Introduction
Construction is one of the most cash-intensive industries, yet businesses that are profitable on paper often run short on cash in practice. While profitability and cash management are closely related, it’s crucial to understand the difference between the two and know where your business stands on both.
Within construction, every job functions as its own enterprise, meaning it has its own budget, balance sheet, income statement, and cash cycle running independently of other projects. Revenue is recognized as a function of what is spent rather than what’s been collected, and cash often leaves before payment arrives. This means that even companies with disciplined practices regularly require a line of credit to bridge the interval between spending and collecting. This is the nature of the industry, which is why well-run construction companies manage cash (alongside margin) deliberately instead of hoping the timing works out.
Know Your Cash Conversion Cycle
The most important number for understanding your cash position is the cash conversion cycle (CCC). It measures how long it takes a company to convert receivables into cash,[AB1] [AB2] [PM3] pay its bills, and when applicable, turn cash into inventory, then sell that inventory. In short, the CCC tells you how many days your own cash is tied up funding operations at any given time.
The CCC is based on three figures that most construction business owners can estimate:
- Days sales outstanding (DSO): how many days clients take to pay you
- Days inventory outstanding (DIO): how many days you hold inventory before it’s used or sold
- Days payable outstanding (DPO): how many days you take to pay vendors and subcontractors.
You calculate CCC by adding DIO and DSO, then subtracting DPO. The result shows how many days your cash is financing the gap between paying for a job and getting paid for it. Because most construction companies don’t carry a significant inventory balance, DSO and DPO do most of the work, so those two figures are the most important to focus on.
While there isn’t one universal target that every business should hit, and you don’t need a short conversion cycle or even a positive conversion cycle to succeed, it is crucial to understand your baseline. Otherwise, you can’t determine the best course of action for your business, be it faster billing, better collections, negotiated vendor terms, or another initiative. A helpful rule of thumb: your cash and available credit should be enough to comfortably cover operating expenses for the length of the CCC. If that cushion is shrinking, or the CCC keeps stretching out while your cash reserves stay flat, that’s a sign it’s time to act. Many businesses gauge success based on how much they have in their bank account, and while that can be an indicator of progress, it might also reflect payment timing more than anything else.
Control What You Can
DSO and DPO require individual attention because they represent two separate levers within the business. Once a client has your invoice, how quickly they pay is largely shaped by their internal processes and priorities, but that doesn’t mean you’re powerless before that point. You can build more favorable terms into the contracting process itself, such as negotiating shorter payment windows, offering discounts for early payment, and avoiding pay-when-paid terms, which tie your payment to when your client collects from their own client. How quickly you pay vendors and subcontractors, however, is up to you, and we recommend using the terms you’re given. If a vendor allows for 30 days, you should take advantage of it in the same way that you’d use the full period to make a credit card payment. Timing payments strategically allows you to have more cash on hand to fund your next mobilization or absorb an unplanned expense.
DIO deserves consideration as well, although it’s not a major lever for most general contractors. Some construction businesses carry significant inventory, such as home builders that have lots and unsold spec homes, or specialty trades like foundation drilling that stock casings, pipe, and other materials ahead of a job. If this describes your business, DIO needs the same attention as DSO and DPO since managing how much inventory you carry and how soon you turn it into a sale can have an impact on your CCC. Look for opportunities to time purchases more closely to when materials are needed and move finished inventory into a sale more quickly.
Ultimately, the objective is to extend your DPO as far as reasonably possible while shortening your DSO wherever you can. However, this should be done carefully, as many subcontractors and suppliers also operate close to the margin, and unpaid subs may walk off the job. Good judgment and relationship management are crucial here.
Understand Overbilling, Underbilling, and Retainage
Overbilling means you’ve billed a client for more work than is completed to date, and a healthy degree of overbilling (usually through the halfway mark of a job) is the ideal position within your current contract schedule. Initiating a project requires a substantial amount of cash up front, so keeping billing ahead of costs prevents future financial strain. The revenue sits as a liability until the work catches up (deferred revenue), and that’s fine. Cash in the door today is worth more than revenue on the books, as the revenue will still be there tomorrow, but the cash might not.
Underbilling is the opposite, meaning you’ve incurred more costs than have been billed and are responsible for carrying the expense without the corresponding cash. As a result, you will recognize revenue but will not have the cash. This is why underbilling carries more risk than reward, even though they are an asset on the balance sheet. The goal is to recover the margin, but when you can’t, the cost-to-complete might have been underestimated from the start, resulting in profit fade.
Retainage is another factor that essentially acts as underbilling on every job. Clients typically withhold 10% of the billing until the project closes out as insurance. While the money is yours on paper, it can’t be billed and collected until final completion, sometimes months or years after you incurred the cost. Even if a project is billed perfectly, there’s still a retainage gap until closeout, so knowing how much is sitting in retainage is part of understanding your cash position.
Watch for Trends that Impact Cash
Because cash management doesn’t occur in a vacuum, it’s important to pay close attention to:
- Interest rate movement. Most lines of credit renew annually, and while you have a fixed rate for the current term, the renewal rate may change with the broader environment.
- Material cost volatility, especially for materials sourced internationally or that are tied to commodity pricing.
Contractors who locked in fixed-price contracts ahead of recent tariff-driven spikes in material costs (concrete being a common example) found that they didn’t have an avenue in place to pass those increases on to clients. A signed fixed-price contract doesn’t always account for changing material costs, so the difference comes out of your margin if you cannot get an approved change order.
Because there will always be factors outside of your control, the best line of defense is to have strong cash management practices from the outset. Cash is the most important line on the balance sheet and the lifeblood of your business. Protecting how and when cash leaves, and understanding when it comes in, is what allows you to manage risk while supporting growth.
Start With Clean Data
In our experience, the businesses that struggle the most with cash are those that don’t know which metrics to track and that have inaccurate underlying data to begin with. Your cash conversion cycle is only as accurate as the balance sheet behind it.
We worked with one client who showed that vendors were being paid in 19 days while collections took 53, which is an expensive gap (34 days) to fund out of pocket every month. After cleaning up the balance sheet, we built a monthly dashboard that pulled directly from their system with cash metrics updated as part of their regular close process. With this data, we were able to attack the cash conversion cycle weighing down the business by about a month. Through collaboration with the client’s AP department, we implemented a new policy to stop paying vendors before the invoice due date, moved to monthly AP check runs instead of weekly, and renegotiated “pay-when-paid” with certain subcontracts. We also collaborated with the client’s AR department and focused on collecting the most aged receivables. We engaged with the project managers to oversee collections and implemented a more standardized process to call on past due receivables. The overall result was a 13-day reduction of DSO to 40 days and a 16-day increase of DPO to 35 days. With a CCC improvement of 29 days, the client was able to retain more cash during the month, deter unnecessary LOC interest, and mobilize more projects simultaneously.
This level of visibility requires clean books and strong processes in place to review the right metrics each month. For many businesses, the hardest piece is getting to the starting point of having clean books and a regular review process. This is where an experienced third party can help establish the baseline visibility these practices depend on and support more strategic decision-making.
