On one hand, cash flow is a simple concept. Money comes into a business, and money goes out. On the other hand, there are good reasons that several different definitions of cash flow exist. What all of those definitions have in common, however, is that they're used to help business owners plan for periods of potential financial stress and make smart budgeting decisions.

Cash flow is a very different measurement of a company's financial health than profit. In fact, confusing one for the other is a common mistake that can cost business owners in the construction industry dearly.

Unlike profit, which is strictly defined as the difference between revenue and expenses during a given period, cash flow only measures the amount of money the business has received compared to the money the business has parted with. If a construction company always paid all of its expenses in cash and always received customer payments in cash at the exact moment it closed a deal, then the company's cash flow and profit would be identical.

However, this isn't how business works in the wild. Suppliers and subcontractors often accept delayed payment terms on credit, and customers often pay over time, too.

Thus, there can be substantial differences between a company's cash flow over a given period and the corresponding profit from operations. In fact, a business can earn a very healthy profit and still end up not being able to pay the bills on time due to poor cash flow. Merely being profitable will not save a company from bankruptcy, but strong cash flow will almost always ensure a healthy profit.

A construction business can show substantial revenue for a given quarter while receiving almost no cash, leading to a healthy profit but significant financial pressure. Likewise, a construction business can incur significant upcoming costs during a period of time while parting with almost no cash, leading to a false sense of security when insolvency is lurking around the corner.

Types of Cash Flow

A cash flow projection report typically categorizes cash inflows and outflows into three categories.

1. Cash Flow From Operating Activities

This is cash received from construction contracts and any other normal operating activities. Construction businesses with a strong cash flow from operating activities have a healthy backstop against economic slowdowns.

2. Cash Flow From Financing Activities

This section of a cash flow report tracks money in and money out from repaying lenders, borrowing money, financing operations by issuing claims on the construction company's future cash flow and similar activities. Furthermore, cash flow from financing activities takes into account outflows from interest payments and loan origination fees. In addition, any dividends and distributions that the company's owners elect to take are best classified as cash outflows from financing activities.

3. Cash Flow From Investing Activities

Through either lease-to-own agreements or outright purchases, construction companies frequently invest in vehicles, equipment, and other high-priced physical assets. Selling these assets typically results in cash inflow, and that inflow is traditionally recorded as positive cash flow from investing activities.

Keep in mind, however, that a cash inflow from the sale of equipment does not mean the company has turned a profit on the equipment. A company can record a large capital loss on a piece of equipment and still have a positive cash flow from the sale for a given period. The resulting cash flow from investments made with the company's treasury, such as buying and selling stocks and bonds or making loans to other businesses, is also considered cash flow from investing activities.

When added together, these three categories can produce a comprehensive picture of whether a construction business is building up a healthy cash cushion to weather tough times or whether there are likely to be struggles ahead. As you can see, even measuring something as seemingly simple as money in and money out can actually be quite complex.

Why Do Contractors Need Reliable Cash Flow Projections?

A detailed cash flow projection report will help construction businesses manage payroll, secure financing to support growth, and potentially gain lucrative joint venture partners. In addition, any prospective business buyer will likely want to see detailed cash flow projection reports that extend as far into the future as possible.

Suppose a large real estate developer in town announces plans for a sprawling new development, and a construction company is interested in trying to land the development's primary building contract. However, fulfilling the contract's requirements will require more manpower and machinery than the construction company presently has. The construction company has two options.

1. Of course, the construction company can sacrifice a large percentage of the contract's revenue and find one or more subcontractors. Even if the company does this, however, they'll need to figure out how to properly time the cash inflows from the development contract with the cash outflows to the subcontractors.
2. Seek new financing that enables the construction company to expand. This financing can come in the form of traditional borrowing from a bank or another lender, or it can come in the form of access to cash secured by existing accounts receivable. The latter is known as factoring.

Either way, the financing providers will need to see a cash flow projection report. In the case of traditional borrowing, the lender will need the report to assess the construction company's solvency and the ability to pay back the loan. If the construction company wants to access fresh growth financing by factoring, then the financing entity will need a projection, at minimum, of when the company expects to receive cash inflows from existing customer invoices. In addition, many factoring firms will be more likely to provide cash against contracts that have a construction bond.

Final Thoughts

In a perfect world, cash flow, and profit would be one and the same. This would make a cash flow projection report as simple as estimating new customer sales and recording all upcoming bills.

However, complex contracts and traditional B2B agreements create the need for detailed cash flow reports to navigate periods of growth and make sure suppliers and employees get paid on time. Fortunately, a general framework for producing such a report already exists. By breaking down project cash inflows and outflows into three main categories, a construction business can seek new ventures, prepare for stagnant periods and access fresh financing to expand market share.