A recent survey report found that half of contractors in the US aren’t getting paid on time. Payment delays, combined with industry-specific practices like retainage, cause contractors to make decisions that can put more pressure on accountants in the construction industry. In this article, we look at some of the impacts that slow payment is having on contractors’ books, and how construction accountants can help.
- Nearly 50% of contractors deal with retainage in excess of 10%.
- More than 40% of the respondents make payments to subs, suppliers and laborers before they are paid by the hiring party.
- Only 4% of respondents always get paid deposits upfront for work.
- 23% of contractors said it takes over 2 weeks to recover after a cash flow problem. (26% said it takes more than a month!)
- More than 58% of contractors surveyed have filed a mechanics lien to get paid.
Slow Payment Stresses Cash Flow
In the construction industry, it takes 83+ days to get paid on average. This delay makes it more difficult for contractors to make projections, plan for new projects, manage AR and AP, and pay for labor or supplies.
Once used to pay suppliers and staff before the first progress payment comes in, deposits have now all but dried up in the construction industry. Only 4% of contractors say they receive up-front deposits on projects. At the same time, 42% of contractors say they pay their suppliers before they get paid themselves. This means accountants will need to help the contractor plan for an immediate outflow of cash on a project.
How to help: Give the contractor an accurate picture of their cash outflow during the first several months of a project before the first progress payment comes in.
Possible solution: Encourage the contractor to ask the GC or owner to pay supplier invoices directly, so they aren’t drawing down their cash reserves or relying on interest-bearing loans to meet material expenses early on.
The stress doesn’t end when the project finished, however. In the survey, 57% of contractors say a percentage of their full payment is “always” or “sometimes” withheld as retainage (also known as “retention”).
A practice unique to the construction industry, retainage is money withheld by the GC or property owner — typically 5-10% — until the entire project is finished. Contractors often have to wait until months, or even years, to recover the retainage.
With profit margins in the industry averaging under 5%, it means that some businesses may be operating in the red until they get the retainage payment. Construction accountants can help prepare their clients for this scenario ahead of time. Contractors will need to have enough cash on hand, or have access to credit that can help them through periods of negative cash flow.
How to help: If waiting for retainage will cripple a contractor’s cash flow, they can try to secure a retention bond to avoid withholding by the GC. The contractor will need to make the premium payments, so this option may only make sense on bigger projects where retainage makes up a significant portion of their cash flow.
Possible solution: Encourage the contractor to ask for better retainage terms in their contract. That might be a lower retainage rate overall. Or they can request variable retainage, where the rate is reduced after a certain percentage of the project is complete. If the contractor has a history with the GC, ask for retainage to be waived.
Lenient with Late Payers
Part of the reason construction payments keep getting slower and slower may be that there are few, if any, repercussions for higher ups on a project. In the survey, 78% of contractors say they “rarely or never” charge interest on late payments. More than half actually give discounts to late payers in an effort to get anything at all.
At the same time, contractors rely heavily on credit lines to meet expenses while they wait for payment. In the survey, 51% of respondents said they use business credit or savings to pay their bills. Even more worrisome, 34% said they use personal credit cards or savings accounts.
How to help: Ensure the contractor understands the full carrying cost of late payments. If they are using credit cards to make it through a project, but aren’t taking interest payments into consideration when costing a job, they could find themselves underwater financially. Understanding the full cost profile of a job — including what it costs them to wait for payment — will help them estimate project costs more accurately.
Contractor Offense Needs Accounting Defense
Contractors don’t get into the construction industry to start a credit business. They want to get paid as smoothly as possible on each project, so they can move onto the next one and continue to build their business. However, a culture of slow, late payments cause many contractors to run into cash flow problems that derail their progress or, worse, put them out of business.
As long as they have protected their rights during the project, contractors generally have a last line of attack to get paid: Filing a mechanics lien. And attack, they do. According to the survey, nearly all contractors and suppliers have threatened to file a lien (98%) and more than half have actually filed one (58%) in order to get paid.
Construction accountants can help contractors deal with slow payments in a number of ways. They can help the contractor get a more accurate picture of the cash they need early on in a project without a deposit. Accountants can provide information on the carrying cost of late payments that helps the contractor estimate jobs more accurately.
A good construction accountant understands the variety of payment challenges that contractors face in order to defend project managers’ and supervisors’ access to their lifeblood: The cash needed to buy materials and pay the workers to complete their project on time, and under budget.
Thanks to Justin Gitelman for sharing the whitepaper focused on the impact that slow paying clients can have on a construction company and how we, as accountants, can help. Reach out to Justin to learn more!