Are Your Construction Contracts Choking Project Cash Flow?
When you think about what’s tying up your available dollars, a variety of culprits may come to mind. Perhaps you’re servicing a substantial amount of debt, waiting for some past-due customer payments or dealing with elevated material costs. But one perpetrator of cash-flow crises that often goes overlooked is the piece of paper you sign in advance of every job — the contract. Construction contracts, or rather the language therein, can start choking your project cash flow before work even begins. So let’s look at some points to consider before signing on the next dotted line.
Front-Load, Where Possible
Payment terms have an enormous impact on cash flow. A construction contract that calls for payment on completion of specified phases of the project can create uncertainty, making project cash flow forecasting difficult. If a contract requires payment in equal installments over the course of a project, it provides greater predictability, but may not correspond to your expenditures on the job. Construction projects often involve significant upfront costs. If possible, negotiate a front-loaded billing schedule reflecting your greater cash needs in a project’s early stages. Also look at language regarding requisitions. It’s not unusual for a construction contract to disallow requisitions for materials until the materials have been installed. To avoid cash-flow disasters, try to negotiate requisition terms allowing you to request payment once materials have been delivered to the job site. Consider the method of payment, too. You might ask for accelerated methods, such as wire transfers or electronic checks.
A 5 percent or 10 percent retainage can easily defer your entire gross profit on a job until after construction is completed. To reduce the impact on your project cash flow, try to negotiate a lower percentage or ask for retainage to be phased out over the course of the project. For example, the construction contract might provide for 10 percent retainage, reduced to 5 percent when the job is 50 percent complete and eliminated when it’s 75 percent complete. Other options include limiting retainage to certain job costs, such as the labor component, or eliminating it altogether through the use of letters of credit, performance bonds or other security.
Clarify Your Construction Change Orders
As you know, construction change orders are an inevitable part of most construction jobs. It’s critical your contracts establish clear terms and procedures for approving and paying them. If your contracts don’t have such terms, your payments may be delayed for additional work. Or, even worse, you might lose out on those payments altogether. Establish clear procedures for your personnel to identify changes in the scope of work and to promptly prepare and document change orders in accordance with contract terms. Moreover, before things get to the point of a construction change order, monitor work-in-process reports closely to ensure you can generate the proper paperwork promptly should a change come up.
Remember cash does flow in two directions, and outflow is just as important as inflow. Scrutinize your contract terms with vendors, suppliers and subcontractors. You may be able to avoid cash-flow problems by negotiating payment terms that, to the extent possible, match your cash outlays with your receipts from the owner or general contractor. For example, include in your subcontracts retainage provisions that have terms similar to those in your contract with the owner. If you’re a subcontractor and your contract with the general contractor contains a “pay-when-paid” or “pay-if-paid” clause, your contracts with subcontractors should contain parallel provisions. That way, you won’t be forced to pay subs until you collect from the general.
Get to Work
Once a construction contract is signed and you get to work, there usually isn’t much you can do about the language or terms of the agreement. So, at that point, it’s critical to regularly prepare project cash-flow forecasts based on your work-in-progress reports and make any necessary adjustments during the course of the job. Doeren Mayhew’s construction accounting professionals in Michigan, Houston and Ft. Lauderdale stand ready to help you implement cash-flow best practices, as well as assist in developing project cash-flow forecasts for your jobs.