Cash-Flow Blueprints Too Often Overlooked

By Jim Jordan

Jim Jordan is director of construction services for Dallas/Fort Worth-based Weaver and Tidwell LLP.

Contractors should protect their financial health by carefully reviewing contract documents and protecting cash flow.

For contractors, cash flow is what makes the world turn. In an inordinately cash-intensive business, consistent cash flow is mandatory if debt is to be kept in check and work is to continue on schedule. More often than not, cash flow measures a contractor's financial health better than even net income.

Contractors typically bid jobs, win contracts and then sign work documents spelling out how and when services will be provided. The problem, however, is that many contractors do not always understand provisions and terms in the documents. It isn't uncommon for contractors to not read the contracts, much less the general and supplemental conditions. That's because many contractors perceive contracts to be nothing more than standardized agreements that they have to accept in order to get the job - a dangerous perception.

To protect cash flow, clauses dealing with payment are the most important provisions. Such clauses explain when contractors are going to bill and when the other party is going to pay. They also specify the interest rate a contractor is to be paid for late payments. To protect cash flow, the savvy contractor will pay close attention to these clauses and not be timid about requesting changes. For example, a contractor should not hesitate to negotiate for payment in 30 days or less, and should charge interest if the payment isn't made on time. Often times a contractor does not want to upset the project owner by pressing for timely payment or interest on late payments.

Contractors should not be afraid to negotiate for more favorable retainage terms, such as a five percent retainage, if they are providing a performance and payment bond. If the bond is not being provided, a contractor still should negotiate for a reduction in retainage once 50 percent of the work has been completed. Also, contractors should get their retainage as quickly as possible once the job is completed. The contractor needs to ensure that terms do not allow excessive retention for minor items. For example, a $1,000 punch-list item should not hold up $10,000 or more in retainage. This happens all too often.

In terms of back charges, contractors should require their customers to notify them promptly of any proposed back charges. Timely notification gives the contractor an opportunity to correct the problem and avoid the back charge. Contractors should never accept any back charge received months after the fact. In particular, they should not accept it simply to get their retainage.

Another issue that affects cash flow is stored materials. Contractors often pay for materials and then store them at the job site or a remote warehouse without being paid for months. Instead they should negotiate payment terms for such material by transferring title to the customer, having the material tagged and physically safeguarded and insured. At that point a contractor can be paid.

In addition to these issues, cash-flow-minded contractors should pay special attention to other contract provisions that carry significant ramifications for cash flow. Some of these are:

Indemnity When a contractor agrees to limited indemnity, he or she agrees not to hold the owner responsible for damage caused by others. That's reasonable. But by signing a provision for unlimited indemnity, a contractor agrees to spare an owner from claims for virtually all damages, injuries or loses - even those claims the owner causes. Signing an unlimited indemnity is similar to blindly giving away the bank: It means the contractor pays for everything.

Change Orders When extra work is requested, contractors should bill for their work as soon as it is completed and not accept change-order laziness on the part of the project owner. The owner may not have the money to pay for change orders once the project is completed. A contractor should remember that he or she was a team player in doing the work before the change order was written, so the owner should also be a team player and pay in a timely fashion even if the change order is delayed.

Warranties for Your Work Any clauses related to warranties need to be closely inspected. Here is a common scenario: An owner demands a multi-year warranty from a general contractor on all aspects of a building, but the general contractor's roofer only offers a one-year warranty. The general contractor's risk begins in year two, meaning he gets to pay for any problems with the roof. The easy solution is to have the warranty terms be consistent.