Negative cash flow 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 cash flow is negative.
Negative cash flow is when the construction company 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.
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 tendered at anything less than a 10% profit 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 the construction company could have paid out up to seven weeks of wages before the client pays for the work that these personnel have completed. Smaller contractors sometimes have to pay suppliers before they will release materials.
There are, however, a number of other factors that make the cash flow 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 cash flow situations worse by submitting their progress valuations late, accepting payments late or not claiming fully for completed work.
To improve the cash flow situation construction companies must submit their monthly progress valuations on or before the due date. Some clients only run 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 required supporting documentation since many clients will use any excuse to delay or reject a monthly 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 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 they are 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 to improve their cash flow.
Other useful articles by the author include:
Construction project variations – have you included all your costs?
What you need to know to close-out your construction project successfully
The construction project manager’s financial duties
The importance of maximising monthly valuations on your construction project
Financial checks and controls on construction projects
Thank you for reading this article. I hope it was useful. Please add your comments and share it with others.
(Paul Netscher is the author of the acclaimed books ‘Successful Construction Project Management: The Practical Guide’ [a required text for Bachelor of Construction Management at some universities] and ‘Building a Successful Construction Company: The Practical Guide’. Both books are available in paperback and e-book from Amazon and other retail outlets. This article is adapted from information included ‘Building a Successful Construction Company’. To find out more about how Paul Netscher can do for your company Read)
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Copyright 2016 - The attached articles cannot be reproduced for commercial purposes without the consent of the author.
The opinions expressed in the attached articles are those of the writer. It should be noted that projects are varied and different laws and restrictions apply which depend on the location of the contractor and the project. It's important that the reader uses the supplied information taking cognisance of their particular circumstances. The writer assumes no responsibility or liability for any loss of any kind arising from the reader using the information or advice contained herein.
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