All businesses experience the ebbs and tides of cash flow at some time or another. But it can be particularly hard if your construction company is experiencing hard times. Fortunately, the very document you sign when starting a job can help you turn that tide around.
Pinpointing payment terms
Payment terms have an enormous impact on cash flow. A contract that calls for payment on completion of specified phases of the project, for example, creates uncertainty — making cash flow forecasting difficult. A contract that requires payment in equal installments over the course of a project provides greater predictability but may not correspond to your expenditures on the job.
It’s not unusual for a construction project to involve significant upfront costs. If possible, negotiate a “front-loaded” billing schedule that reflects your greater cash needs in a project’s early stages. You might also ask for accelerated payment methods, such as wire transfers or electronic checks.
Before you even start a job, assess the financial strength and creditworthiness of the owner as well as other contractors, suppliers and vendors involved. Doing so can give you a better idea of whether the payment terms are realistic.
In addition, many contractors find it helpful to prepare project-specific cash flow forecasts to get a better idea of how the payment terms will affect their overall financial positions going forward.
A 5% or 10% retainage can easily defer your entire gross profit on a job until after completion. To reduce the impact on your cash flow, try to 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.
Clarifying change orders
Change orders are an inevitable part of most construction jobs. It’s critical that your contracts establish clear terms and procedures for approving and paying them. Train your staff to identify changes in the scope of work and to promptly prepare and document change orders in accordance with contract terms.
Contracts often disallow requisitions for materials until the 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.
Remember that cash flows in two directions, and outflow is just as important as inflow. If feasible, don’t make payments to contractors, suppliers or vendors earlier than required unless you’re entitled to a discount for doing so. Try to negotiate payment terms that, to the extent possible, match your cash outlays with your receipts from the owner or general contractor.
Reading the fine print
When entering into a contract, it’s essential that you read every word, especially the fine print, and clarify any ambiguous terms. Your financial advisor can help you apply these and other ways to ensure your contracts strengthen, rather than weaken, your cash flow.
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