Payment delays or slow payment processing is a problem that the construction industry has been facing for a long time now. According to Levelset’s National Construction Payment Report published in 2020, 48% of businesses wait for more than 30 days from the day of invoicing to receive payments.
Further, a similar report published in 2019 by Rabbet indicated that slow payments cost the industry a total of $ 60 billion. The 2018 – 2019 PWC Working Capital Survey indicated a 51-day sales outstanding for the US construction industry.
These statistics are worrying. They raise a lot of questions regarding what is ailing the construction industry payments. What has been accepted as the status quo is costing us so much that we must begin looking for solutions to this problem.
The Nature of Construction Jobs
Construction projects are temporary endeavors with definite start and end dates. Usually, they involve multivariate teams. The project team comprises consultants, the client, financiers, contractors, subcontractors, suppliers, specialized trades, among others. Because of the complex nature of these projects, contracts are usually put in place to guide how the contractor and the client will relate during the construction period. If comprehensive enough, they also include their relationship with the consultants, subcontractors or speculated trades.
Also, the so-called standard forms of contracts have clauses that direct how the issue of payments should be handled. The contractor undertakes to mobilize labor, materials and equipment and undertake the construction works. As a business, they are looking into making profits.
The client undertakes to pay a sum of money equivalent to the value of work done by the contractor. This amount is determined through a valuation process undertaken by the contract administrator or quantity surveyor jointly with the contractor/subcontractor. The process is initiated by the contractor when they write to the client through the contract administrator requesting payments.
Construction work requires a lot of financial investment to be successfully executed. Clients may have their sources of funding but the actual work is normally funded by the contractor before they can ask for payments.
This means that the contractor is going to invest money upfront in the project. This may be borrowed from the banks that will charge interest. When substantial work is done, it is only fair for the contractor to get promptly paid by the client to enable them to finance the next phases of the project and repay their lenders.
Similarly, subcontractors and specialized trades people rely on borrowing to finance their projects and on cash flow to keep their employees paid, equipment serviced and projects running.
Cash flow is very important to these businesses. Prompt payment of invoices due will improve their cash flow and streamline project progress and success. Nonetheless, payment delays continue to be witnessed and are hurting such businesses that depend on cash flow to keep things going.
Causes of Payment Delays
The most significant cause of payment delays in the construction industry is deeply rooted in the processes of certifying payments. The traditional process that is largely recognized by most standard forms of construction contracts relies on paper-based documentation (in the form of valuations, progress reports, payment request letters, invoices etc.).
These documents are either sent through email in PDF and spreadsheet formats or are submitted as printed hard copies to the relevant parties. As payment certification sometimes involves more than one person verifying the information, this process may take a longer time meaning the contractor has to wait longer to receive payments.
Also, some payment delays can be directly attributed to the contractors and subcontractors themselves. Where the contractor uses inappropriate procedures to submit payments requests or makes significant errors when submitting requests for payment, this could result in delays. Such errors might include inaccuracies in valuations for quantities of work done, or failure to submit any relevant supporting documents certifying the payment claims.
Further, the supply chain in a construction project is a lengthy one and a potential cause of payment delays. Especially to the subcontractors and specialized tradesmen who are down there in the chain, payments may take longer to move from the client, through the main contractor to them. There are verification processes along the way that may take time.
However, payments may even take longer when unfavorable clauses such as “pay-when-paid” get introduced to the contact between the main contractor and their subcontractors, trades people or suppliers. It gives the main contractor grounds for withholding payments to them while citing non-payment from the client and project financiers.
Other issues such as conflicts between parties, contractual disputes or malicious reasons, such as clients who choose to withhold payments to contractors to receive gifts from them, contribute to delays in payments.
In some other cases, the client might be having financial management issues. Funds for the project might have been misappropriated. It could also be a result of stringent measures by the banks on how much and when should the client draw money from the bank to finance the project.
Effects of Payment Delays
Cash flow is an important component of running and sustaining a profitable business. For subcontractors and specialist trade running small businesses and relying on cash flow to fund their projects, a delay in payment could mean that the next project phases have no funding.
If there is no money to invest in the project, work on-site might be temporarily delayed or stopped. This hurts the subcontractor’s businesses as they need money to pay their workers, service their machines and equipment, and repay loans from lending institutions.
Further, the delay will have an impact on the client’s business in some way. Let’s take an example of a real estate client who targeted for their residential apartment to be complete to start earning revenue from rent. If the project gets completed one month later, the client will lose revenue for that period.
Also, payment delays are costing the industry a whopping $ 64 billion. That extra cost is partly due to the costs that the contractors and subcontractors incur as they chase down payments. In some cases, they submit expensive bids to cater for the risks of the slow payment process. Subsequently, projects cost more than they normally would. Are the project owners getting value for the money they pump into these projects?
In addition to that, most subcontractors and speciality trades shy away from contractors who have a history of non-payment or delayed payments. Most people will not be willing to work with a contractor who has concisely paid late. As a result, some overprice their bids while others don’t bid at all. With fewer bids, the probability of getting the best-suited business to work on the project is reduced.
Suggested Remedies to the Payment Delays Problem
Most of the causes of delays identified above can be avoided in one way or another. Although interactions involving human beings are complex and issues may arise that don’t have a straightforward solution, the following suggestions can help improve the situation.
First, causes that are directly attributed to the actions of either party should be addressed from that party’s point. Clients and contractors should exercise goodwill and avoid withholding money from their payees for any personal gains.
Secondly, the inclusion of detrimental clauses to construction contracts such as “pay-when-paid” or “pay-if-paid” should completely be avoided. Such clauses only serve to protect the commercial interests of one party while hurting those of the other.
Also, contractors and subcontractors should be very attentive when preparing payment claims. If possible, they can employ a specialist who will be in charge of preparing payment requests, attaching all the required supporting documents, while following the right submission procedures. This will reduce delays that would otherwise arise out of the submission of erroneous payment claims.
Overall, a shift in mindset is required to allow veteran industry participants to embrace digital technology. While writing checks and waiting for the banks to process them works well, it takes time. Digitized transactions can save this time by allowing the client to only click a button and authorize payments to the contractors/trades. Payment is received promptly without having to wait for days of processing by banks.
Collaborative Digital Workflows
The PDF-based invoicing, billing and payment procedure takes more time, with emails back and forth and time lags as different key people in the payment approval process verify and certify the payments.
Embracing the culture of openings and collaboration could help remove these lags. What if all the valuations, invoices, project progress photos and payment applications were organized in a shared digital database? Any key project member can assess that information anytime, anywhere.
Instead of waiting for one party to approve for the other to be given the documents for subsequent verification and approval, they can do it concurrently. They can compare invoices due to valuation amounts and progress reports on the same platform without having to make calls to be sent email copies or having to visit the site physically. Huge time savings, right?