The construction industry is like no other, and possibly the most difficult to understand the inner workings of, particularly when it comes to finances. It is the only sector I am aware of where the system of applying for a payment rather than raising an invoice for work done in common practice.
Why are payment applications raised rather than an invoice?
The answer comes down to how the construction work is performed and completed on site as well as the time it takes for jobs and much larger projects to complete. Payment applications are more complex than a simple invoice, requiring multiple pieces of documentation to prove the legitimacy and validity behind the request for payment.
For construction businesses, these applications are a much-needed source of finance required to successfully undertake a project and are essential to the ongoing working capital of a construction business. Working capital is the lifeblood of any business and is defined as the money the business has available to meet its short-term obligations.
It is therefore crucial that these payment applications are completed correctly, and have all the necessary information and supporting documents to substantiate payment.
How does the application work?
The working capital cycle of a construction project contract is that cash leaves the business for a period of for example a month, an application is made at the end of that month and the cash is then received say another 30 to 60 days after issue.
It is therefore very important that these applications are made at regular intervals and are a fair reflection of the value of work performed so that there is a constant flow of cash into the business, and (of course) enough working capital in the bank to continue with the project and keep the business trading.
Unfortunately it is not uncommon for a profitable business to go under, simply by running out of cash.
What should a payment application include?
As with any legal contract, a payment application must be clearly laid out and it must be issued within the timeframe outlined in the contract document. It must be spelled out that the application is a demand for payment, and what the recipient needs to do to meet that demand.
The terms used in the payment application should mirror those in the contract. For example, if you refer to ‘interim payment application’ in the contract then you should use the same form of words in the payment application. The key is to be as clear and unambiguous as possible. The payment application must include:
- The total contract value originally quoted in the project documentation
- The financial value of all work completed to date, and also details of any materials stored on and off site
- The total amount of money still owing to you
- The amount you have earned to date from the client, compared to the payments you have so far received
- The financial value of any amounts retained
- The balance that remains to complete the contracted project.
You may also choose to include supplementary information such as:
- A breakdown of the rates you charge for each element of the project, matched against the value or cost of the item
- Any changes that have been made over the course of the project so far which may have affected costs, such as materials, schedules, alterations to work requirements etc
- Visual evidence, such as pictures taken on your phone, to show that you have completed the work you are charging for, or that you are storing materials that have been purchased for the job
- Invoices from suppliers for materials delivered for the job, but which are still to be paid
- Receipts from suppliers for materials delivered for the job which have been paid
- Compliance documentation which provides evidence of regulatory requirements such as insurances, VAT registration, and the signed subcontract
How to Avoid Mistakes
There are some easy ways to avoid payment delays as well as maintaining relationships with your employers/clients:
- Make sure that any payment applications are in line with regulatory guidelines for the Housing Grants, Construction and Regeneration Act 1996
- Be punctual with sending in your payment applications
- Check that all the information and supporting evidence is included within your application. This must include visual proof of work performed
- Make sure that other compliance requirements such as insurance are in place and up to date, and that the client has been informed
- Follow that up with a phone call and/or email to make sure everything has been received and no other documentation is needed
Even when all your paperwork is complete and submitted on time, there will inevitably be situations where the employer/client who owes you money disputes your application and tries to pay less than you have asked for. In order to legally do this the client who owes you payment needs to issue a Pay Less Notice to you, which must be served within the time periods set by the contract with you, prior to the final date for payment.
If the employer/payer has not served a Pay Less notice, there may be an option for a Smash and Grab adjudication. This route focuses on enforcing payment and recovering monies currently owed as soon as possible, without having to deal with claims and counterclaims for delays and charges. It is not designed to determine the total value of what is owed, rather it aims to resolve what needs to be paid now, and as such it won’t resolve any arguments over the true value of costs further down the line.
Both of these options are complex legal issues and require professional advice before they are relied on to deal with any contractual disputes.
How we can help
The construction industry has many employers who want to hold back payment, often because they fear the work contracted out won’t be completed properly or on time. On the other side of the coin, contractors want and need to be paid promptly. Getting the job done is a collaborative process between the two parties, hopefully building and maintaining a good relationship in the process. Managing the cash flow between the two is a vital part of business operations, and one where the services of a trusted professional adviser are crucial.
We have a team of Business Advisory specialists who have been selected from across our business for their experience in the construction sector and who are ready to help you with all aspects of your financial and business affairs.
Our construction team includes tax, accountancy, insurance, and financial planning professionals who have extensive expertise and knowledge of trends in this sector.