Big Risks, Slow Rewards

Avoid the headaches of slow-paying construction accounts and keep the cash flowing

Big Risks, Slow Rewards

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Maintaining cash reserves and cash flow are challenging for many contractors, particularly those working in the commercial arena, where payment is typically issued after the work has been performed. The waiting is the hardest part, as general contractors and property owners can take 45 to 60 days or more to issue payment. Meanwhile, payroll needs to be issued weekly or biweekly and your vendors often refuse to wait more than 30 days to receive their money. So management of all this can be taxing.

But, according to construction industry experts, lackluster project management and failing to be in front of the fine details associated with commercial work is a major contributing factor impacting cash flow and, thus, cash reserves for portable sanitation, pumping or onsite installing contractors.

“General contractors are programmed to withhold money from subcontractors if everything is not done just right,” says Fritz Marth, senior managing consultant at Greyhawk, a New Jersey-based project management and consulting firm. “On public projects in particular,” he notes, “there’s normally a substantial amount of paperwork, and having a firm grasp on the flow of the paperwork and the timeliness of submitting it is important to timely payments.”

Stay on their case

Even if contractual paperwork is submitted appropriately and timely, it is wise to follow up in writing after each submission to ensure the general contractor or property owner has received it and it is complete. Having everything documented protects you should a customer come back subsequently and say they didn’t receive something in a timely order.

Commercial projects typically have the same due date each month for invoices. If a document is missing or wasn’t submitted on time, you run the risk of missing that month’s cycle and not receiving payment for another 30 days.

While the paperwork requirements vary from project to project, typical required documents include the signed contract or purchase order, insurance forms, schedule of values, submittals, schedules, lien releases, warranty documents, and labor rate forms.

Ensuring projects are complete and punch list items are promptly addressed is critical to maintaining healthy cash flow. “Contracts in the construction industry are written largely to protect and benefit the general contractors issuing them,” says Tina Ray, project manager at Amento Group, a Seattle-based construction industry consulting and dispute resolution firm.

“Many contracts are written such that a substantial amount of money can be withheld if the work to be invoiced is not fully complete.” What that means, Ray explains, is that a lot more than 1 percent can be withheld if 99 percent of the work is complete. “It’s important to understand the contract terms and conditions when it comes to payments and substantial completion so you don’t get caught by surprise when it comes to release of funds.”

Room to negotiate

Working with a small group of suppliers and maintaining good relationships is another way to help cash flow. While standard terms from most suppliers and manufacturers are net-30, some suppliers and manufacturers will work with you and be flexible if you are a loyal customer. Fostering a good, lasting relationship with both sales and credit reps can help substantially when negotiating more flexible terms. The objective, naturally, is to pay vendors once your payment has been received on that particular project.

Subcontracts and purchase orders are written with terms and conditions that help general contractors, but there’s often room to negotiate to help with cash flow. When evaluating a new contract, Seth Schimmel, a Tampa, Florida-based construction law attorney with Phelps Dunbar, advises focusing on a couple of terms and not redlining every item you have a small issue with. “If you start bringing up too many issues, general contractors are going to be less likely to work with you because a lot of subcontractors are willing to take on a substantial amount of liability,” he says. “But if you carefully address a couple of items, then most general contractors will be open to work with you if you are competitive and have a good reputation.”

One item Schimmel suggests trying to negotiate on commercial contracts is retainage, the contractual term that withholds a portion of each progress payment earned by a contractor until a construction project is complete. Retainage is calculated as a percentage of each progress payment, typically 5 to 10 percent. The problem, however, is loose ends on a construction project can remain untied for months, and that can hold up retainage payments for every contractor working on the project.

“It’s typically better to take a few points less on the overall contract than it is to get a higher number but have retainage included,” Schimmel says. Retainage of 10 percent can equate to 30 or 40 percent of the profit, and then you have to devote time to following up and chasing down that money. It puts you in a better cash flow position normally to give up a couple percentage points to ensure the full invoice will be paid when it’s due.

A comfortable cushion

A healthy cash flow is directly related to the amount of cash reserves a given business needs for a comfortable cushion. While there is no hard and fast rule to determine the magic number, businesses in construction should strive for a six-month reserve to account for industry volatility and payment delays.  

“You need to be able to maintain payroll and sleep well at night in the event a big customer doesn’t pay your invoice or sales decline considerably during a recession,” Ray says. “Unexpected events are not uncommon, and a sufficient reserve will help you weather the storm long enough to make appropriate adjustments to your business.”

Relying on a line of credit to maintain basic obligations like payroll and vendor payments is a red flag that a company is not in good financial health. “A line of credit should never be a go-to tool for keeping the lights on,” she says.

At the same time, there is a point where a company can have too much in cash reserves and that’s not wise either. In general, liquidity that exceeds a reasonable safety net won’t hurt the business, Ray says, but she has seen companies flush with cash also overspend. She notes large sums of cash sitting on the sidelines for extended periods won’t help a company grow because some capital should be invested in the business.

“It’s a delicate balance between having a good safety net of cash and having too much capital,” she says. “And often only the business owner and senior management really know where that sweet spot is.”



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