Contractors need to be paid promptly for their work. This helps ensure they can pay their subcontractors, purchase materials and rent equipment.
It’s also essential to remain tax-compliant and avoid misclassifying contractors as employees. Managing payments effectively starts with having a clear payment process and implementing best practices like those listed below.
Establish a Payment Schedule
The schedule specifies the maximum sums contractors may pay and the frequency of payments due. Employing a schedule management system, such as Roll by ADP, is advised to reduce financial risks for organizations and contractors.
The type of contract will influence the payment schedule. For example, time and materials contracts can include a payment schedule based on the number of work hours completed. In contrast, projects that require significant investment may be billed on a milestone-based payment schedule.
Analyzing payment trends can help identify customer payment issues and help you create a contractor payment schedule that works for everyone involved. Keeping track of these details prevents overpayments, double payments, or even payments for work that still needs to be completed. This helps protect both contractors and business owners from legal complications. Once the payment schedule is established, it can be checked off your list of steps to take when managing payments to contractors. This will make the process run more smoothly and ensure all parties understand their obligations. Then, it’s just a matter of getting the job done!
Have a Clear Invoice Process
Clearly outlining payment terms in invoices prevents misunderstandings and reduces the time it takes to process payments. This is especially important when working with international contractors. Consider offering multiple payment methods to make sending funds easier for your clients. These can include traditional ACH/SWIFT transfers, wire transfer services and popular online payment platforms such as Payoneer or PayPal.
Invoices should clearly explain what services or products were provided and billed for and how they relate to the project milestones established in the billing schedule. It also helps to have a robust change order management process that clearly defines and records all additional work, costs or invoice adjustments.
Finally, it’s worth establishing a standardized formatting convention for invoices and a consistent approach to date-coding or referencing different line items to ensure consistency and minimize confusion. This can help you avoid spending valuable time collecting and sending backup documentation when a dispute arises with a customer.
Include a Payment Retention Clause
Contractors have a unique payment process called “retention.” This involves a percentage of work held back until the project has been finished and verified without flaws. This is a common way for owners to ensure that contractors meet the contract terms and standards while also giving them peace of mind.
It also serves as a form of insurance for lenders and insurers looking to reduce their risks on a project, offering them more security that the project will be completed properly. But it isn’t without its challenges.
Retention withholding can significantly negatively impact a construction company’s cash flow. In the worst-case scenario, it can cause an entire project to stall or stop due to a lack of working capital. To minimize this risk, companies should include a payment retention clause in their contracts and a clear process for claiming retention funds and accounting for them during each progress application. They should also ensure that they submit invoices and supporting documents in the required time frame, taking photos of the site and supplying work schedules remaining.
Use a Schedule of Values
A schedule of values (SOV) is critical for project cost tracking, payment application management and progress reporting. A good SOV can help ensure that contractors are paid for the correct amount of work for each pay request and that the total project costs stay within budget.
SOVs are especially important for contractors working on large-scale commercial projects with many moving parts. These complex projects often involve various contract types, including fixed price, approved budget and guaranteed maximum price contracts. These agreements predetermine the overall project cost, and an SOV’s in-progress cost breakdowns can help ensure that the contractor stays within budget during construction.
An SOV also promotes accountability between the contractor and the client. It encourages the contractor to be transparent about its materials, labor and funding needs and realistic about the project timeline. This can increase the contractor’s and client’s trust, making it more likely that they can negotiate an agreement that provides a consistent cash flow and benefits both parties. This is a great way to avoid front-loading, which can cause significant problems for both parties.
Ask for a Cash-Flow Forecast
A clear cash flow forecast is critical to business health. With one, a company may refrain from over- or underbilling. Overbilling means invoicing for more work than is completed, putting cash in the contractor’s pocket early but negatively impacting cash flow in the long run. On the other hand, underbilling can cause a short-run cash shortage while providing no real benefit in the long run.
A cash-flow forecast includes estimates of your business’s likely sales, the timing of payment receipts and the timing of cash outflows. It should consist of recurring and non-recurring transactions, including wages and salaries, investments, interest income, debt payments and one-time expenses such as advertising and promotional activities.
Historical data from past projects can also help to estimate future revenue and costs. Factor in seasonal sales and other factors that could change the projections. Some companies prefer to produce a cash-flow forecast annually, while others do it more often, like every six months or even weekly. Having a designated group responsible for cash-flow forecasting will ensure consistency and accuracy.