Managing cash flow is a huge challenge for businesses in the construction sector. Long project timelines, high upfront costs and staggered payment schedules can restrict flexibility and make it hard to maintain liquidity. As construction projects are rife with uncertainty and changeable conditions, this can lead to cash flow problems and various subsequent knock-on effects.

We explore the common challenges and provide practical solutions to manage and improve cash flow, including how cash flow loans can support your business.

What are the challenges of cash flow in construction?

Cash flow is the movement of money in and out of a business or project. In the context of the construction industry, it encompasses all the financial transactions related to the costs of materials, labour, subcontractors and other expenses required to complete builds. 

Due to the nature of construction projects, with funds raised upfront before many of the details are clear, managing cash flow is a moving target. Payments are often tied to project milestones, which can lead to cash flow gaps, especially if there are unexpected delays or spiralling costs. 

Proactive planning and cash flow monitoring are essential to avoid liquidity issues. So, access to credit facilities to boost working capital is becoming increasingly important for construction businesses.

Interested in a short-term business loan for your construction project? Find out how much you could borrow with our loan calculator.

What is the S-curve cash flow model?

The S-curve cash flow model is a graphical representation of cumulative costs, labour hours or other quantities plotted against time. In construction, this model helps illustrate the relationship between project progress and cash flow needs.

The "S" shape of the curve indicates the following things in construction projects:

• Initially, expenditures are low during the planning and early stages of the project. 
• As the project progresses, costs accelerate, peaking during the most active phase of construction. 
• Toward the end of the project, expenditures taper off as work is completed and the project closes out.

This model is relevant because it helps construction managers predict when cash flow demands will be highest. By anticipating these peaks, companies can ensure they have sufficient funds available to cover expenses and avoid disruptions.

Key cash flow patterns, phases, and management needs in construction

Cash flow in construction projects operates through a series of inflows and outflows. Understanding these patterns is vital for project managers to maintain financial stability and project momentum.

An example of cash flow patterns in typical construction project phases

1. Initial phase:
   
   • Inflow: Minimal, often limited to initial deposits or advance payments.
   • Outflow: Initial expenses for planning, design and obtaining permits.
2. Active construction phase:
   
   • Inflow: Periodic payments based on project milestones or completion of specific stages.
   • Outflow: Major expenses for materials, labour, subcontractors and equipment.
3. Completion phase:
   
   • Inflow: Final payments upon project completion and client acceptance.
   • Outflow: Finishing touches, cleanup and final inspections.

Key construction cash flow management components 

Effective cash flow management in these example construction project phases involves the following key components:

• Cash flow forecasting: Anticipating future cash flow needs and planning accordingly.
• Budgeting: Establishing a detailed budget that aligns with construction project timelines.
• Monitoring: Regularly reviewing cash flow statements to identify and address potential issues early.
• Contingency planning: Setting aside funds to handle unexpected costs or project delays.

Common cash flow issues in the construction industry  

Cash flow problems can come from a range of sources and causes in the construction sector. Here are the most common cash flow issues you can run into:

• Delayed payments: Construction companies often face delays in receiving client payments, which can disrupt cash flow and affect project timelines.
• High upfront costs: Construction projects typically require significant upfront investment, which can strain cash reserves.
• Variable cash flow: The nature of projects means cash flow can be highly irregular, with periods of high outgoings and delayed income.
• Cost overruns: Unexpected expenses or project changes can lead to cost overruns, impacting the planned cash flow and budget.
• Inefficient billing processes: Inefficiencies in invoicing and collection can delay inflows, making it challenging to maintain a steady cash flow.
• Seasonal fluctuations: Construction activity can be seasonal, leading to periods of low revenue and cash flow issues during off-peak times.
• Poor financial planning: Inadequate cash flow forecasting and budgeting can result in liquidity problems and financial instability.
• Supplier payment terms: Strict payment terms from suppliers can create cash flow pressures, especially if the company's inflows are delayed.

Key cash flow metrics and formulas for construction projects

When monitoring cash flow, there are various views and metrics to track. Those most relevant to you depend on your situation and project stage. We outline the most important cash flow metrics and the formulas to calculate them below:

Net cash flow

Net cash flow represents the difference between cash inflows and outflows over a specific period. It indicates whether a project or business is generating enough cash to sustain operations.

Formula for calculating net cash flow: 

Net cash flow = Total cash inflows - Total cash outflows

Example: If a construction project receives £500,000 in payments and has expenditures amounting to £400,000, the net cash flow would be £100,000.

Operating cash flow 

Operating cash flow (OCF) measures the cash generated by the core business operations. It focuses on the cash inflows and outflows directly related to construction activities, including non-cash expenses (e.g. depreciation).

The formula for calculating operating cash flow: 

OCF = net income + non-cash expenses + changes in working capital

Example: If a construction company's net income is £200,000, depreciation is £50,000, and changes in working capital result in a £20,000 decrease, the operating cash flow would be £270,000.

Free cash flow 

Free cash flow (FCF) indicates the cash available after accounting for capital expenditures, which are the funds used to acquire, upgrade or maintain physical assets such as buildings and equipment.

The formula for calculating free cash flow: 

FCF = operating cash flow - capital expenditures

Example: If the operating cash flow is £270,000 and capital expenditures are £100,000, the free cash flow would be £170,000.

Cash flow to debt ratio

The cash flow to debt ratio measures your ability to cover debt obligations with operating cash flow. It's a crucial indicator of financial health and risk.

The formula for calculating your cash flow to debt ratio: 

Cash flow to debt ratio = operating cash flow / total debt

Example: If the operating cash flow is £270,000 and total debt is £1,000,000, the cash flow to debt ratio would be 0.27, indicating that the company generates 27% of its debt in cash flow annually.

Cash flow yield

This metric measures the return on cash flows relative to the company's value or its market price. This is a useful metric for investors.

The formula for calculating cash flow yield:

Cash flow yield = operating cash flow / market capitalisation

Example: If the operating cash flow is £270,000 and the market capitalisation (the total market value of the company's outstanding shares) is £5,000,000, the cash flow yield would be 5.4%.

How to manage cash flow in construction projects in 6 key steps 

So, you understand the cash flow challenges and metrics to follow, but you need to ensure you have the tools and tactics to manage cash flow as best as you can.

Below, we offer 6 key actions to take to support efficient cash flow management in construction projects:

1. Accurate cash flow forecasting

Accurate cash flow forecasting is the baseline for successfully managing your finances in construction projects. By preparing detailed cost estimations and cash flow statements, project managers can identify potential cash flow issues, anticipate working capital needs and make informed decisions about financing, billing and expenses.

2. Establish suitable payment schedules

Setting clear and realistic payment schedules with suppliers, subcontractors, and clients ensures money is available to cover project expenses. This involves negotiating favourable payment terms and maintaining open communication about payment expectations.

3. Monitor expenses

Expenses quickly mount up, so monitoring costs regularly is essential for preventing overruns. Project managers should track expenses in as close to real time as possible, comparing actual costs to the budget and identifying areas where costs can be reduced. 

4. Efficient billing and invoicing

Implementing a streamlined billing and invoicing process ensures timely payments. Accurate and prompt invoicing, along with clear communication about payment terms, helps avoid delays and maintains a steady cash flow.

5. Manage project timelines

Keeping projects on schedule is crucial for construction cash flow management. Detailed project plans with clear timelines, regular progress monitoring, and proactive corrective actions help minimise delays and meet milestones on time.

6. Accessing finance when you need it

Construction finance provides access to liquidity when you need it most, allowing your firm to keep the project moving forward when cash is tight. That could be by purchasing materials, hiring equipment or paying contractors. 

There are various forms of business finance to support cash flow in construction projects, from working capital loans and lines of credit to invoice financing. 

How to finance your construction cash flow needs

As mentioned, construction firms can leverage several forms of finance to help navigate cash flow challenges during projects and provide the necessary funds for key purchases, regular financial obligations, and to accommodate any unexpected costs.

Funding solutions to finance construction cash flow needs include:

• Unsecured business loans: Short-term financing without the need to use business assets as collateral. These are generally quicker and easier to access than secured loans and offer greater flexibility. 
• Overdrafts: A financial buffer to dip into, up to an agreed limit. While flexible and easy to use, they may not offer the sums you need and have relatively high interest fees.
• Business lines of credit: A useful working capital solution to draw from as and when required, and a cost-effective way to avoid incurring unnecessary interest. It’s a revolving credit facility for ongoing cash flow needs. 
• Invoice finance: Advances of a large proportion of a client’s invoice value, providing fast cash injections to counteract late or staggered payments.
• Trade credit: An agreement with suppliers to provide goods without having to pay upfront, where you can negotiate deferred payment terms to help align cash flow with construction project timelines. 

If you're after fast and flexible access to funds, without heaps or paperwork or the need to provide assets as security, consider using iwoca’s Flexi-Loan. We help construction companies manage cash flow effectively during key stages of projects, in slow periods or when unexpected delays and costs arise.

You can borrow £1,000–£1 million for a few days, weeks or up to 60 months, only paying interest on funds you draw down, with the option to repay early or top up (subject to approval). Funding decisions are usually given within 24 hours, and successful applicants can expect funds in their account on the same day.

Discover how to apply for a business loan from iwoca and the great benefits of our solutions, plus use our handy loan calculator to see your likely repayments.