Invoicing an owner for work is as complex as higher-level math these days, as contracts are more convoluted and payout terms are frequently extended from 30 to 90 days and beyond. That puts the pinch on cash flow in a big way.
Turner Industries’ accounting department in Baton Rouge has grown significantly in the last 10 years. While some of that is due to organic growth, much of it is necessary to manage the increasing difficulty of simply getting paid.
Turner CFO Jimmy Sylvester says it’s all part of a greater effort by many industry procurement departments to hold onto their cash. Gone are 30-day payment terms. Industrial owners are now pushing it to 120 days in some cases.
Several states have taken action to block the trend over the years. Texas, for example, passed a Prompt Pay Act in 2003 that requires owners to pay an invoice by the 35th day after receipt. Failure to do so is a violation of the act, unless there is a reasonable basis for dispute.
Unfortunately, no such legislation exists in Louisiana, and owners are pushing their payment terms into the stratosphere. This is the reality of the industrial world.
“It takes the contractor weeks to put a bill together, and then the customer typically performs a 30-day audit (of the invoice),” says Jay Montalbano, a partner at CPA firm Hannis T. Bourgeois in Baton Rouge and former president of the Construction Financial Management Association’s South Central Chapter. “And God forbid if there’s a discrepancy, because it’ll get kicked back.”
This disproportionately affects subcontractors, since general contractors often pass the longer terms down the line. “The subs can’t pass that on to their workforce,” Montalbano says. “Their workers still must be paid every Friday.”
Whether a small scaffolding job or a $200 million capital project, the trend is industrywide. And Sylvester, who is responsible for cash flow management at Turner, among other things, says it shows no sign of slowing down.
“Clients we’ve had a relationship with for decades will arbitrarily tell us they’re changing our terms to 90 days,” he says. “‘If you want to still work for us, you will go to 90 days.’”
That’s because the invoicing responsibility has shifted away from the local plant manager to a corporate procurement department. “They (the plant managers) were our champions,” says Sylvester, a 25-year Turner employee. “That’s who we’d negotiate with. That’s who we discussed payment terms with. That paradigm has completely and totally turned upside down.”
Some owners even require that contractors submit a pro forma invoice for review and approval. Once the “practice” invoice is approved, the contractor is allowed to submit the actual invoice. “Here’s the problem: The contract doesn’t say how long they can review our pro forma and get it back to us,” Sylvester says. “It could sit in the pro forma stage for six months. By the time we get paid, we’ve paid our employees 98 days ago.”
Further complicating matters, contractors are often responsible for breaking down their invoices into multiple accounting “buckets” for the client, whether by units, purchase orders, work breakdown structure, etc. This can turn into a costly and time-consuming invoicing delay, and further decrease cash flow.
Montalbano says contractual language can be particularly impactful on cash flow, so contractors should be fully aware of their contractual obligations and comprehend the consequences. This is especially true when dealing with owners based out of the country, as they can be shrewd negotiators.
“Lump Sum” and “Cost-Plus” contracts are the friendliest to cash flow. “The margins and cash flow are better because the billing process is simplified,” he adds. Additionally, some lump sum projects will allow a contractor to bill in advance for mobilization costs.
Time & Materials (T&M) contracts, on the other hand, are more complex and take weeks to invoice. “On the T&M side, the customer wants to see the labor records. They want to see the records for the material and the equipment that was used, etc.”
And, Montalbano says, there are far more complicated contracts entering the scene. “You now see Lump Sum hybrids or Cost-Plus with guaranteed maxes, which essentially converts them to a Lump Sum. You also have contracts that start out as Cost-Plus and get converted to Lump Sum at a certain point, and some that start out Lump Sum but the change orders are done on a Cost-Plus basis.”
Just which contractual arrangement an owner uses is a plant-by-plant decision that incorporates numerous factors, including the level of acceptable risk, the timeline for project completion and the current pool of contractors.
The Newtron Group, an industrial contractor in Baton Rouge, currently has a mix of 60% T&M and 40% Lump Sum, but those percentages can vary from year to year. CFO Tami Misuraca says most of the time larger projects are bid Lump Sum, but an engineer or owner may also bid them as Unit Price or T&M depending upon the state of engineering designs.
Says Misuraca: “When the projects are being pushed through and the engineering isn’t far enough along, owners or engineers will elect to use a T&M contract because change orders could raise the price too much.”
Successful contractors, she says, keep a mix of both. “With the Lump Sum work, there is the potential to get help on the cash flow side if the contract allows up-front billing, but there is more risk. While T&M is safer work, these projects require many days of cash flow and the lower margins affect profitability.”
Misuraca says industrial subcontractors feel somewhat powerless in regard to cash flow, as owners and general contractors are usually calling the shots on contractual language. The key to success, therefore, is a reliable cash flow projection model, along with a good understanding of market conditions.
As one of her roles, Misuraca determines future needs from a cash perspective, then ensures that her company’s existing capital and line of credit exceed projections. That’s because cash flow can swing wildly and quickly become a concern. “For industrial contractors, cash flow is very volatile, and the larger the job the more volatile it can become,” she adds. “I look at what I call ‘stretch scenarios.’ For example, if this one thing happens, are we going to be in a good cash position?” The contractor’s projected needs are then communicated to its banker of 46 years, JPMorgan Chase.
Montalbano agrees that the banking relationship has never been more important. Some of his clients earn hundreds of millions in revenue but don’t have the capital to make payroll, so they have large lines of credit—as high as $75 million in some cases—to provide the cash they need.
While that carries additional risk, savvy contractors price the interest expense back into their contracts. “We tell them that we’ll absolutely go from 30 to 90 days, but it will cost you this much,” Turner’s Sylvester says. “We’ll increase our rate structure by ‘X’ amount to cover our cost.” In those cases, Turner accounts for any potential future rate increase.
Nonetheless, cash is still king and there are consequences to a diminished cash flow. Perhaps most significantly, it impacts a contractor’s ability to invest in equipment or facilities.
It can also limit a contractor’s ability to take on new work. After Hurricane Ike made landfall near Galveston in 2008, The Newtron Group was able to take on a large influx of work because it was well capitalized. “That takes cash,” Misuraca says. “In a six-month period we saw a $50 million swing in cash flow.”
There are other steps a contractor can take. Billing in a timely manner is perhaps the simplest approach to improving cash flow. Others include negotiating more favorable terms or billing in advance when possible.
Perhaps most importantly, a contractor should practice fiscal responsibility. That by itself, Sylvester says, can overcome many obstacles. At the end of the day, executive management has the ultimate call as to whether Turner accepts the risk or walks away from a project. “Contractors don’t go out of business because they can’t make money,” he says. “They go out of business because they can’t pay their employees on Friday.”