Construction companies are in a good position to benefit from the Government’s housebuilding platforms, but strong cashflow management is vital, warns David Prosser
Prime minister Keir Starmer has promised to build 1.5 million new homes in England alone during Labour’s term in office. That should be good news for construction companies and housebuilders, but for many businesses in the sector, tough challenges stand in the way of realising the opportunity. As they deal with high costs and often late payments, good cashflow management is crucial – including a strategy for managing cash deposits.
Indeed, cashflow problems cause huge problems in the construction sector. Over the year to 31 October 2024, more than 4,200 construction businesses slipped into insolvency, accounting for close to a fifth of insolvencies across all industries, according to the Business Cost Information Service. Insolvencies were 31% up on 2019, the last year before the Covid-19 pandemic struck the UK.
No wonder. Managing cashflow is particularly challenging in construction. Projects take a long time to compete, with payments for work often made in stages and invoices not always settled on time. In the meantime, businesses have to meet the cost of materials and labour, largely upfront. These can spike upwards unexpectedly; materials prices, in particular, have been unusually volatile in recent times.
Budget to eliminate cashflow uncertainty
The first step in battling these headwinds is to budget as accurately and in as much detail as possible. For each project currently on the books, construction companies should have a clear view of what payments they will receive and when, as well as their costs – including both regular costs such as wages and project dependent costs such as raw materials – and when these will fall due.
Inevitably, that involves makes some estimates, particularly on the costs side, where predicting the cost of materials in, say, six months’ time may be challenging. It is therefore important to build some contingency into forecasts. The budget will also need to reflect the nature of the contract for each project, such as the extent to which it is possible to pass on cost increases.
The goal here is to build a cashflow timeline, setting out projected inflows and outflows of cash over the next few months and beyond. This provides the business with crucial visibility – at any given moment, business leaders should know how much cash they will have available and what payments are coming up.
Make the most of cash at hand
Construction companies working with such a budget often find they have little choice but to maintain large cash balances, enabling them to pay suppliers on time even when they’re between stage payments or pursuing customers for late payments. However, they can turn virtue into necessity by ensuring this cash is working as hard as possible; the idea is to balance the business’s need to have cash on hand with the goal of earning as much interest as possible on deposits.
Generally, accounts that require more notice of withdrawals, or lock up cash for a longer period, pay higher rates of interest.
In this context, a portfolio approach to savings can work well. The first objective should be to hold enough cash in the business’s current account, or in very short-term savings accounts, for leaders to be confident they will be able to pay all bills as they fall due, with some contingency for unexpected outturns built in. Cash not likely to be needed for some time can then be invested in accounts that pay higher rates.
Identifying the right approach is not always straightforward. Bank and building society interest rates rise and fall over time as the Bank of England adjusts its base rate. In the current market environment, where the Bank is widely expected to reduce base rates in 2025, construction companies therefore need to decide whether a fixed rate of interest is a better option than a variable rate.
It’s also worth noting that some longer-term accounts currently pay lower rates than their shorter-term counterparts, reflecting these market expectations about the direction of travel.
Still, the principle here is important. Construction companies need to shop around to make sure they’re depositing their cash with the banks and building societies that offer the best interest rates. And they need to split their deposits carefully to manage cashflow needs while maximising their interest earnings.
Get tough and be efficient
There are plenty of other tactics construction companies can use to manage cashflow effectively. It may be possible to negotiate better payments terms, for example, with both clients and suppliers. Many construction companies are using variable-price contracts that pass some or all the risk of cost increases on to the client. Inhouse efficiencies can reduce costs and improve financial management – examples include automated invoicing and cloud-based accounting.
However, construction companies that make their cash work harder will be best-placed to weather cashflow problems. Robust budget forecasts and sensible use of deposit accounts are critical. These are the foundations on which they should look to build for financial stability.