Keep the cash flowing: balancing progress, payment and risk

Cash flow isn’t as unpredictable as some think. In fact, it is very predictable and, in very simple terms, is a product of the agreements you make, the progress you achieve, and the unplanned events that occur.

When an activity happens (a drawing is produced, a unit is ordered, a unit is installed etc), you incur a cost and will, at some point in the future, pay for that activity and (hopefully) be paid for that activity. As a QS, a primary part of your job is making sure you get paid more than you spend (profit) and that you are paid money before you pay (cash flow).

Simple, in theory: you manage to price the job correctly, and you manage your agreements so that profit and cash flow are covered. However, what happens when an unplanned activity or event occurs and you incur the cost, but your recovery is uncertain because it relies on you jumping through contract clauses before an amount is certified in your monthly payment notice?

When this happens, a business can end up funding these unplanned events for months (maybe years!) without payment; it is these issues that can threaten a business’s existence.

In this article, we will provide some top ideas that will help you actively manage this risk.

Sketch the payment process

It sounds simple, but what is the payment process in your contract? Who has to do what, by when, and what triggers the payment period? Sometimes it is a date (X days from month end), and sometimes it is an event (X days from date of payment notice).

Watch out for sneaky wording that makes it look like 30-day payments, but when you map the process, you actually find it is 45 days or 60 days because it is triggered by an event that occurs later than the end of the valuation period.

When you map the process, you want to determine the overall period by looking at the lag from the start of the valuation period until the date you are paid. If you are paying operatives in the first week of that period, then you are funding that cost until the date you are paid, so consider whether anything can be done to manage that cash flow risk.

Delivery model

When considering the project cash flow and the terms you require to achieve the best possible cash position, the delivery model will be an important driver.

If you are self-delivering, then you have a more significant cash burden than if you are subcontracting. If you are self-delivering, then explore options to improve the cash position. You are bringing delivery certainty to the project, and whilst you need to achieve progress before being paid, you might find your client is open to improving its terms and supporting your cash flow. If you are a subcontractor working for a main contractor, you are more likely to achieve this if delay damages are significant because it should be in your client’s interests to de-risk completion and avoid damages.

If you intend to procure, or are required to procure, materials off-site, then it will be crucial that you include contract provisions that allow for payment of materials off-site. This will be subject to certain conditions, e.g. only paying for completed products and having acceptable insurance cover in place etc, so check that the conditions are achievable and that these are acceptable to the supplier from whom you will buy the materials.

You do not want to find yourself in a position where you are obliged to pay for the materials but have no right to be paid because the conditions are different.

Understanding the programme

The payment process and the delivery model will have a bearing on your cash flow; however, undoubtedly the thing that will have the biggest bearing is the planned programme and the actual performance of the project. What are the highest cost activities, what is the rate of production, and how achievable is the programme?

When it comes to actual performance, do you know whether you are on programme? Again, another simple and obvious question, but it is remarkable how many do not know this because of the opaque way that the programme is being managed. If you are behind, then do you know the plan to get back on track? Is this recoverable? What is the delay damages exposure?

Time and cost recovery

This will be explored further in a later article, but where an unplanned event occurs, consider what hurdles exist in the contract to be paid for that event. Do you recover it through a variation/loss and expense process if JCT, or do you recover it through a compensation event process if NEC?

Whichever contract it is, the contract will require you and your client to do various things to operate those clauses. It normally starts with a notice, provision of supporting information, assessment and (hopefully) payment / award of time.

If you anticipate that the project, because of its nature, will have a lot of unplanned events, then you need to ensure that the contract hurdles are reasonable and can be overcome to achieve recovery at the earliest possible opportunity. If they provide the client with very comfortable assessment periods and the opportunity to ask for more and more information, then these are concerning because they provide a low level of certainty.

In your delivery of the project, focus on demonstrating entitlement to the change in the first instance. Too often people jump to supporting their variation with cost information, but the first hurdle you need to get over is the principle that it is actually a variation. Get over that hurdle, get some money paid on account at least in the short term, and then focus on the quantum.

Final reflections

Contracting in construction is challenging. We build almost unique projects every time; we have to price and programme with a huge amount of uncertainty very early in the project, and contract terms are often geared towards transferring risk down through a fragmented supply chain.

The impact of this is blockages in the flow of cash from the entity that desires the built asset to those actually performing the work. When unplanned events occur, the flow of cash becomes insufficient to cover the amounts being paid. This inevitably leads to disputes as a business exercises its options to turn the cash flow tap back on.

In this article, we have provided a few things to think about that might help you actively manage that risk. Given the nature of what we do, it is difficult to eliminate the risk, but being a bit more wide-eyed is never a bad thing.

In next week’s article, we will explore delay damages and the things you can think about during the contract negotiation phase to manage your commercial exposure.

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