As Business Picks Up, Cash Flow Is Critical

6/20/2016 - By Zachary Farrington

- This excerpt is from our Summer 2016 Dimensions Newsletter -

With many industry analysts projecting the remainder of 2016 to be a positive period for construction companies, contractors might feel they have good reason to feel optimistic. Ironically, this type of environment presents its own unique risks.

As you gear up for greater volume, cash flow management is critical. This is especially true when it comes to managing project start-up costs. Don’t let enthusiasm influence your judgment or lead you to assume everything will work perfectly. If you do, even a slight payment delay on one major project could lead to serious problems.

Choose Customers Carefully
One of the most dangerous mistakes an eager contractor can make is to take on a project without ensuring that funding is in place. Contractors that fail to verify project financing can find themselves acting as interim financiers, fronting the money for project costs while they wait months for payment. That’s a role few contractors are prepared to handle.
Start with a thorough credit check on the owner of the project. Be particularly alert to past litigation and any history of liens on older jobs. Your bank and bonding company can also be good sources of information. Under certain circumstances, they might be willing to approach the project’s lender for updated project funding information. If possible, get permission to confirm the project’s funding directly with the financing source and continue monitoring funding after you win the bid.

Get Off to the Right Start
Once you’ve won the contract, a good preliminary meeting with the project owner or developer and the lender can help prevent cash flow problems down the road. Discuss in detail how you will be paid and be clear about what documentation will be required. Subcontractors should conduct a similar meeting with the general contractor.

Lenders, sureties and owners are sometimes willing to negotiate certain issues, such as the amount of retainage or lender set-asides. Don’t be afraid to ask for an exception to standard practices.

One of the primary tools general contractors use to help reduce cash flow risks is the inclusion of “pay when paid” clauses in their subcontractor agreements. With these terms, subcontractors share some of the cash flow risk, since payment is not due to them until the general contractor is paid.

In preparing cost forecasts, general contractors should pay special attention to expenses that are not covered by such clauses. Examples include direct labor and burden, equipment costs, fuel, supplies and some project materials (depending on the contract).

Stay Vigilant
After work commences, contractors and subcontractors alike should be careful to pursue recognized best practices to maintain adequate cash flow. For example:

• Always invoice promptly. Be sure you understand the billing cycle of your payment source and schedule your invoices accordingly. Missing a cut-off date by just one day could cause a 15- to 30-day delay in payment.

• Document change orders thoroughly. Contractors must always be alert to requests that are outside the original scope of work. Document such requests immediately and thoroughly. Don’t wait and allow memories to fade.

• Submit change orders without delay. Waiting until the end of the project to submit batches of change orders greatly reduces your chances of getting paid in full. Once the work is complete, you have little leverage — and other cost overruns may compete for the remaining funds in the budget.

• Follow collections closely. Track pending invoices carefully and notify the payer immediately if payment terms are not met.

• Protect lien rights. The deadline for filing a contractor’s lien is set by statute. If you miss it, you no longer have a valid claim. To avoid misunderstandings, let the owners know in advance that you file liens automatically without exception whenever a deadline approaches.

Finally, stay informed about your payment source’s financial health. If you’re a general contractor, pay attention to the status of other projects the owner or developer is building. If you’re a subcontractor, stay alert to the contractor’s standing among other trades. Keeping your ear to the ground can provide valuable early warning of an imminent problem.