Numerous transactions and agreements are created quickly in the construction industry, and at times they even do not agree on what was agreed upon. This makes financial management of most construction projects tough, problematic, and laden with more challenges.
Handshake deals are common in the industry. Also, making sure that each financial decision is in line with the business strategy is not easy.
Yet, if any construction company is not careful about its finances, treasury, and financial circumstances, it can spell disaster for itself. For each business, the ultimate objective is profitability.
Which financial pitfalls should construction companies avoid at all costs?
It should be understood that financial traps and ensnarement might not be observed until and unless it has already given the business a huge blow. It is best practice to be smart and vigilant. Let us now have a look at some of the financial pitfalls construction companies and contractors alike must look out for:
Relying Only on Accrual Accounting
Accrual accounting is an accounting practice in which any company records revenue before the invoices have been paid or expenses are recorded as incurred before they have been paid.
Though this can simplify record-keeping during the planning phases (and other preliminary phases), it can create rifts between the actual financial position and what is present in the statements.
In the construction industry, delays in delivery and payment are common. Relying only on accrual accounting can lead to poor financial management and operational decisions in the construction industry.
Forensic delay analysis experts explain that a lot of companies often fall into the trap of relying on accrual accounting for monitoring expenses and running payments on a project, whether or not the actual transactions haven’t been completed yet.
Incorrect Estimation of Most Projects
Estimation is a key component of a construction business. A lot of deals and contracts usually rely on estimates. This is why many solutions help suppliers and contractors make accurate estimates for making informed decisions regarding dealings.
Yet, poor estimation is also a practice that is widespread in construction. It can come out from executives not checking actual costs on a regular basis. Also, using outdated or old pricing to make new project estimates is disastrous.
Over the previous few years, there have been price fluctuations that have been drastic, and making wrong estimates can only favor the business in terms of profits in a few instances. Why? Because it can hurt the company in the long term.
This is why experts favor regular review and audit of actual costs and financials of a project, as this can lead to accurate calculations of the actual costs of things on site. It is always best to be vigilant when checking prices at the point of making bids and estimates.
Inability to Provide Protection for Lien Rights
Delayed payments are sadly a normal thing in construction. Average days sales outstanding (DSO) numbers up to more than 60 days, and such was recorded last year. Timely payments are good for cash flows, but sometimes clients cannot pay what is owed on time. At times, they might even forgo it altogether.
Lien laws help protect contractors, suppliers, and other construction professionals in times like these.
Mechanics lines work by placing a hold on the title of the project a company has either worked on or is working on as a security in the event of a non-payment.
However, the presence of right to enforce this lien is present when a contractor is neither paid nor the construction businesses are tasked with following pre-lien requirements in the timing and manner as stipulated by law.
This is true for those construction companies handling projects across numerous state and international borders. Another problem requiring enforcing this lien is that preliminary notices which are duly filed can be cumbersome. Those who lead to notices which are either missed or erroneously filled require enforcement of such a lien.
Notices which are either incorrect or missed can result in the loss of the right to lien. This is quite expensive if any company requires a lien to recover payments but has lost the right to do so. Industry experts find such an issue quite problematic, putting contractors out of business.
This is the very reason companies must protect their lien rights across all projects at all costs. The process can be automated by utilizing software that properly manages the liens of construction financial management. This helps streamline the process of protecting payments and ensures notices are filed accurately and timely.
Change Order Documentation Problems
Change orders are a key component of construction projects. They are usually created without much planning. A lot of paperwork often follows such documentation, which is either incomplete or documented properly.
What does the contractor get over here? Forced to complete incomplete and unpaid work beyond the contract. At times, they even have to pay for labor and materials for work that is not profitable and that which is not part of the contract.
A delay expert based in Dubai recommends examination of incumbent change order processes to ensure each request and addition has been cleared with clients. Each cleared request should have all needed details pertaining to expenses and timelines before new work commences.
Contractors must avoid all the above financial traps because they will face further problems in terms of construction claims. This is the very reason contractors face issues in cash flows and also face hurdles when it comes to clearing dues.