Understanding Construction Industry Payment Terms: A Flexbase Guide
Construction industry payment terms have long been a mystery to contractors, who are often left struggling financially as a result of the irrationally slow payment times on most projects.
Even legal contracts with perfectly laid out payment terms don’t always protect contractors from costly payment delays, or even payment refusal.
These delays impact everyone on the job, with subcontractors and laborers at the end of a long line of people waiting to be paid.
So, what can contractors do to prevent these seemingly inevitable delays?
In this guide, we’ll teach you:
- Everything you need to know about construction industry payment terms
- How they affect subcontractors; and
- What you can do to streamline the payment process and get paid sooner.
Table of Contents
- Flexbase: Your Construction Billing Terms Management Solution
- Brief Review of the Standard Components of a Contract in the Construction Industry
- Construction “Payment Terms’ Defined
- Standard Construction Contract Payment Terms
- Why is it Essential to Understand All Payment Terms Before Signing a Contract in the Construction Industry?
Flexbase: Your Construction Billing Terms Management Solution
One of the biggest issues facing subcontractors today is payment — Not just getting paid on time (which is already rare in and of itself) but getting paid in full every time.
Flexbase has streamlined the payment process for contractors by automating every step.
Simply upload your contract, complete with standard construction industry payment terms, to your free Flexbase account and let us take care of the details, including:
- Project tracking
- Applications for payment
- Legal reminders
- And much, much more
The Flexbase platform integrates fully with the accounting and project management software you already use, making the transition seamless.
And, our resources are 100% free to use. You don’t pay unless you get paid.
Brief Review of the 5 Standard Components of a Contract in the Construction Industry
The success of a construction contract depends heavily on the terms laid out within.
Without these standard and essential details, contractors are left vulnerable to payment delays and even payment refusals.
Every construction contract should contain the following elements:
- Legal names, addresses, and signatures of both parties: Without these components, a contract is not legally binding, so as obvious as it seems, it’s important to know that a contract missing these details will not hold up in a court of law.
- Scope of work: This area of the contract should be greatly detailed, explaining not only the general scope of work, but the exact services to be provided, all materials required for the job, as well as the quality, grade, and schedule of work expected.
- Project costs and payment terms: It’s extremely important to clearly and simply state the total cost of services included in the contract, as well as any services beyond the scope of the job. A schedule of payments will indicate the amount due, along with any terms and conditions of payment to avoid any confusion.
- A schedule of work: Establishing a construction start and end date, as well as a clear notice to proceed date is essential in any construction contract. It’s wise to indicate in the contract that any delays caused by the property owner obtaining the necessary legal documentation (permits, easements, approvals, etc.) or delays caused by bad weather are not the responsibility of the subcontractor. Any lead time required by suppliers should be documented in the event of change orders, too.
- Authority: To avoid any disputes as to who will make and finalize decisions during construction, it’s important to establish, and make legally binding, who has this authority before project initiation.
Even with a firm and comprehensive contract in place, subcontractors are all too familiar with how difficult it is to get paid in the industry.
Contracts that clearly lay out standard construction industry payment terms are not always enough to ensure timely payment, with nearly half of construction payments not being paid on time.
So, what are the payment terms that should be specified in a construction contract, and what can contractors do to ensure scheduled payments are being made?
Construction ‘Payment Terms’ Defined
As indicated above, construction industry payment terms are the terms and conditions laid out in a contract that cover the essential components of payment.
Included in the payment section of a construction contract, you may find some of the following terms detailed within the subsections:
- Contract sum
- Schedule of values
- Application for payment
- Change orders
- Certificates for payment
- Progress payments
- Payment timeline
- Final completion and final payment
Even though construction contracts include a section dedicated to payment terms that have been agreed upon by both parties, slow payment still remains the number one issue facing contractors today.
Below we break down the standard payment terms for contractors, why they’re important, and what you can do to get paid sooner.
Standard Construction Contract Payment Terms
Every owner or GC will have a standard contract expected to be signed by every subcontractor on the job, but these contracts are not always the same.
This is why it’s critically important to thoroughly read and understand the terms within each individual contract.
Below we’ve listed some of the standard construction industry payment terms found within a contract (see an example here) and what they mean to subcontractors.
The contract sum is the agreed-upon price with the contractor that is entered into the contract.
It’s very important that the contract sum is calculated carefully, and checked for errors, as this is the sum that is deemed accepted by both parties once the contract is signed.
It’s also important to know that the contract sum is never considered a fixed price, even in a lump-sum or fixed-price contract, as this would mean that the contractor would have to factor in every possible risk into the price. This would not be to the benefit of the GC or owner.
All contracts will have a clause allowing for variations and other adjustments relating to the total cost of the project.
Construction industry payment terms typically have a due date set out that determine when progress payments are to be made and when the final date for payment occurs.
Every contract is different, so you should ensure that the payment terms reflect your usual invoicing processes.
Applications for Payments
Application for payment forms are documents that outline exactly how a contractor is to be paid.
The form includes all of the…
- Materials; and
- Labor costs
…that are associated with the job and are executed under the contract terms.
The application should be as detailed as possible, including:
- Itemized lists including the cost
- Quantity of items required for the project; and
- A description of all items being furnished.
Applications may vary from project to project, but they will include one general form as well as a few schedule documents.
When you upload your contract to the Flexbase app, our team will review all of the payment details and set up your account to send:
- Automatic applications for payments
- Payment reminders; and
- Legal notices if required.
Quite simply, a construction change order is an amendment to the scope of work originally laid out in the contract.
Change orders represent a mutual agreement between all parties involved in:
- A change to the project
- The schedule
- The price; or
- Another term of the contract.
These need to be written out and approved by all parties, which can take time and patience, and ultimately slow the progress of a project.
Schedule of Values
The schedule of values (SOV) is a comprehensive list of every work item on a job, including the cost of the item, and represents the entirety of the construction project from start to finish.
Typically submitted along with the payment application, the SOV gives the GC or owner the ability to see the portion of each item completed which allows them to agree to or dispute the progress payment.
As part of the standard payment terms for contractors, retainage refers to the percentage of the value of work that is retained by the owner and usually represents the contractor’s profit margin.
Upon completion of the project, the retainage is paid in full and therefore acts as an incentive for the contractor to complete the work in a timely and satisfactory manner.
Depending on the initial contract terms, retainage is sometimes reduced after an agreed-upon portion of the project has been completed.
A payment timeline, or schedule of payments, is the list of dates set out in the contract that determine when payments will be made to the contractor.
Usually, the payment timeline includes the:
- Contract start date
- Initial payment amount
- Scheduled intervals for subsequent payments
- Project completion timeframe; and
- Estimated total amount for construction.
Lien waivers work like a “receipt” of payment in the construction industry and are an important document for all stakeholders on a project.
When a subcontractor has received payment, a signed lien waiver guarantees that a mechanics lien will not be filed on the job for non-payment.
With a Flexbase subscription, lien waivers are automatically sent to GCs and owners with every application for payment.
Not only does this alleviate the ongoing administrative tasks weighing down contractors, but it also speeds up the payment process.
Certificates of Insurance
Working on another person’s property presents certain risks to contractors, such as damaging personal property, or even sustaining an injury while performing the job.
Owners and GCs that hire contractors need to be assured that they will not be held liable for:
- Injuries; or
- Subpar work.
So, as a part of standard construction industry payment terms, a certificate of insurance will likely be requested.
As part of the payment process, Flexbase automatically notifies you if your subcontractor’s insurance is…
- Expired; or
- About to expire
…ensuring that you’re in full compliance with your contract at all times.
Why is it Essential to Understand All Payment Terms Before Signing a Contract in the Construction Industry?
First, and most importantly, work should never begin before a contract is agreed upon and signed by all parties involved.
As a contractor or subcontractor, it’s wise to conduct a simple background check on the company you are being contracted by to see if there is a history of bankruptcy or litigation.
If so, you may want to incorporate further financial measures into the contract, such as:
- An escrow account
- Advance payment; or
- A payment bond.
Additionally, the price in the contract should include clear details of the work to be completed, and the payment and completion timeline of said work.
It’s also important to include a provision for additional work and variations, should they occur.
While neither party would hope to become entangled in a dispute, they can arise, so a clause that covers dispute resolution is advised.
Typically, disputes can be resolved through…
- Arbitration; or
…rather than in the courts.
In short, ensuring that the contract includes every possible scenario with regards to payment terms will help to mitigate potential legal situations.
Manage Cash Flow Accordingly
Whether you’re an owner or GC struggling to pay subs, or you’re a contractor dealing with late payments, it helps to have a plan to manage your cash flow and reserves on any project.
Construction loans are not unusual, but the process to obtain a loan can be very time-consuming.
Banks can take weeks — even months — to approve and issue construction funding loans, which can leave either party in a financial pickle.
Flexbase customers are automatically pre-approved for construction funding by our preferred lenders.
Flexbase can provide high-quality data to lenders right from the start because:
- We have access to your past statements
- Our software integrates with all of your business tools and banks accounts; and
- We analyze all of the data before sending it to lenders.
As a Flexbase customer, you not only save yourself the burden of dealing with creditors and banks, you immediately know whether your company is prequalified for a construction equipment loan.
Instead of waiting for the banks to make a decision, you can get working capital now.
Flexbase can free up your cash flow with construction equipment funding in 24 hours.
Know Your Legal Rights for Recourse
If you’ve followed the actions required by your contract and you’re still not getting paid for work completed, there are steps that can be taken.
- Make a phone call: Believe it or not, phone calls can prove very effective as owners and/or GCs often respond more positively to a friendly phone call than a threatening notice — but, don’t wait too long. Make the call within a few days to a week from when the payment was expected and document the call in a follow-up email or letter.
- Send written notice: A letter should contain all of the pertinent information, such as:
- Amount owed
- Original due date
- Terms of the original agreement
- Your expected timeline for payment
- Violation of the Prompt Payments Act (if applicable in your state); and
- Your intention to file a mechanics lien.
- File a mechanics lien: Typically the most effective way to secure a late payment is to file a mechanics lien. But, bear in mind that mechanics liens have expiry dates and you should check your state laws to learn about the time limits on filing a lien.
It’s a well-known fact that in the construction industry, payment terms are a known cause for dispute, headaches, and cash flow issues.
Don’t let the stress of…
- Payment applications
- Lien waivers
- Payment reminders
- Legal notices; and
- Mechanic’s liens
…get you down — Flexbase can help.
Our automated payment software integrates with your current accounting and project management software for a streamlined and flawless payment process every time.
Don’t get caught up in legal battles — get Flexbase and get paid sooner.