How to Identify and Mitigate your Construction Payment Risks

What every Construction CEO needs to know

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In the Construction industry, one of the most effective ways to protect your profit margins is by rigorously identifying, recording and mitigating your payment risks.

A payment risk is the possibility of delivering a construction project and not getting paid what you applied for, on time or at all.

In other words, you run the risk of late payment, less payment and no payment if you don’t take your payment risks seriously. Some construction companies don’t have a process to identify, record and mitigate payment risks. Leaving them with severe cash flow problems because a funding gap develops. To bridge the gap, construction companies often engage in a game of “robbing Peter to pay Paul”. You probably have been there, or you are there right now. It affects your business, employee morale and your mental health. To come out of this unhealthy cycle of “robbing Peter to pay Paul”, you need to equip your team with the right processes and systems to identify, record, mitigate and monitor your payment risks. Unfortunately, many construction companies focus on site risks, programme risks and so on and forget other risks that impact their bottom line. If you are experiencing this right now, implementing these tips will help you.

Learn how to identify payment risks

It is not uncommon for me to work with a construction company, request to see their risk register and realise that payment risks are not listed. It is no wonder they are having payment issues. No one stopped to identify, record and think of mitigation measures to protect the business if late or non-payment occurs. Whenever I bring this to their attention, the reality is that there needs to be a process to follow regarding payment risks. Immediately, we jump into action to help the company write down a step-by-step process that will help them avoid similar issues in the future.

Here are some things you can consider when creating your process:

1. Employer creditworthiness. You need to assess the financial stability of your Employer (we call clients or customers — Employers in construction). It is easy to check their credit rating and get a copy of their financial statements and reports on the Companies House website. If the Employer is overexposed, you should seriously consider whether this is someone you want to work with. Sometimes, clients tell me they need the contract and wish to proceed. Nothing is wrong with doing that; the point is that you have enough information to make an informed decision. And there are specific mechanisms you can put in place if you choose to proceed. It is better to go into the deal with your eyes wide open.
2. Contract terms. The days of signing the contract and sticking it into the drawer are gone. Construction companies can no longer operate this way. So many drivers for change, including the shortage of cheap labour. Every construction CEO now knows that they have to be astute business people. And one area you need to focus on is your construction contract. The document determines how, when and where you get paid. You must scrutinise the payment terms and look for clauses imposing conditions that may delay payments. It would help to have a chart outlining the payment process and the compliance requirements.
3. Project viability. Get in the habit of evaluating the financial health of the projects you are interested in. Who is funding the project? And for how long is funding available? I have worked on projects funded by grants that needed to be used by a specific date. The contractor was unaware of this and had a programme that passed this cut-off point. They didn’t ask about financing, which became an issue until the Employer could find additional funding. You can check the project’s viability by checking the third-party documents mentioned in your contract with the Employer.

Mitigate Your Payment Risks

Once you have identified your payment risks, you need to create a document, something as simple as an Excel sheet and put all the payment risks identified. Many construction companies are in the habit of identifying site risks, programme risks, and so on, but they need to consider the payment risks as well. Here are some things to consider:

1. Clear payment terms. Negotiate clear and balanced payment terms in your construction contract. For many construction CEOs, this will mean getting outside specialist help. Don’t try to do this yourself. Delegate.
2. Late payment penalties. Include late payment penalty clauses in your contract. Some Employers dislike penalty clauses because they dislike paying out more than needed. So it works!
3. Regular invoicing. You need to submit your invoices or applications for timely payments using the process under the contract. If your application for payment should go to Kerry in Accounts by 16:00 on the 28th of each month, you must comply. Too many construction companies don’t invoice correctly, present the information unclearly and don’t comply with the contractual process. If you do this, don’t complain when you don’t get paid on time.
4. Escrow or project bank accounts. Consider proposing that the project use an escrow or project bank account. You want the Employer to set funding money apart from the business-as-usual funds. Additionally, retention should separated from business-as-usual funds. You may find that some contracts state that retention will not separated from business-as-usual funds. Always push back on that because, at the end of the project, you want to ensure the Employer has not spent the retainer.
5. Milestone payments. Structure your payments around project milestones to maintain a steady cash flow. If you buy materials and pay subcontractors, you must ensure that the payment gap is small. Always make it as small as possible so you only fund the project for a short period. See diagram above.

Understand that implementing these strategies and tactics will help secure the financial health of your entire project portfolio and your construction company. You will experience benefits, including:

1. Improved cash flow.
2. Reduced stress caused by economic pressure.
3. Enhanced business reputation due to cash flow and paying people on time.

Remember that your construction contract is the lifeblood of your construction business. Your money (payment for work done) sits under your construction contract. If you work and constantly have payment issues, check your construction contract to understand why and what to do next.

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