Why Is AR Management So Challenging In The Construction Sector?

Don Orchertonm, Director of OTC Credit & Collections, National Trench Safety

The construction business often faces challenges in collecting payments due to a variety of factors inherent to the industry. Here are some key reasons:

1. Complex Payment Structures:

• Construction projects typically involve multiple parties, including contractors, subcontractors, suppliers, and clients. The payment chain can become complicated, with each link potentially causing delays.

• Payments are often based on project milestones or completion percentages, which can lead to disputes over whether specific conditions have been met.

2. Change Orders and Scope Creep:

• Construction projects frequently undergo changes in scope, leading to change orders. These can cause disagreements about the additional costs and payment responsibilities.

• Unclear or poorly managed change orders can result in delays in invoicing and payment processing.

3. Retainage Practices:

• It is common for clients to withhold a percentage of the payment (retainage) until the project is completed to their satisfaction. This retainage can significantly impact cash flow for contractors and subcontractors.

4. Payment Delays and Disputes:

• Disputes over the quality of work, project delays, or unmet contract terms can lead to payment delays. Resolving these disputes takes time and legal resources.

• Clients may delay payments intentionally due to cash flow issues or as a negotiation tactic.

5. Economic Factors:

• The construction industry is highly sensitive to economic fluctuations. In downturns, clients might face financial difficulties, leading to delayed or defaulted payments.

• Cash flow problems in the industry can trickle down the payment chain, affecting all parties involved.

6. Documentation and Administrative Challenges:

• Proper documentation is crucial for timely payment. Incomplete or inaccurate invoicing, lack of supporting documents, and administrative errors can delay payments.

• Managing the extensive paperwork involved in construction projects can be cumbersome and prone to errors.

7. Legal and Regulatory Issues:

• Construction contracts often contain complex legal terms and conditions that can lead to disputes.

• Navigating lien laws and other regulatory requirements can be difficult, especially for smaller contractors and subcontractors.

8. Client Insolvency:

• If a client becomes insolvent or bankrupt during the course of a project, collecting outstanding payments can become nearly impossible without legal action.

To mitigate these challenges, construction businesses often take measures such as:

• Detailed Contracts: Ensuring contracts are thorough and clearly defined payment terms, milestones, and conditions.

• Regular Communication: Maintaining open lines of communication with clients and other stakeholders to quickly address issues as they arise.

• Efficient Documentation: Implementing robust documentation and invoicing processes to minimize errors and delays.

• Legal Protections: Utilizing legal tools such as mechanics' liens and or Notice to Owner programs to secure payments.

• Financial Management: Managing cash flow effectively and having contingency plans for potential payment delays. Understanding and addressing these challenges can help construction businesses improve their chances of timely payment collection.