In construction, nothing is ever as simple as 1, 2, 3. From unexpected delays to labor shortages, there’s almost always something that has the potential to put your cash flow at risk. Slow or late payments can be a particular headache, squashing your ability to make special orders, pay subcontractors on time, and take home your cut of the profit.
This doesn’t have to be the norm, though. In this article, we’ll walk you through common payment terms for contractors and how to negotiate the most favorable terms for you and your team.
Key Takeaways:
- Paid when paid, Net 30, and retainage are all common payment terms for contractors, and can all affect your cash flow in different ways.
- For larger jobs, progress payments allow you to bill monthly based on milestones or the amount of work put in place during the period.
- Building a good rapport between you and project owners/GCs can help you negotiate more favorable payment terms, reducing your cash flow risks.
In this Article
The Foundation of Construction Payment Terms
As with most aspects of construction, communication and your contract document are two of the most important tools you can have under your belt when it comes to invoicing and payments. Establishing clear, detailed payment terms between you and the project owner (or between you and your subcontractors) is crucial to protecting yourself and your cash flow. Payment terms should include total price, pay schedules, retainage, and any other relevant information.
If you’re a subcontractor, you’ll want to request the prime contract (the contract negotiated between your GC and the owner) before starting work. This way, you can make sure you’re on the same payment terms as them.
Exploring Common Payment terms for contractors
Generally speaking, some of the most common payment terms for contractors you’ll see include “paid when paid”, Net 30 days, and retainage. As you’ll see in our breakdowns of each, some present more risks than others.
“Paid when paid”
“Paid when paid” payment terms are one of the most common you’ll encounter. Paid when paid simply means that if you’re a general contractor, you will be paid once a project owner receives funding from the bank. If you’re a subcontractor or vendor, you’ll be paid once the GC is paid – and so on and so forth. Each state has specific laws on how long each rung of the ladder has to pay the next one down.
While paid when paid terms are often used in construction, they’re also inherently risky. If for some reason a project owner doesn’t pay up, you’re left high and dry – and will have to pay any subs or vendors out of your own pocket.
Still, if you’re a GC, there’s a greater chance you’ll be able to establish a positive relationship with the project owner and hopefully avoid these payment terms.
Net 30
Another common payment schedule is Net 30. This means whoever you’re invoicing has 30 days after they received your invoice to make a payment. Less commonly you might see Net 45 or Net 60.
If you’re able to set these terms, it’s vital that you’re both clear and firm on them. According to Levelset and Fieldwire’s 2020 construction survey, contractors are often far more lenient on payment terms than they should be, with subcontractors being especially so. For example, almost half of contractors offer customers 30 days or more to pay their invoices, and 8% offer terms above 45 days. What’s more, a meager 11% actually charge interest or fees for late payment.
If you’re worried about maintaining your cash flow, there has to be an incentive for your customers to pay on time. Of course, since construction is a largely relationship-based industry, sometimes things might be a bit more flexible – but that doesn’t mean you should have to shoulder the risk of nonpayment. There’s always a middle ground to be found between causing friction and being paid fairly and on time.
Retainage
A standard practice between owners and GCs and GCs and subs is retainage. This is the practice of holding back a portion of payments to ensure a job is successfully completed. Rates may vary, but you’ll typically see a range between 5-10%.
Retainage can be fixed or variable as a project progresses, with variable retainage terms being more favorable for GCs and subs alike. If you’re a subcontractor whose trade is early on in a project, retainage can add another layer of stress to your payment terms. Not only are you waiting until your GC gets paid, you also have to wait until the end of the job to recover the rest of your owed money (an amount that often represents your profit margin on a job).
We explain retainage and best practices around it in greater detail here.
Progress payment terms and milestones
On larger, long-term jobs, your contract will include progress payments. Instead of billing for a project all at once, progress payments allow you to bill on a month-to-month basis based on the amount of work put into place during the period. Each of these progress billings should be built into the schedule of values you give to either the project owner or GC once the job is established. Once the owner or GC receives your payment application, they’ll verify that the amount of work put in place has been successfully achieved, and issue payment under the terms of your contract.
If you’re being paid by project progress, it’s important to first make sure you’re clear on what the person upstream from you is looking for in terms of project phases. For example, if you’re working on a larger hotel build, the owner or GC might break down the job by floor, with more incremental milestones, like subdivided areas for each floor built into each phase. Consistent communication here is a must, and will ensure you know exactly what counts as a milestone being completed
As with most jobs, you’ll probably be funding some of it upfront – so make sure you know where you sit in terms of cash before starting. While progress payments can help you maintain a more consistent cash flow month to month, missing a deadline or getting backed up with payment applications can quickly throw a wrench in your finances.
Key takeaways here:
- Know your due dates
- Use the right construction accounting software to avoid billing on ‘gut feel’ alone
- Always follow up to make sure your payment applications have been seen and approved
Negotiating favorable payment terms
If you’ve worked with a particular owner or GC several times, that positive relationship and rapport might also help you negotiate more favorable payment terms. The trick here is not being afraid to initiate tough conversations. If something comes up that’s out of your control, communicate that you need to be paid for a couple months on Net 30 terms instead of paid when paid. Ultimately, for both you and the person upstream to be successful, you might need a little extra help. If you find yourself in a bind, don’t wait too long to ask for help. Everyone in a contract needs the possibility of being successful. If only one party can have success, it’s more than likely the job will have issues.
If you’re not able to set your own payment terms, or don’t have as much wiggle room to negotiate, one thing you can do is request a retainage reduction rider by job progress or milestone. For example, the retainage rate starts at 10% and is set up to decrease to 5% at 50% completion, 2.5% by 75% completion and so on. Since retainage often represents your profit margin percentage (or a large portion of it) on a job, anything you can do to reduce it will help you increase your cash flow and give you peace of mind.
Regardless of your payment terms, outdated systems and manual processes can make invoicing a hassle. With CrewCost’s all-in-one construction accounting software, we connect your back office to the jobsite, so you can save time on invoicing, quotes, employee management, and more.
Sign up to get early access to CrewCost, and see just how much time you can get back.
Yancy Lassiter, a CPA with a degree from the University of Texas, has 12 years under his belt as a Controller and CFO in the construction industry; he’s your go-to guy for finance in the building industry.
