credit amount very similar to a credit card that you can use for short term financing on your project. I’m not a big fan of debt for projects, but if you have a solid contract, you don’t have to worry too much about the nonpayment of your credit line because you were the pretty much-guaranteed payment. The one word of caution for credit lines is that many companies have taken too many projects and overextended their credit line, and many have gone out of business because they take too many projects and can no longer finance them. Just make sure you have an accounting team overseeing your numbers.
Suppliers figured out that if they can offer terms with their payments where you can pay later, they can make a lot more money in construction. When ordering materials, try to avoid COD terms because this will eat up a large amount of your cash. Instead look for a NET 30, 60, and even 90 terms. There is even a special type of term in construction called 60 days next. Suppliers invented this after realizing that contractors submit their billing at the end of every month, and there is typically a two-month wait before getting a check. So now they will bill you at the end of the month with 2 to 3 months to pay. Some suppliers and even offer discounts for paying early. On small projects, it doesn’t make a big difference, but when you’re dealing with thousands of dollars of invoices, 5% is a lot of money.
Use a Schedule of Values to receive and make payments
A challenge many contractors face is receiving the correct amount of payment for the work performed and paying the right amount for the work performed by your Subcontractors. The solution is to use a Schedule of Values when you submit your billings, and when your Subcontractors submit their billings. A Schedule of Values as a detailed breakdown of how you will be billed for the job on a percentage of completion basis. Essentially you just create a breakdown of all the important milestones on the job so that at the end of every month you can bill the estimated percentage of completion for each line. This avoids a back-and-forth with the order on how much work is completed.
My favorite topic to teach clients is about Change Orders. Essentially when you are asked (or required) to perform any work or provide any materials outside of your agreed contract, this comes with additional costs. Many contractors are afraid to bill for change orders because they think it’s going to affect their relationship with their client, but COs are common practice in construction. The issue is when there is price gouging. When bidding a project, you know you have to bid low to be competitive, but when it comes to change orders, you are already on-site and don’t have any competition. We typically recommend to charge aggressively and bill aggressively with change orders. An old boss of mine once told me “Change orders are the lifeblood of this business”. It’s common to see 15-20% in Change Orders based on your contract value. This is critical if you’re going to have a well-financed job. Don’t do work for free.
Bill a large amount upfront
Try to bill as much as possible upfront or in your first billing because it often takes, like I mentioned earlier, 90 days to get paid for your work. If you start a project at the beginning of January, you don’t submit your billings until the end of January. It is then reviewed by the General Contractor, then the Architect or Owners Rep, and if there is a bank involved, then the bank reviews too. Once the bank approves and issued the check, it is typically mailed so you lose a few days there, then it’s held for a few days by the owner while he finalizes his paperwork, then it goes to the General Contractor where he holds it for a few days while he finalizes his paperwork, and finally, they mail it to you or you lose a few more days while it’s in the mail. And if we are going to be very technical, when depositing checks that are in the tens or hundreds of thousands, the bank typically takes longer to clear them. So, I add all these days up and it could be up to 90 days before you see your first payment cleared in your bank. That is why I say to the invoice as much as you can upfront before even starting or submit a lot in your first invoice.
Use Project Management and Accounting Software
My last tip is going to be to use software specifically for construction to manage your projects. And specifically, apps with mobile features so you can run your projects in the field. According to Small Design Ideas, 71% of the internet is mobile already. In our office we use Corecon, but you can use Procore, Builder Trend, and any other similar software to manage your projects which includes the financial part of them. For the accounting part, I highly recommend QuickBooks or any similar platform that allows you to bill by the percentage of completion. If you handle this part well, you are going to have all your payments in order and your finances will run smoothly.
Managing construction finance can be a challenge, especially if your specialty is in building not in finances or in building a business. I highly recommend hiring a professional to help you manage this as this is an entire industry all by itself. Use these suggestions to help you manage your finances and construction and you’ll be successful.
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