Lesson 1: Why Getting Paid in Construction Is Hard
Participants in the construction industry face complex and unique challenges to running a profitable business. Year after year, studies name the construction industry as the slowest industry in the world for payments.
Companies in construction wait an average of 83 days for payment
This is according to PWC’s Global Working Capital Survey 2018-2019 . That means many construction businesses are waiting 2-3 months to receive payment (which is unheard of in other industries).
Why is the construction industry in this predicament? What are the root causes of the industry’s payment problems?
Reliance on credit + low profit margins = tight cash flow
It’s no secret that the construction industry has a cash flow problem. This is because construction jobs may require significant upfront investment to get off the ground, and many construction companies rely heavily on credit to run their businesses.
Instead of requiring payment upfront before delivering materials or performing work, contractors often furnish materials and labor in exchange for a sort of IOU. Labor and materials are supplied with the understanding that payment will be made later. This is true for all parties on a job, from the general contractor all the way down to a supplier or a sub-subcontractor.
Often, the value of the materials furnished or labor provided can be substantial. It takes a lot of financing upfront to float these costs. Businesses frequently have to wait until they receive payment before they can pay their subcontractors, suppliers, or laborers. Oftentimes they are waiting for payment for work they’ve already performed on other jobs as well.
It also doesn’t help that most companies working in construction are operating on razor-thin margins. In fact, net profit margins (before taxes) for the vast majority of the construction industry hover in the single digits.
A large number of players compounds the issue
The number of stakeholders involved in a construction project can compound the problem of slow payment and tight cash flow. With more players involved, money may need to pass through more hands to get everyone paid. Any miscommunication or delay in payment along the payment chain can have a domino effect.
Generally, financial risk on a construction project increases in proportion to distance from the top of the chain (i.e. the source of money). The farther away a player is from a direct contractual relationship with the property owner, the more likely that player is to run into slow payment.
Even when someone is directly hired by the property owner, they can encounter frequent slow payment, especially when dealing with third parties like insurance companies or lenders. Every participant on a construction project faces their own construction payment challenges.
Lack of visibility slows down payment
Whether the job is big or small, payment issues can generally be traced back to the same underlying cause: lack of visibility.
The people who are processing payments on the job – for example, an accounts payable manager working at the general contracting company – may not have eyes into a subcontractor or supplier’s participation on the job site. These folks often need to collect paperwork like pay apps and lien waivers from everyone working on site. If they don’t know about a certain participant, it makes their job much harder and slows down payment for everyone involved. This lack of visibility into who is working on site, who needs to get paid, and who needs to complete paperwork increases financial risk for everyone.
In our next lesson, we will explain how you can address problems of slow payment, tight cash flow, and lack of visibility by instituting a simple, proactive business practice of sending preliminary notices.
But first, take the quick quiz below (it takes 30 seconds!) to see how much you’ve learned so far.