Cash is king in construction. Being able to effectively maintain cash flow throughout the project is vital to successfully completing a job. Sometimes this takes some creative maneuvering. One way this is accomplished is through the controversial, but common, practice of front loading a schedule of values.
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Schedule of values recap
A schedule of values is a list of work items representing the entire construction project from start to finish. The work line items are then each assigned dollar amount or percentage of the total contract price, based on labor, materials, and markups for overhead and profits. It is also a valuable tool to monitor progress and track progress payments.
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What is frontloading?
Front loading a schedule of values, (also known as front-end loading) refers to shifting the value of the contract to the beginning of the project. Rather than evenly distributing overhead and profits over the entire schedule, it’s common for construction businesses to shift a lot of the project costs toward the beginning of the project.
What’s the point?
Front loading is an attempt by contractors to offset any negative impacts on cash flow. This could be due to aggressive retainage practices, compensating for initial material and mobilization costs, or minimizing the risk of a slow-paying customer.
The construction industry is credit-heavy. Meaning, services are almost always paid for well after they’ve actually been completed. By invoicing a little bit more on the front end, that money helps to survive the (sometimes extensive) time between payments.
Is front loading fair?
That’s a tough question to answer. Anyone who has worked in construction long enough knows there is a long waiting period between submitting an invoice or pay app and actually receiving payment. This puts contractors at risk, particularly in the initial phases of the project, because they have to pay the mobilization and material costs to get the job off the ground.
This isn’t a complete and total accident, though. For owners, keeping the carrot out in front of the horse has its benefits. When a contractor and their subs are hungry for their next payment, it’s great incentive to keep the project on-budget and on-schedule.
Contractors and subs front loading their projects isn’t necessarily unethical or even in poor taste when it’s within reason. At the same time, billing for work or materials not yet furnished or intentionally overbilling is a great way to ruin relationships, and it could even get you into legal trouble.
What risks are involved?
There are risks involved on both sides when front loading takes place. Even when a “reasonable” amount of front loading is done, project participants all along the payment chain could find themselves in trouble, depending on the circumstances.
For parties who make payments
The biggest risk for parties who make payments is that too much will be paid too soon. If a schedule of values is front loaded and an issue pops up mid job or late in the project, there might not be money left on the table to smooth things over. Here are two examples:
Example 1: An owner pays their GC based on a front loaded schedule of values. The GC walks off the job after a dispute (or gets kicked off the job). If the owner wants to keep the project moving, they’ll need to coordinate their subs’ work, promote some stakeholder, or bring in another contractor. But, if the owner doesn’t have the funds to pay off the subs and suppliers or the money to hire another contractor, what gives?
Example 2: A GC pays their subcontractor’s front loaded invoices. Somewhere along the way, that sub hits financial trouble and requests more money. Since the schedule of values was front loaded, that contractor might not have enough left money left over to either pay that sub to finish the work, or to bring in a replacement. The contractor may have to do the work themselves or go out of pocket, and both are bad options.
It’s easy to see how this applies all the way down the payment chain. After all, it’s a chain. Actions by one party affect everyone else involved. So, even for those contractors and subs who keep things in check, some other party’s decision to front load their schedule of values could be problematic, and approving bloated invoices could be an expensive mistake.
For parties submitting payment requests
The biggest risk might be damaging relationships and your construction company’s reputation. Cash flow problems are present for everyone on the job (for better or for worse). Contractors and project managers usually have a pretty good feel for what costs should be – and they’ll probably be less inclined to work with someone notorious for front loading to an unacceptable degree.
Further, front loading a job could exacerbate cash flow problems later on. If the bid for work was too low, or if there’s an unexpected cost overrun, a contractor or sub could find themselves between a rock and a hard place. How would a request for additional funding look when a sizeable portion was paid up front?
There are also prompt pay law considerations that should be kept in mind. If a frontloaded task ends up being subbed out, what happens if those extra funds were used to float mobilization or materials? Under the Federal Prompt Payment Act, as well as many states’ prompt payment once a contractor receives payment, there are strict deadlines for releasing payments down the chain. If funds aren’t immediately dispersed, the contractor may have to choose between later paying out of pocket or risking a prompt payment claim.
Lastly, all federal construction projects and most state or county-owned projects are subject to some form of a False Claims Act. These are meant to prohibit any fraudulent or false requests for money from the government. Excessive frontloading may reach the level of overbilling. If found guilty of submitting a false claim, the contractor can be liable to steep civil and criminal penalties.
Communicating and collaborating diminishes the need for front loading
It’s extremely common for some degree of front loading to take place in any given construction project. But there’s plenty of risk that comes with front loading, particularly when issues arise after funds have been paid and spent.
What’s the path out? Better communication and collaboration.
If a contractor can be honest with their owner about their startup costs, or if subs can be more transparent, the need for front loading diminishes some. Further, when contractors and subs know they’ll be treated fairly at project closeout, and when they aren’t missing huge chunks of their progress payments due to questionable retainage practices, the cash flow fears subside (to a degree). Properly communicating and working with other project stakeholders can help avoid manipulation of the schedule of values, and that will help get a clearer snapshot of the project every step of the way.