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Cash is king, and cash flow couldn’t be more important in construction. Contractors and subcontractors face steep costs upfront, well before any work is invoiced. From there, cash flow concerns continue in an industry historically home to slow payments and payment disputes.

Even when everything goes right, construction budgets tend to be tight, shoestring affairs. Issues like a dispute on some other part of the project, a dodgy customer or an uncooperative lender could screw up everyone’s cash flow.

Because construction cash flow is such a fickle thing, it’s crucial that businesses’ set themselves up for success. By doing that, contractors ensure they’ve done their part to maintain a healthy business. However, if contractors are waiting until work begins, it’s already too late. Here are some ways contractors can set themselves up for cash flow success before hitting the jobsite.

Ease the Pain of Mobilization

 Contractors and subcontractors carry extensive mobilization costs. Vendors typically require payment well before the first invoice even gets issued for the contractor’s work (and long before the first progress payment is received). The result is that contractors and subs end up carrying the credit burden for the beginning of their projects.

One of the best ways to cover mobilization costs is by requiring a mobilization deposit. The customer knows there will be upfront costs, and requiring a little money to pay for those costs can make life a lot easier at the beginning of the job. Including mobilization language in the contract is a great option. While there may be pushback from customers, if you can itemize the expenses the mobilization costs will go toward, it should be hard to form a coherent argument as to why mobilization costs shouldn’t be paid for upfront.

Another option is to use credit lines from the supplier. This is extremely common, and if credit lines aren’t already being used, it’s certainly worth a discussion. Many vendors will be willing to work with their customers—especially the reliable and organized ones with good credit. Ultimately, these suppliers benefit from keeping their customers in business, and many will be interested in keeping customers’ cash flow healthy.

Yet another option for reducing the cost of mobilization could be to finance the materials. By financing materials, contractors and subcontractors get the materials they need with a payment schedule more similar to the timeframe when they will get paid. The cost of these programs is generally pretty comparable to the cost of credit lines with the suppliers. However, suppliers like the idea of getting paid full price really quickly. They’re also motivated to keep their customers’ businesses healthy and coming back for more materials. They may be able to connect contractors with a preferred partner for this sort of arrangement, or they can at least grease the wheels to make it work.

Avoid Pay If Paid and Pay When Paid Clauses

If at all possible, contractors and subcontractors should try and negotiate their way out of pay if paid and pay when paid clauses.

Pay when paid clauses change the timeframe for payment: under a pay when paid clause, a contractor gets paid after their customer receives payment. However, payment must still be made in a reasonable time, even if the customer never gets paid. That’s why a pay when paid clause is generally referred to as a “time shifting” provision, because it simply changes when the payment will be made.

Under a pay if paid clause, the entire risk of nonpayment gets transferred down the payment chain. If their customer never gets paid, payment is never owed to the contractor—even if that contractor performed all of its work and upheld all of its responsibilities. Because this changes more than just the time frame for payment, it’s called a “risk shifting” provision.

Under both clauses, a contractor and their customer’s accounts receivables become interlocked. This is true despite the fact that the contractor doesn’t have much transparency into their customer’s accounts receivables or their process for recovering payment. Accepting someone else’s risk is a scary and unfair proposition, and so is accepting poor cash flow for the business when the contractor has held up its end of the bargain.

Clarify Change Order Expectations and Procedures

Change orders are a common source of payment disputes. They can crush cash flow when they’re not properly compensated. Nobody wants a reputation of being hard to work with, and it doesn’t always make sense to be an absolute stickler for minor changes. At the same time, small changes and extra work add up. It’s extremely common to have tight profit margins on construction projects due to competitive bidding processes. If cash is flowing out to cover changes, but cash isn’t flowing back in to pay for those changes, it doesn’t take much to alter the economics of the project.

The best way to avoid change order frustration during the job is to talk about it before the job. Discuss the expectations surrounding extra work, change order approvals, and the documentation of both. If it’s clear how the additional work will be accounted for and compensated, and if it’s clear what documentation should be present and executed, there’s not much room for dispute later on when the change orders start flowing.

Conversation is good, but change order processes should really be established in the contract, itself. That doesn’t mean some complex process needs to be laid out, though. A few simple sentences are all it takes to lay out who has the authority to approve changes, how the payment for extra work will be calculated, and how the whole process should be documented. Including a simple change order form right there in the contract could really simplify things, and there are tons of sample change order forms available online.

Talk About Retainage

Speaking of cash flow, it pays to discuss retainage before the job. All too often, retainage is treated as an afterthought, despite the fact that it could be the difference between a profitable job and losing money. Contractors assume that, if the work is done and done right, then retainage will be paid without issue—and that’s usually true. However, contractors may be putting far too much faith in the other stakeholders on the job. Even if that retainage eventually gets paid, late retainage payments could throw a wrench into expected cash flows.

Commonly, a contractor’s retainage being paid is wholly dependent on their customer’s receipt of retainage. But really, retainage represents amounts owed but not paid to a contractor for their work which they’ve already completed. And, if there’s no issue with that work, there’s no reason the contractor should have to wait for it. It may make sense for a customer to withhold certain amounts to cover potential latent issues, but there are probably other contract terms to protect against that sort of thing (like warranties on the work & construction defect regulations).

The timeframe for retainage payments and the process for collecting retainage should be laid out in the contract, just like change orders. The agreement should stipulate what percentage is being withheld, when that retainage payment will be paid, and what factors will affect whether and when retainage gets paid out. But retainage should actively be discussed between the parties—just like with change orders. When there’s an open discussion about retainage early in the job, it will be easier to revisit the conversation later on if there’s an issue.

Preserve Mechanics Lien Rights by Sending Notices

Mechanics lien rights exist for a reason. No one likes to talk about them, but they’re a necessary part of the construction ecosystem. Lien rights are specifically designed by lawmakers to strike a balance between the interests of construction businesses and property owners. Part of that balance is the preliminary notice, and these notices are required to preserve lien rights in the majority of states.

Preliminary notices were created so that owners, lenders, and general contractors wouldn’t get blindsided by mechanics liens they didn’t know were coming. These notices inform necessary stakeholders that the sender is working on the job, and that they’ll ultimately have to be paid—or else a mechanics lien may be filed. By sending preliminary notices, contractors show their commitment to protecting their cash flow.

Preliminary notices shouldn’t be personal, and they shouldn’t negatively impact relationships. They should be a matter-of-fact business process, and customers should know that you have no plans to leverage or use lien rights unless it becomes absolutely necessary. By the time cash flow issues reveal themselves on the job, it’s probably too late to try and send notice and preserve lien rights—so ensure that those rights are preserved from the jump by sending a preliminary notice.

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