We all know that “cash is king” for construction companies, and, therefore, cash flow is the company’s lifeblood. Cash flow health is essential to mitigate the ever thinning profit margins, and the contract can be used as a blueprint for managing and maintaining strong cash flow.
Entryway: Construction Contract Payment Terms
It’s possible to negotiate payment terms that can accelerate cash flow. Negotiate a “front-loaded” billing schedule that reflects your greater cash needs in a project’s early stages since most require significant upfront costs. Also consider requesting accelerated payment methods, such as wire transfers or electronic checks. Meanwhile, avoid contracts requesting payment on completion of specified project milestones (which complicate cash flow forecasting), as well as equal installment payment contracts (which improves predictability but don’t necessarily correlate with job expenditures).
Also consider the impact of change orders, which are an inevitable part of most construction jobs. It’s critical that contracts establish clear terms and procedures for approving and paying them. Failure to do so may delay or negate payments.
Close the Door on 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 cash flow impact, consider one of these two ideas:
(1) 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.
(2) Limit retainage to certain job costs (such as labor) or eliminate it altogether through the use of letters of credit, performance bonds, or other security.
Create an Alternative Route for Requisitions
It’s not unusual for a contract to disallow requisitions for materials until those 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. 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 (and, when in doubt, have your construction attorney review the language) 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. Contact CRI to ensure that your business is maintaining a strong and healthy cash flow.