How can revenue forecasting help you manage cash flow in construction?

From my experience in the roofing contracting business, revenue forecasting has proven to be an invaluable tool. It provides a clear vision of potential earnings, enabling the company to plan its financial strategies more effectively, ensuring that we allocate resources efficiently, and maximizing profitability. It also offers a tangible gauge to measure actual performance against expected outcomes, highlighting areas needing adjustment. Furthermore, having an accurate revenue forecast boosts stakeholder confidence, assuring investors and partners of the business's growth trajectory. In essence, it enhances our financial management capabilities and strategically positions us in the marketplace.

Having worked in construction and business partnered with different departments in industry, revenue forecasting is key, especially in high inflationary environments. For example, during and after the pandemic, lumber costs have fluctuated so much that instead of planning quarterly or monthly for pricing, it continued to increase in price further exasperated by supply chain issues that it was monitored weekly, if not daily to ensure prices are reasonable and delivery of goods would come on time. Any delays and/or high prices would cause completion of work to be pushed out, causing revenue recognition to stall. Moreover, higher prices eat away at gross margins and therefore profitability. So revenue forecasting is key for success!

I agree with these methods. They help gauge what needs to be measured and the delivery of projects over time. Here's what I've used currently and in the past: % of completion, estimate at completion (EAC), earned value (EV) cost/schedule variances (CV/SV), cost/schedule performance indexes (CPI/SPI), cost-benefit analysis (CBA), %s based on revenue for related labour, material, direct or indirect costs, SG&A, CapEx just to name a few. There are many methods to choose from and picking the right metrics can make or break construction work or projects, and can relay useful or useless info to stakeholders accordingly.

These are all appropriate ways of revenue forecasting based on the various streams of revenue in construction. The other revenue stream I saw was "fixed price" contract and "cost plus fixed fee". With a fixed fee or firm price method, close monitoring is extremely important, to identify cost overruns and when it starts to dip into the contingency portion. % completion and estimate at completion, earned value are useful computations in this case.

Tools are great depending on the needs of the business and its respective departments and stakeholders. The key here is to get as many data points, as requested to put in report form, that is usable for decision-making by stakeholders in the business/company. Revenue forecasting is more of an art than a science since many inputs and factors, especially in construction can happen. For example, worker strikes, unexpected material cost delays, supply/demand shocks, seasonality and weather issues, revised requests from clients, supplier/vendor issues, etc. are factors that may not be captured by tools and needs re-forecasting for the success of the projects. Thus, flexible revisions of revenue are key to managing stakeholder expectations.

It is critical to distinguish between revenue forecasting and cash inflows. It is possible you may be able to record something as revenue in the current month, but this may not result in cash receipts until a future period (depending on invoicing structures, payment terms, etc.). Since cash is the lifeblood of any company and necessary to sustain the ongoing operations of the business, it is important to follow the flow of funds all the way to when they arrive in your bank account in order to build a proper projection of your future financial position.

Carefully reviewed contracts are the foundation in construction cash flows--for the GC, subcontractors, and material suppliers. Retention, paid when paid provisions, construction delays, etc. are all considerations. Also, knowing the contract language for billings and payments should be at the forefront. For example, if a GC requires a subcontractor's pay applications to be submitted by the 15th of the month, and the deadline is missed, then the subcontractor has a full month to wait to bill before any cash inflows can be expected.