Why Is Cash Flow So Critical in Construction?

By Martin ยท Updated 2026-02-02
Construction cash flow is critical because you typically pay labor, materials, and subs before getting paid by the owner. With 30-60 day payment terms and potential retention holdbacks, a profitable contractor can still run out of cash. More construction companies fail from cash flow problems than from lack of work.

Why This Matters

I've watched profitable construction companies go bankrupt. Not because they didn't have work. Not because they weren't good at what they did. Because they ran out of cash.

Construction is uniquely brutal on cash flow. You pay your workers every week. Your suppliers want payment in 30 days. Your subs send invoices the day the work is done. But your customer? They take 30 days to approve your pay app, then another 30 days to pay it. Add 10% retainage held until project closeout, and you're funding millions of dollars of work from your own pocket.

You can be profitable on paper and broke in the bank. This is the paradox that kills contractors. Your P&L shows a profit. Your WIP report shows you're making money on every job. But your checking account is empty because all your profit is tied up in unbilled work and unpaid receivables.

How It Works

Let's walk through the timeline of a typical construction job:

Week 1: You mobilize. Pay $50K for equipment delivery, site trailers, permits. Cash out: $50K.

Week 2-4: Work is underway. You're paying weekly payroll ($40K/week), buying materials ($30K/week), and paying subs as they invoice ($25K/week). Total cash out over three weeks: $285K.

Week 5: You submit your first pay application for work completed through week 4. Amount: $300K. Cash in: $0 (it's just submitted).

Week 5-8: Work continues. More payroll, more materials, more subs. Another $285K out the door.

Week 8: The owner approves your first pay app (finally). But they're paying via check, which takes another week to arrive and clear. You're now $570K into the job and haven't collected a dollar.

Week 9: First check arrives: $270K. Why not $300K? Because they held 10% retainage ($30K). You've now funded $300K of work out of pocket.

This pattern repeats for the entire project. You're constantly 60-90 days behind on collections. You are your customer's bank.

The Real-World Impact

Let's say you're running $10 million in annual revenue. Your average gross margin is 12%. You're making $1.2M in gross profit. Sounds good.

But here's your cash flow reality:

That $1.67M is the cash you need sitting in the bank to fund the gap between when you pay costs and when you collect from customers. If you have $500K in the bank and land a big new job, you'll run out of cash before the first payment arrives.

This is why banks care so much about your line of credit. It's not about covering losses. It's about funding the float. Every contractor needs access to capital to bridge the payment gap.

Now add overbilling to the mix. Say you've been aggressive on early billings. You're sitting on $400K in overbilled positions across your active jobs. That looks great in the bank account today. But over the next 3-6 months, you're going to do $400K worth of work that you won't bill for (because you already collected it). Where's the cash going to come from to pay for that work?

This is the cash flow cliff. Overbilling pulls cash forward, but it doesn't create cash. When the bill comes due, you're funding work from operations or your credit line.

Common Mistakes

Mistake 1: Confusing profit with cash

Your WIP report shows $200K in gross profit across active jobs. You think "great, we're making money." But $150K of that profit is in underbilled positions. It's real profit, but you haven't collected it yet. You can't use it to make payroll.

Profit is accounting. Cash is survival. Track both.

Mistake 2: Not managing collections aggressively

You submit a pay app on the 1st. The owner approves it on the 30th. Payment terms are net 30, so you expect payment on day 60. Day 60 comes and goes. You call on day 75. They promise a check "next week." You finally get paid on day 95.

You just funded an extra 35 days of float. On a $200K pay app, that's $19K of additional working capital tied up (assuming 10% cost of capital). Multiply that across all your jobs and you've burned through your credit line.

Call on day 31. Not day 75. The squeaky wheel gets paid. Your laid-back competitor who waits patiently? They're funding their client's cash flow problems.

Mistake 3: Taking on too much work without the capital to fund it

You're running $5M/year, and you've got a good line of credit. You land three new jobs totaling $4M. Great for revenue. But you just committed to funding 18+ months of work with only 6 months of working capital.

Your bank account looks fine in month 1. By month 3, you're maxed on your line of credit and calling subs asking for 60-day terms. By month 5, you're negotiating payment plans with your suppliers. This is how profitable contractors fail.

Your capacity isn't constrained by backlog. It's constrained by working capital. Before you sign that big new contract, run the numbers: How much cash will I need to fund this project through the first payment cycle? Do I have it? If not, where will it come from?

Mistake 4: Seasonal swings without planning

If you're in a market with weather-driven seasonality, your cash flow swings are brutal. You spend all winter building backlog and maintaining overhead with minimal revenue. Come spring, you mobilize 5 projects simultaneously and burn through $2M in cash in 30 days. By the time summer payments start rolling in, you've blown through your line of credit.

Smart contractors build cash reserves in Q3/Q4 (when collections catch up) to fund Q1/Q2 (when spending outpaces collections). The contractors who go broke do the opposite: They spend the Q3 cash on equipment or distributions, then scramble in Q1.

The Bottom Line

Cash flow is not a side issue. It's not something your bookkeeper handles. Cash flow management is as critical to construction success as estimating or project management.

Here's what you need to do:

  1. Track cash flow weekly. Not just the bank balance. The forecast. What's going out this week? What's expected in? What pay apps are outstanding? What's the aging on your receivables?

  2. Manage your over/under position. If you're heavily overbilled, plan for the cash you'll need to complete that work. If you're heavily underbilled, get those pay apps submitted and collect what you're owed.

  3. Know your working capital requirement. For every dollar of revenue, how much cash do you need in the bank to fund operations? Most contractors need 15-25% of annual revenue in working capital. If you're growing, that requirement grows too.

  4. Collect aggressively. Submit pay apps on time. Follow up immediately on approvals. Call on day 31 if payment is late. Every day of delay costs you money.

  5. Plan for growth. More revenue requires more working capital. You can't grow from $5M to $10M without increasing your line of credit or bringing in equity. Plan for it.

I've seen contractors with 15% gross margins go bankrupt because they didn't manage cash flow. I've seen contractors with 8% margins thrive because they did.

Profit is important. Cash flow is survival. Manage both.