Construction professionals are all too familiar with the payment issues that plague the construction industry. Contractors, subcontractors and material suppliers often have to deal with payment delays and even nonpayment—affecting cash flow and their ability to meet expenses.

According to an Atradius study, a quarter of all B2B invoices issued in North America are overdue. The construction industry accounted for one-third of those past-due invoices, and many contractors and construction business owners do not have a positive outlook on the industry's payment issues. The same survey found 55% of U.S. firms think there will be no change in the industry’s payment practices over the coming months—one-third even expects an increase in late payments.

These findings show that managing cash flow is a significant challenge in the construction industry. Having a negative cash flow will push the company toward financial trouble, which may ultimately lead to its demise. Understanding the reasons why payment issues persist in construction will help contractors protect their business, prevent these issues from happening or at least minimize their effect on the current operations.

Here are some of the reasons why late payments are the norm in construction.

1. The industry’s hierarchical payment structure

Slow payment issues in the industry can be traced back to the way construction billing works. Construction contracts follow a hierarchical framework in which payment accountabilities start from the top stakeholder, such as the property owner and the general contractor, followed by a series of subcontractors and finally to the material suppliers.

The duration of construction projects makes credit transactions a necessity for labor and material supplies. For this reason, subcontractors with little cash on hand may need to wait to get payment from contractors higher in the hierarchy before they can pay their subcontractors and suppliers. In cases where their clients fail to pay, subcontractors may need to file a mechanics lien just to get paid for the work they have done on a project. This is why it’s best practice for subcontractors, material suppliers and, in some cases, even general contractors to secure their lien rights by filing appropriate pre-lien documents.

In general, property owners and general contractors, who are at the top of the chain, will want to make sure everything is in order and the contract is followed before proceeding with the payment. This ensures no double payment will happen and there will be no filing of liens from stakeholders in the lower part of the chain.

2. Communication issues

Since every construction project has multiple contracts signed by multiple parties forming a hierarchical payment structure, not only is the payment process prolonged, but communication issues are also rampant among stakeholders.

Contracts often do not contain provisions that can help participants address issues encountered when the project has begun. One common occurrence is when a contractor has to do something that’s required to complete the project but is beyond the scope of the original plan. For example, there’s too much underground water that needs to be pumped out. Draining this water will incur additional costs. If the contract does not state which party will shoulder the cost, it will lead to a payment dispute.

3. Competitive bidding process

One of the unique aspects of the construction industry is the competitive bidding process. Most construction projects are secured by contractors through a bidding process during which they promise high-quality work at the lowest price. This allows the project owner to determine the cost of the project before it starts. However, this can also lead to a conflict between the parties.

When the construction project begins, the winning contractor may negotiate with the owner to avoid incurring heavy costs. For example, the contractor may convince the client to choose a cheaper material that is different from what is specified in the plan. The client may also think that the work done is subpar or inconsistent with what was promised during the bidding process. Conflicts like these lead to payment disputes.

Final thoughts

The fundamental structure of the construction payment process gives rise to issues that lead to payment delays and even nonpayment. It can be quite challenging for contractors to get paid, especially subcontractors and suppliers located at the bottom of the payment hierarchy. Stakeholders need to have a firm grasp on the reasons behind late payments to address them effectively. By understanding why late payments tend to be common in construction, business owners will be able to take the necessary steps to manage cash flow and maintain positive working capital.