April 5, 2021

The best defense is a good account balance

Cope with delayed jobs through sound financial management

When a severe delay hits a construction project, a contractor’s level of financial risk tends to skyrocket. If the owner can pin the slowdown on you, your company could be liable under the job’s contract for “liquidated damages.” Such clauses typically provide that, for each day of delay beyond the stated completion date, the contractor will pay the owner a “liquidated” sum in lieu of actual damages.

Even if you’re not at fault, the owner may withhold payments while the situation is sorted out, directly throttling your cash flow if you’re a general contractor or indirectly if you’re a subcontractor. Unfortunately, there’s no way to completely prevent the possibility of a project delay. The best defense is to strengthen your financial position to the point where you can absorb the risk of a slowed-down job without it threatening your livelihood.

Preparing for common delays

All sorts of unforeseen events can impede a contractor from completing his or her work. Some of the most common include:

  • Inclement weather. “Mother nature” plays no favorites and cares not for a construction schedule. Document the number of days and the severity of adverse weather conditions. Meanwhile, keep your crew ready to regroup and launch as soon as conditions clear up. Doing so will demonstrate that your company did nothing to exacerbate the delay.

  • Owner financial issues. As you may have experienced, owners sometimes run out of money midproject and must renegotiate financing or seek new funding sources. Meanwhile, no one gets paid. You can improve your chances of avoiding such situations by fully researching a project before submitting a bid.

  • Discord or antagonism. You’ve probably worked on a job or two that wasn’t all sunshine and rainbows. Sometimes owners dispute choices of materials or in what order certain tasks should be completed. Other times an owner may not communicate well or simply lack patience. It’s for these predicaments that superior communication skills and a thorough knowledge of dispute resolution options are critical.

Defining financial risk

Whatever the cause of the delay, your construction company needs to be able to recognize and quantify its financial risk. Informally, one can define financial risk as the likelihood of negative possibilities — from being unable to meet your short-term obligations (vendor invoices, payroll) to, at its most extreme, failing as a going concern.

Financial risk tends to proportionately increase as a construction company owner panics or succumbs to reactionary measures. For example, if an owner’s payment is delayed, some contractors might decide to drag out their performance because they’re not getting paid.

However, a smarter move would be to recognize the short-term risk of liquidated damages as well as the longer-term risk of nonrenewal of awarded contracts. These dangers can lead to ongoing and potentially devastating cash flow constrictions.

Protecting yourself

No one can predict the future. If a construction company is always relying on its next payment to stay in business, one delayed project can spell disaster.

Many contractors turn to lines of credit to insure themselves against job delays and slow payments. But a line of credit is like a mortgage that never gets paid off, because interest is charged on the open balance. Even if you keep up with the payments, you’re still accruing interest. And interest charges will explode exponentially if you must repeatedly use the line to bail yourself out whenever an owner or general contractor doesn’t pay up.

For this reason, among others, you’ll be much better served by prudent, proper financial management. This all begins with what can be a big challenge for many contractors: creating and maintaining a cash reserve. A general rule of thumb says every small to midsize business should keep on hand enough cash to cover anywhere from three to six months of operating expenses.

If you’re struggling to maintain your cash flow as it is, this may sound like a tall order. Yet a cash reserve is really the only foolproof defense against project delays and slow-paying owners or general contractors. When you have the money to cover payroll, supplies and the like, you also have the peace of mind to exercise patience with owners or general contractors and avoid the temptation of expensive lines of credit.

Precisely how a construction company should go about establishing and maintaining a cash reserve is a topic for another article. In short, your CPA can help you set up an interest-bearing account for this purpose and determine a reasonable way to set aside incoming cash flows from each job without feeling the pinch.

Getting sound advice

In light of the coronavirus (COVID-19) crisis, delayed projects have become commonplace and building up a cash reserve may be out of the question. You might already be using savings to manage expenses or cover payroll. Your CPA can offer sound advice on managing your finances in today’s difficult economic environment.

Keep your cash reserve close to the vest

Every construction company should establish a cash reserve to guard against delayed projects and slow-paying owners or general contractors. (See main article.) But, as anyone who has ever accumulated a large amount of cash can likely attest, as word gets out about the sizable balance, legal claims may suddenly start to occur.

For example, a disgruntled former employee might decide to file a lawsuit. Or a vendor or subcontractor might begin to invoice you for extra or outlandish charges that you’ve never seen before. For these reasons, and others, it’s important to be discrete about your cash reserve. Restrict access to the account, as well as information about it, to only those who need to know. And ask those parties to keep the details confidential.

The content featured in this article originates from our bi-monthly Contractor Newsletter. Subscribe below and stay in the know.