What is agreed on in the contract should be observed by a construction company. However, it is not uncommon that there are transactions and agreements made verbally or spontaneously during the project. This reality poses a challenge for contractors, particularly when managing their finances. 

As a contractor, you should ensure each decision accords with your business strategy. Risks present themselves when you are not careful on the financial management side. Remember that the primary objective of your construction business is to generate profits from a project, and you should avoid financial pitfalls that can derail your business goal. 

Always practice prudence in your dealings and transactions. Be watchful of these five financial traps in a construction project. 

Inaccurate Estimates

A construction company relies heavily on estimation. In truth, many agreements and transactions are done through estimates. Thus, it is not surprising that a construction business suffers from financial losses due to poor or inaccurate estimation. 

Failure to review actual costs regularly and using outmoded pricing to estimate a project are bad for your business. Price changes coupled with inaccurate estimates can either be a financial benefit or a drawback. However, there is uncertainty when you handle transactions this way. 

Accurate estimates regarding your construction dealings minimize the risks of financial losses. Also, check the actual costs of required materials before making estimates and bids.

Heavy Reliance on Accrual Accounting

Using the accrual accounting method can create a gap between your financial records and your actual cash position. It is because this accounting method records transactions as they occur, even when payments for goods or services have not yet been made or received. 

Accrual accounting can simplify bookkeeping during preliminary and planning stages, but relying solely on it is detrimental to your business. The fact that delays in delivery and payment are common in the construction industry makes this accounting method even more problematic. Heavy reliance on accrual accounting may result in poor business decisions and financial management. 

Many construction companies suffer from financial losses because they rely solely on accrual accounting when monitoring costs and running payments on projects, even before invoices are paid. 

Failure to Document Change Orders

It is common in a construction project to have change orders. This matter refers to any modification or removal of particular works agreed upon in the contract. A change order may be significant in scope, forcing the contractor to alter the original project price and completion date. 

Without adequate documentation or proper planning, a change order may lead the contractor to complete unpaid work or shoulder labor and material costs. The project may drain your finances due to poor documentation of change orders. 

Adopt a process of documenting and managing change orders which is efficient and practicable. Make sure you have clearance with the client regarding all requested additions or modifications. Check all details concerning costs and completion date before starting with all the newly requested works. 

Failure to Protect Lien Rights

Improving your cash flow requires timely payments for the construction projects you are handling. However, the sad reality in the construction industry is that delayed payments are common. A client may not pay what he owes you on time, which can stagnate your cash flow. 

Fortunately, contractors, construction professionals, and suppliers can resort to lien laws to ensure they are paid on time. For example, a mechanic’s lien places a hold on the title of the project in which you have supplied labor or material for its completion. This type of security motivates the client to pay what he owes you. 

However, you must adhere to pre-lien requirements provided by the law to use your right to enforce a mechanic’s lien. Ensure you duly file preliminary notices to use a lien in case the client does not pay on time or fails to make payments. You can use software to automate the process of protecting your lien rights for every project and ensure you file notices timely and accurately. 

Poor Cash Management

Contractors need to invest money into a construction project, and they only generate profits when the client makes payments at the end of the contract. It is rather financially risky, especially when you are a newbie contractor without enough liquidity to take on more than one project.  

You need to improve your liquid assets and cash management to create a buffer when delayed payments or financial losses occur. Create a considerable cash reserve to protect the profitability of your business in the long term. 

Final Thoughts

Be prudent when it comes to managing your business finances. As a construction contractor, your ultimate goal is to generate profits. Avoid practices that can lead to financial losses and cause a big blow to your business. Take note of the common financial traps we have discussed in this article and avoid them at all costs.