How Contractors Can Avoid a Cash Flow Crisis

Cash flow has always been a major concern for contractors. With today’s competitive business landscape, smaller margins and tighter credit standards it’s more important than ever to establish policies and procedures for collecting timely payments.

When a construction contract is awarded, a contractor typically has to allocate additional time, effort and money to identify subcontractors, order materials and put field crews in place. During this early flurry of activity, however, many contractors pay little attention to the process of capturing payments. The problem is, waiting until a project is well underway to address cash flow is risky. A single job that is significantly unpaid can potentially ruin the entire year – or even worse, put your company out of business.

Poor cash flow doesn’t need to jeopardize your company’s livelihood. With a bit of proactive planning using the advice below, you can eliminate most obstacles associated with receiving payment.

Perform a Contract Review

Before signing the contract, understand exactly what you’re signing. Be wary of no-lien contracts, for example, or waiving all lien rights up front. It’s a good idea to add your own amendments to the contract if possible because issues such as schedule delays and prevailing wage rate increases can affect your costs.

On some projects, retainage is flexible but don’t expect the owner or general contractor (GC) to offer a reduced percentage. During contract negotiations, do your best to minimize retainage by asking for a lower rate. If you are working directly with the GC, try to negotiate the same retainage percentage that the GC has with the owner. You don’t want to reach the end of the project and have the GC holding 10 percent retainage on your subcontract when the owner is only holding 2 percent on the GC’s contract.

If you’re unsure about a clause in the contract or aren’t comfortable with some of the language, consult an expert before you sign. It’s an expensive endeavor to litigate contract disputes after the ink is dry!

Identify the Four R’s of Billing

Once the contract is in place, you’ll want to identify the four R’s of project billing.

Right person – Who needs to receive your billings? Depending on the company, your key point of contact could be the project manager, office manager, controller or another employee. For expediting payments, make sure your invoices go to the right person.

Right place – Where should you send your invoices? Mailing a progress billing to a satellite office when checks are cut from the corporate headquarters could cause a payment delay. If e-mailed invoices are acceptable, it doesn’t make sense to physically mail your billings.

Right forms – What payment application forms and additional documents are required for the project? To ensure prompt payment, identify whether AIA or alternate billing forms are required and always submit your invoices on the correct forms providing additional required documents if needed (prevailing wage reports, waivers, etc.).

Right time – When does your billing need to be submitted? Knowing when checks are cut and how long invoices spend moving through the approval process allows you to time your billing submissions to optimize the payment lifecycle.

In addition to identifying the four R’s, take the initiative to follow-up once your invoice is sent. An invoice approval delay due to an outstanding question can significantly affect your cash flow.

Manage Your Receivables

Review your accounts receivable on a weekly basis and put an experienced person in charge of collections. Contractors with consistent cash flow usually aren’t having to chase money that’s three months past due because they stay on top of payment delays by regularly monitoring receivables.

Put some thought into identifying the best person in your organization to manage your receivables and pursue collections. Choosing someone with the right temperament for this particular task is important. It takes a firm and commanding individual to successfully collect past due payments.

Track Liens and Waivers

To protect your company when submitting a signed waiver with a draw request, be clear that you’re only releasing lien up to the amount of payment received. In addition, consider adding a footnote stating that the waiver only becomes effective upon receipt of payment.

If the project has multiple lien levels, failure to collect waivers from second tier subcontractors and suppliers could delay payment. Put a process in place for tracking these waivers and submitting timely documents, such as Notice of Furnishings statements.

Get Retainage Released

As a project nears substantial completion, ask for partial release of retainage if the contract supports that request. If not, make it a priority to tie up loose ends. Get sign-off on unapproved change orders so you can bill for them. Complete your outstanding punch list items. And submit your as-builts and warranties.

Retainage often represents the profit for the project. Do everything you can to complete your contracted obligations and get the final money released.

Evaluate Your Cash Flow Tools

Many contractors use spreadsheets to track the vital details related to cash flow. But using construction-specific software to manage the processes outlined allows you to automate the many steps toward payment and gain visibility into areas that need improvement.

Process improvement through historical data tracking is an excellent way to grow business but difficult to do using spreadsheets. Construction-focused accounting software gives you the historical perspective to identify the types of jobs that drain cash flow and the owners or GCs that pay slowly. This information allows you to make decisions that ultimately will optimize your cash flow.

Contractors will often attempt to utilize generic accounting software and spreadsheets but quickly realize it doesn’t address the complexities of construction. Tracking retainage down to the penny, tracking or generating progress billing and having associated notes that outline what is required for final payment can only be done with advanced construction accounting software.

Building Best Cash Flow Practices

Managing your business to optimize cash flow is an evolving process. At the end of each job, ask yourself what you learned and what you could have done better. Then, take action to improve and refine every aspect of your process, from contract signing to receipt of final payment.

Don’t hesitate to consult a professional for advice if needed, or replace inadequate technology. The investment you make up front to establish best practices for cash flow management should yield a significant return on investment while giving you a better chance of avoiding a cash flow crisis.