If you’re the owner of a construction company, cash flow problems likely aren’t anything new to you. According to a recent survey conducted by TSheets and Levelset, 1 in 5 construction companies says cash flow is a constant problem. As a result, these companies sometimes have a tough time making payroll, investing in future growth, or even taking on new projects.
How much of this struggle is preventable, and how much is out of the company’s hands? How can construction owners and managers take control of their cash flow situation so budget items like payroll, investments, and growth don’t take as hard of a hit? Given the vast majority of construction companies are contractors, the answer to that question often comes down to knowing the laws of the state where the work is being performed, building an airtight contract, and proactively sending preliminary notice on all new projects.
Cash Flow Struggles Start with Delayed Payments
The results are staggering. Despite the fact that more than a third of respondents say they either incentivize early payments or penalize late ones, 92 percent of construction companies say their customers don’t always pay them on time. Nearly a third say they rarely get paid on time.
While 63 percent of respondents report receiving regular payments and even some payment in advance, the remaining 37 percent say they only receive payment after a project’s completion, with the vast majority receiving that payment 30 or more days later. In fact, a recent levelset article on cash flow reported that the average time it takes for a construction company to get paid is around 73 days.
According to Sanam Assil, an expert in construction contracts and associate at the law firm Greenberg, Trager & Herbst, LLP, there’s a reason we see so many construction companies receive payment 30 days after receipt of invoices, once certain work has been completed.
“The parties to a construction contract, by mutual agreement, will establish a billing cycle for the submission of invoices/requisitions requesting payment for work performed pursuant to a construction contract,” Assil said. “In the absence of an agreement by the parties as to the billing cycle, the billing cycle, depending on the state law, will typically be the calendar month within which the work is performed — with payment being made up to 30 days after the month in which the work is performed. Practically speaking, that creates the real-world scenario where contractors are, in the best case, made to wait at least 30 days from completion of a given month’s work before they are paid.”
Delayed Payments Spell Complications with Payroll
When construction companies don’t get paid on time or as expected, one of the biggest challenges owners or managers face is figuring out how to cover the cost of payroll. For 17 percent of respondents, payroll is the biggest worry when asked how inadequate cash flow might affect the business.
When asked how they’ve dealt with payroll when money was scarce, 38 percent of respondents said they had to take out a short-term loan to cover the expense. A quarter of respondents said employees weren’t paid their wages. Twelve percent said employees quit, while 5 percent said employees forfeited their bonuses. Finally, 3 percent said they took out loans, while another 5 percent said they (the business owners or leaders) were not paid — presumably so employees could receive a paycheck instead.
Assil says this makes a lot of sense. Despite being contractors themselves, most construction companies have their own subcontractors to pay, as well as a laundry list of suppliers. “Once the owner [of the company hiring the construction firm] pays the contractor, the contractor first has to pay its subcontractors and suppliers hired for the project prior to paying himself,” she said. “Then he pays independent contractors hired by him to perform work at the project, and last but not least, he will pay his employees and laborers.”
One of the biggest challenges with this is, as previously mentioned, for 19 percent of construction companies, cash flow is a constant problem. Once they’re in the hole, it’s tough to get out. That kind of volatility can affect a company’s image, their ability to retain good workers and make it tough to plan for the future. No wonder 1 in 4 respondents viewed business growth as the biggest challenge they face when considering the effects of poor cash flow.
Know the Laws Where You Work
As a construction company owner or manager, it’s important to understand the laws of the state where you’re working and how those laws affect your right to receive payment, and when. The flip side of this is you should know what the developer/project owner’s rights are to withhold payment.
“Most states have prompt payment laws that govern the timeline, irrespective of contract terms, of when contractors must be paid,” said Assil. “For instance, there are state laws that provide if payment by the developer or owner of the project is dependent upon getting approval from the lender for the project, then once the lender approves the contractor’s invoice, the lender will distribute payment to the developer or owner out of the loan proceeds. Once the developer/owner receives the payment from the lender, the owner/developer must send such payment to its contractor seven days after receipt from lender of those funds.”
Another extremely important provision to be mindful of is whether your state’s statutes enforce “pay-if-paid” or “pay-when-paid” provisions, also know as “contingent payment provisions.” If you’re new to the field, contractual terms like these can be tough to deconstruct, but the meaning, essentially, is this: “Pay-if-paid” means contractors are only obligated to pay their subcontractors if they are paid by their client, shifting the burden of nonpayment to the subcontractor.
“Pay-when-paid” does not always pass on that burden, but rather tells contractors when they must pay their subcontractors. As the name suggests, the payment comes after they themselves are paid by the client. Therefore, a contractor can use a “pay-when-paid” clause as a justification for delaying payment to the subcontractor, but cannot use the clause as a justification to avoid paying the subcontractor altogether, no matter what happened with the payment from the project owner at the top of the of project’s payment chain.
For the owner of a construction company, it’s important to be aware of “pay-if-paid” or “pay-when-paid” provisions, in part because some states feel “pay-if-paid” provisions go against public policy. If your company is in a state where “pay-if-paid” provisions are fine and legal, it may be worth it to bring those clauses into the contracts you make with subcontractors, if only to spread out your own financial burden.
These are just a few of the state-specific contract provisions construction companies should be aware of as they make their decisions, particularly in regard to payments and payroll. Knowing how the laws of their area might factor into the overall plan may help a company owner better manage their cash flow.
The Cost of Doing (Bad) Business
A good contract can do more than outline an agreed-upon billing cycle. Should a dispute arise and a client fail to pay, an air-tight contract with a prevailing party provision covering attorneys’ fees of the substantially prevailing party of such a dispute may be all that keeps a company from having to pay out tens of thousands — if not hundreds of thousands — of dollars’ worth of attorney fees in order to battle out a dispute.
“This depends on a variety of factors,” said Assil, “including the venue for disputes (mediation, arbitration, or litigation), how large the amount of dispute is, and whether or not there are other parties involved in the action, which is the case more often than not on larger scale project claims. Attorneys’ fees will probably be the biggest cost of litigation, and those fees can escalate quickly if the scope of discovery in a matter is broad.”
Assil advises companies to try mediation first when a major dispute arises, as it’s the most cost-effective method, but only after filing a lien on the property. “The best way to go after the [client] is to file a lien on the property because they do not need an agreement to do so. They only need to have made improvements to and worked at the project site,” Assil said.
Construction companies that wish to place a lien on their client’s property will find this is the most affordable method since the only cost is if the state court has any filing fees.
“The owner of the project can purchase a bond to discharge the lien off the property,” said Assil, “but that won’t make the case go away. It’s merely a quick fix companies can use if their lender is really stern about having no liens on the property or if they want the property’s title to be free and clear of any liens.” [Note: This is also known as “bonding off” a lien.]
By putting a lien on the property, the construction company can force their client to come to mediation or settlement talks to solve any outstanding debts and ensure the project gets back on track.
An Ounce of Prevention Could Protect Your Cash Flow
Depending on the size of the project, construction companies have a few different options for preventing future cash flow problems. For instance, on large projects costing $100 million or more, many construction managers will insist their client provide a working capital account of several hundred thousand dollars. Within that account, “amounts are replenished on a monthly basis, to cover day-to-day general conditions costs otherwise reimbursable under the agreement,” said Assil. “These kinds of accounts typically help alleviate cash flow concerns.”
With smaller projects, construction companies can head off cash flow issues by requesting significant deposits and asking down payments be made at the start of their project — upwards of 20 to 30 percent of the total cost of the job. “When those down payments are made, contract terms regarding when owners are credited with those payments become the subject of negotiation,” Assil said.
Assil says many construction companies are also pushing harder to end the withholding of retainage once the job is over halfway complete. She believes they should insist on a release of retainage at substantial, rather than final, completion of the project.
Cash Flow Concerns May Be the Norm, But Should They Be?
Many construction companies have a cash flow problem, and that problem rolls into multiple aspects of their everyday business operations, from payroll to planning to future growth and prosperity. But being in constant fear of running out of cash shouldn’t be your company’s status quo. What can your company do to come out on top, even before the job is finished? Stay tuned for our response to this difficult question, as we take on cash flow solutions for your construction business.
Editor’s Note – A Proven Method to Speed Up Payments
Thank you to the entire team at TSheets for their work on this cash flow initiative. We’re grateful to have found a partner that shares our beliefs as to the importance of this issue.
After a decade in business helping tens of thousands of contractors, subs, and suppliers get paid on their jobs, we have seen first-hand the challenges faced by the industry, and as this article and the accompanying survey once again attest, one of the biggest is the pervasive slow-payment status quo that affects a majority of industry participants.
However, over that same period of time, we’ve also learned how even the most pervasive problems can be overcome by adopting available tools and best practices. And when it comes to speeding up your payments on a project, there is no better tool available than to proactively send preliminary notice. Our customers’ experience has proven time and again that the companies that send preliminary notice on their projects get paid faster than the companies that do not send preliminary notice.
Read more about the benefit of sending preliminary notices (as well as a couple of other helpful tips) in this article: “These Three Tips Will Get Construction Companies Paid Faster.”
And if you’d like to discuss this further, we’re available to talk. Our business is helping people like you get paid. Get in touch with us and let’s see how we can help you.