Negative cash flow probably causes more construction companies to run into financial trouble, often leading to bankruptcy, than any other cause. Even a profitable project can cause contractor’s financial problems if the construction project cash flow is negative.
Negative cash flow is when the contractor is paying money to suppliers, equipment hires companies and subcontractors, or in wages and salaries, before the client has paid for the work that has been completed.
Unfortunately, most construction projects are cash negative to some extent. Many clients hold 10% cash retention until the end of the project when this is reduced by half and the balance may be paid months later. Consequently, if the project is priced with a profit of less than 10% then the project will be cash negative until the end.
In addition, most clients only pay the contractor thirty days after the contractor submits an invoice. These invoices are normally submitted at the end of each month. Many contractors pay their workers fortnightly or in some cases weekly. This could mean the contractor has paid out up to seven weeks of wages before the client pays for the work that these employees have completed. Smaller contractors sometimes have to pay suppliers before they will release materials, yet the contractor’s client only pays for these materials after they have been fixed in place – and then only 30 days after the contractor invoiced for the work.
There are, however, a number of other factors that make the cash flow situation even worse. Many projects have payment terms longer than thirty days. In addition, some clients habitually pay progress claims late. Of course, the ultimate knockout blow for many contractors is when clients don’t pay at all. This could be a result of the client disputing the value of work, defaulting on the contract or going into liquidation.
Yet, even with the odds stacked against construction companies, they often make their cash flow situations worse by submitting their progress valuations late, accepting payments late or not claiming fully for completed work.
How can contractors improve their construction project cash flow?
Submit monthly progress valuations before the due date. These must be in the correct format and include the required supporting documentation. Check that the client has received the claim.
Follow up to ensure invoices are paid on time.
If interim valuations are made when milestones are achieved then ensure that all work and documentation required to meet the milestone is completed as soon as possible. Frequently contractors are 99% there, but a missing certificate, or outstanding punch list items, hold up final completion. Literally, a few hundred dollars of outstanding work is holding back a payment of hundreds of thousands of dollars!
If the progress valuation is made according to the percentage of work completed as recorded on the progress schedule, then ensure that the schedule has been updated correctly. Why get paid less than you are entitled?
Submit and agree on variation claims as soon as possible. Clients don’t pay variation claims until they have been agreed. That argument over the last few hundred dollars in your variation claim may be delaying you receiving payment for it.
Always check that the client has issued the correct site instructions and order amendments. Again clients won’t pay for variations until a variation order has been issued.
Many clients hold retainage money which is only released when the project is completed. Ensure that all work required for project completion is done as soon as possible. Outstanding documents could prevent the project from being completed.
Ensure that there aren’t large amounts of materials lying on the project. Normally clients only pay for materials once they are built in, yet, the contractor has to pay the supplier when they are invoiced, which is usually when the material is delivered. Try and time materials to arrive just in time.
Avoid delivery of expensive items near the end of the month. Suppliers normally invoice at the end of the month during which the materials were delivered. An item delivered on, say, the 28th of the month will be invoiced at the end of the month (the 30th or the 31st). If the item is delivered 3 or 4 days later on the 1st of the following month then the supplier usually invoices at the end of that month. In effect, delaying the delivery by a couple of days will result in the supplier being paid a month later.
Try to get expensive items built in as soon as possible, and certainly before the progress valuation is prepared. Getting an item in a couple of days quicker may just mean it’s paid a month earlier. Let the team know why it’s important to build the item in.
Overclaim on progress valuations. Obviously not enough so that the client is going to kick your valuation claim back. But, if your claim is due by the 25th of the month then usually your claim is prepared by the 23rd. Typically the client isn’t going to check the progress claim before the end of the month. Therefore try and estimate where the project will be by the end of the month and claim for that extra week’s work.
When pricing the project it may be possible to improve the project’s cash flow by:
- Offering the client a discount for earlier payment.
- Asking the client to accept a retention bond instead of retention monies.
- Offering a discount if the amount of retainage money is reduced.
- Front loading your price – which is done by adding more profit to the work items, or milestones, that is completed early in the project life.
- Requesting that materials that are on the project site but aren’t yet built in are paid by the client.
- Offering the client a discount may make your price more attractive to the client. The loss of profit is often more than compensated for by the improvement in cash flow.
Taking a few simple steps can improve cash flow. Most importantly before pricing a project check the credentials of the client. Do they have the money to pay you? Do they have a reputation for paying contractors late? Do they have a habit of engaging contractors in legal disputes over variation claims? If there are any doubts that you’ll be paid then don’t price the project. No contractor is a bank that can finance their clients.
Of course, avoid the temptation to pay subcontractors and suppliers late to improve your construction project cash flow. This is unfair to them and will cost you in other ways.
What do you do to improve cash flow on your projects?