In a business with significant labor and material costs, poor cash management can threaten the viability and long-term health of any contractor. And trends in the industry are putting pressure on contractors to improve liquidity and increase general reserve levels.

Pay When Paid
One industry trend — emerging notably over the past three years or so — involves the terms and timeframe for payment of subcontractors. Historically, general contractors paid their subcontractors after receiving funds from the project owner and upon completion of the project. But today there’s a movement away from “pay when paid,” often with support from state legislatures. As a result, many general contractors are required to pay for subcontracted work before they’re reimbursed by the owner.

Retainage
Another trend involves retainage — the withholding of a percentage of the contract value or a specified dollar amount until completion of the project or some other specified time. The American Subcontractors Association (ASA) is pushing for legislation to eliminate this practice, but reduced retainage levels may be an intermediate step in states where the issue is being looked at seriously.

Note that reducing or eliminating retainage could increase the capitalization needs for subcontractors if it results in increased requirements for performance bonds.

Greater Need for Cash
These trends and others are manifesting themselves in higher cash requirements for contractors and the need to prudently manage larger cash balances. Faced with this backdrop, what should contractors do to address these cash management issues?  Here are some suggestions:

• Make sure the owner has solid financing for the project.
  
  
• Investigate the potential need for a letter of credit, bond, or other payment source that extends beyond the contract funds and is sufficient to cover change orders or other work.
  
  
• Take the time to implement a concrete plan to build the balance sheet. Consider debt-reduction strategies and other recapitalization options.
  
  
• Most important, make good credit decisions with regard to project owners. Conduct proper due diligence at the front end of any project, establish protocols, and adhere to strict disciplines, particularly in a slowing economy. Don’t lower credit standards just to win jobs.
  

Reluctant Lenders
As cash requirements increase, several national banking institutions are retreating from or limiting their lending to construction firms. Bank of America and Wells Fargo, for example, have said they don’t plan to extend new lines of credit to contractors. As a result, contractors may need to look to smaller, regional institutions for financing, making it even more critical to increase capital and take steps to keep the balance sheet strong.

Maintaining sufficient cash has never been more important. As the construction industry sorts through changes in its payment protocols, contractors should be prepared. All contractors should analyze their business needs and determine whether higher cash balances are needed to mitigate risk and ensure smooth operations for the years to come.