Understanding Cash Flow in Construction Management
One of my advisors recently asked, “Which clients do you need to break up with?” My immediate answer was none of them; we are happy to help all of them and appreciate their business. Upon further thought, I decided the “happy to help” and “appreciate their business” were correct. Yet those unwilling to follow our proven process or whom we always have to keep calling to get paid don’t respect us as the others who understand how it affects our morale when working with them and the business we have to sustain when we have to be in the collections business.
Navigating Payment Challenges in the Construction Industry
Several of the subcontractors we work with have shared their anguish at getting paid and the stress it causes in their small businesses. This pattern in our industry most often happens when our economy is in question, as it is currently. Although the pay-when-paid clause in construction legally protects the general contractor from outlaying money when an owner has not paid for the work completed, projects are built by trade contractors, and they must carry the burden and cost of time. Many times over the years, the former business owners I met who closed their subcontracting firms stated, “I was tired of chasing money,” as the reason they folded. Despite their level of business acumen and ability to obtain sustaining credit lines, it just wasn’t worth the effort any longer, and they are now doing something else. Sadly, we lose excellent business and people managers to other industries as they get soured on ours, especially if it affects their home lives.
None of us who work in construction or as a service arm to the construction industry are in the collections business. This includes general contractors seeking to collect from their owners. How does this cycle improve for everyone?
Understand the “Food Chain,” as It Is Called in Construction
“He who has the gold rules” is well-known by everyone. Who is that to your company? In construction, it is not always who you sign the contract with; it is the owner of the project. Sometimes, that owner is the developer or development manager, and sometimes not. Even if you have a contract with a general contractor or are a sub or vendor to a subcontractor working for a general contractor, and you have terms with them, they may be at the mercy of who their contract is with and the contract and relationship tied to the initial money being released. That initial cash amount released, starting from owner to construction management firm, then gets cut each step down the line until it gets to your respective place in line. If you are a subcontractor to a subcontractor, then you, for sure, know the pain of trying to make payroll, attract the top trades, and meet your manpower obligations when not on a consistent payment schedule. Often, construction management and accounting professionals who are your contacts following initial negotiations do not understand the repercussions of the choices they make when it comes to getting you paid or delaying payment at another’s request.
Importance of Prompt Payment Laws in Construction
How Payment Affects a Project and the Industry Itself
When it comes to getting paid, one of the suggestions Construction Executive’s online article covers is to put prompt payment laws into effect, which includes following the lien law process in most states. They further explain:
Prompt payment laws are a set of rules included in the federal and state laws that ensure payment is made to contractors and suppliers in a timely fashion. These laws specify the time when payments should be made through the payment chain and limit the time period where payment can be withheld. They may also provide rules regarding penalties or interest incurred when payment is delayed. The rules relating to prompt payment vary from state to state, so contractors need to make sure they comply with the requirements set by their state laws.
Despite the prompt payment laws that have helped with eventually collecting, it does not solve the cash flow issues while enacting them, including stress and employees going elsewhere if payroll is challenged in the interim. Larger companies have the capital to sustain, and they budget for challenges that might occur, even with typically timely and consistent payers, yet small businesses in our industry often fold because they can’t hold out. Just recently, a couple of the municipalities went from a typical thirty-day cycle to almost sixty days, and although the subcontractors got their money, the smaller companies that the general contractors did not help fund could not take on other projects, lost workers, and, ultimately, are still in business on paper but down to a core team to sustain the company.
Do Your Part to Keep Others in Business
In September of last year, I wrote a blog post called Construction Accounts Payable – More than the Bottom Line to provide a tool to use when hiring the person responsible for your accounts payable. The accounts payable role is one of the most important jobs at a construction company. A company that hires someone who understands how to communicate with you (or whoever approves payments for release) and all parties when payment is an issue is invaluable to our industry and the success of all parties, financially and relationally.
Strategies for Improving Cash Flow in Small Construction Businesses
If you are responsible for negotiating contracts, understanding how the payment process, payment schedule, and overall estimated profitability of the project aligns with your scope of work and business model is critical. Often, a subcontracting company has a Go No Go established, with questions like: “Is the contract type the same type we are used to?” (This is a pay-when-paid contract, whereas other contracts have negotiated payment terms for cash flow.) Other questions, such as, “Do we know how the project is funded?” and “How will payment be released to the contractor and ultimately to us?” should be on every contractor’s Go No Go. If you do not have a Go No Go in place to help you determine the right projects to take, here is a sample. A Go No Go with the questions answered by two or more people in your organization creates accountability and buy-in and helps prevent an individual from taking a job because of sales pressure or other emotions. Rather, it reveals the facts of the risk involved despite how exciting the project might be or how heightened their desire to work with the company offering the project.
Cash Flow Impact on Construction Project Profitability
One of my sayings for the construction industry is, “Just because you have a project does not mean you have a business.” We have met many construction managers who formed corporations or LLCs because they were given a project and needed an entity to build it under, and that was the launch of a business—in name. They may have been able to get a second or a third project, yet sustaining and growing the business requires cash flow to cover expenses that are less than the income and the ability to save for a rainy day. Labor is the largest expense and talented labor is the rarest commodity these days—both at trade and management level.
Reciprocity and Relationships in Construction Management
Reciprocity is exchanging things for mutual benefit, especially privileges granted from one organization to another. Reciprocity in our industry goes a long way, and relationships make the difference between mutuality through good times and bad. After all, the last thing we need is to lose more people to other industries as they are tired of doing the good work yet having to chase the money. Those people always have choices over those who don’t do good work and cost everyone money and years off their lives.
To Knowing Who Is Signing the Check and When,
Suzanne Breistol
