Cash flow is the lifeblood of any business, but it’s particularly critical for construction companies. And, in today’s economy, the construction industry’s typically modest profit margins are even thinner than usual. That’s why it’s essential to lay a solid foundation for healthy cash flow, starting with the contract. In many cases, it’s possible to negotiate contract terms that can accelerate the flow of cash.
Pay attention to payment terms
Payment terms have an enormous impact on cash flow. A contract that calls for payment on completion of specified phases of the project, for example, creates uncertainty, making cash flow forecasting difficult. A contract that requires payment in equal installments over the course of a project provides greater predictability but may not correspond to your expenditures on the job.
It’s not unusual for a construction project to involve significant upfront costs. If possible, negotiate a “front-loaded” billing schedule that reflects your greater cash needs in a project’s early stages. You might also ask for accelerated payment methods, such as wire transfers or electronic checks.
Limit retainage provisions
A 5% or 10% retainage can easily defer your entire gross profit on a job until after construction is completed. To reduce the impact on your 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 contract might provide for 10% retainage, reduced to 5% when the job is 50% complete and eliminated when it’s 75% 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.
Get change order procedures in order
As you know, change orders are an inevitable part of most construction jobs. It’s critical that 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.
Don’t let requisitions wreck you
It’s not unusual for a contract to disallow requisitions for materials until the materials have been installed. To avoid cash flow disasters, try to negotiate requisition terms that allow you to request payment once materials have been delivered to the job site.
Look both ways
Remember that cash flows in two directions, and outflow is just as important as inflow. (See the sidebar “9 cash-flow management tips.”) 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 retainage provisions in your subcontracts 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 sub-subcontractors should contain parallel provisions. That way, you won’t be forced to pay subs until you collect from the general.
Watch your language
Because contract terms can have a significant financial impact on your bottom line, you must review the language in all your contracts with an eye toward forecasting and managing cash flow. Whenever possible, negotiate terms that will enable your firm to maintain a healthy cash position throughout the life of each job.
9 cash-flow management tips
Although healthy cash flow begins with a carefully structured contract (see main article), there are several more ways you can avoid cash flow problems. Among other things, you should:
- Assess the financial strength and creditworthiness of the owner as well as other contractors, suppliers and vendors,
- Prepare cash flow forecasts and make any necessary adjustments during the course of a job,
- Monitor work-in-process reports, cash flow reports and other documents to spot cash flow issues while there’s still time to do something about them,
- Make sure your project management team submits paperwork and issues invoices on a timely basis,
- Develop working relationships with customers’ accounts payable personnel, staying in touch to ensure payments are on schedule rather than waiting until a payment is past due to contact them,
- 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,
- Not make payments to subcontractors, suppliers or vendors any earlier than required unless you’re entitled to a discount for doing so,
- Tie bonuses or other incentives to effective cash flow management, and
- Use sweep accounts or zero-balance accounts to maximize investment returns on your funds.
These are just a few ideas for staying on top of cash flow during a project. Whichever strategies you adopt, your employees must understand the critical role that cash management plays in your company’s success.