Negative cashflow probably causes more construction companies to run into financial trouble (leading to their closure) than any other cause. Even a profitable construction project can cause a company financial problems if the cashflow is negative.
Negative cashflow is when the contractor is paying money to suppliers, equipment hire companies and subcontractors, or in wages and salaries, before the client has paid for the work that has been completed. In effect they are paying with money they haven’t yet received from their client.
Unfortunately most construction projects are usually cash negative to some extent. Many clients hold 10% cash retention until the end of the project when this is reduced by half. Consequently if the project is priced with less than a 10% profit, then the project is usually automatically cash negative until the end of the project.
In addition, most clients only pay the contractor thirty days after the contractor submits an invoice. These invoices are normally submitted at the end of each month. Many contractors pay their workers fortnightly, or in some cases weekly. This means as a minimum the contractor has paid out up to seven weeks of wages before the client pays for the work that these employees have completed. Smaller contractors sometimes have to pay suppliers before they release materials.
There are, however, a number of other factors that make the contractor’s cashflow situation even worse. Many construction projects have payment terms longer than thirty days. In addition some clients habitually pay progress claims late, or not in full. Of course, the ultimate knockout blow for many construction companies is when clients don’t pay at all. This could be a result of the client disputing the value of work, defaulting on the contract, or going into liquidation.
Yet, even with the odds stacked against construction companies, they often make their cashflow situations worse by submitting their progress valuations late, accepting payments late, or not claiming fully for their completed work.
To improve the cashflow situation contractors must submit their monthly progress valuations on or before the due date. Some clients only process progress payments on a particular day in the week, or month, so missing a submission date could cause the client to delay payment by up to a month. The valuations must be submitted in the required format and with the requisite supporting documentation, since many clients will use any excuse to delay or reject a monthly payment claim.
It’s important to track the progress of the payment through the client’s payment system. With major clients there may be several people that check and approve the valuation and payment. Sometimes, the process is disrupted when someone is absent, or the claim simply gets ‘lost’. I’ve had more than one client who consistently paid progress claims late, always with some excuse about our valuation being late, the claim being incorrect (either arithmetic errors, insufficient supporting documentation or disagreement with our progress) and people in the approval process being absent. Of course many of these problems were only reported to us when the payment was due, despite the client having had the payment claim for thirty days.
Some contracts are structured such that payments are only made when the contractor achieves particular milestones. It’s important that Project Managers understand what these milestones entail and ensure that they’re met. It’s obviously pointless to achieve 99% completion if payment is only made for 100%. Often contractors take several weeks to complete the last few items (which may just be completing documentation), which delays payment.
In forth coming articles I’ll suggest other steps that construction companies can implement to improve their cashflow.
Do you want to learn more?
Paul Netscher has written several acclaimed easy to read construction management books for owners, contractors, construction managers, construction supervisors and foremen. His books include ‘Successful Construction Management: The Practical Guide’, and ‘Building a Successful Construction Company: The Practical Guide’, and ‘Construction Management: From Project Concept to Completion’. These books are available in paper and ebook from most online stores including Amazon. Paul Netscher is also available to help your construction project or company. Visit www.pn-projectmanagement.com for more info.
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