Cash flow, progress billing and payment law

A contractor can make a profit on paper and still run out of cash. On a building project, the contractor pays its workers weekly, its suppliers within 30 days and its subcontractors when it is paid, while the owner pays monthly in arrears and withholds part of every payment until the end. The gap between money going out and money coming in has to be financed, and the cost of that financing comes out of the fee. This lesson covers the progress billing cycle from the contractor's side, how holdback or retainage and payment timing shape the project's cash flow curve, how to forecast and finance the gap, and the prompt payment laws that now set the timetable on many projects. The legal rules on progress payments, holdback, liens and adjudication are explained fully in CON-220 Lessons 5 to 7; the accounting of billings and revenue in CON-320.

The schedule of values and the pay application

Progress billing starts with the schedule of values: the breakdown of the contract price into line items, agreed with the owner's payment certifier at the start of the job. Each month the contractor submits a progress claim (or pay application) showing, for each line, the value of work completed to date, materials stored on site where the contract allows, and the totals. The owner withholds holdback or retainage and deducts previous payments to find the amount due.

In the United States, pay applications are often prepared on the AIA G702 and G703 forms or an owner's equivalent and certified by the architect, and the owner withholds retainage set by the contract and, on public work, limited by statute. Sales tax treatment depends on the state; on many projects tax is part of the contractor's material cost rather than added to the bill (CON-300 Lesson 9).

# Progress claim for Riverbend Commons, month 8 (amounts $, before sales tax)
sov = [  # line, scheduled value, percent complete to date, materials stored on site
    ("General conditions",          1_995_000, 0.50,      0),
    ("Site work and foundations",   1_484_000, 1.00,      0),
    ("Structure",                   3_302_000, 0.88,      0),
    ("Envelope",                    2_863_000, 0.50, 62_000),
    ("Mechanical",                  2_311_000, 0.38, 48_000),
    ("Electrical",                  1_148_000, 0.35,      0),
    ("Interiors and finishes",      3_010_000, 0.06,      0),
    ("Site works and close-out",      737_000, 0.00,      0),
]
holdback_rate = 0.10
done = sum(v * p for _, v, p, _ in sov)
stored = sum(m for *_, m in sov)
gross = done + stored
holdback = gross * holdback_rate
previous = 6_820_000          # net amount certified in months 1 to 7
due = gross - holdback - previous
print(f"Contract value {sum(v for _, v, _, _ in sov):,}")
print(f"Work completed {done:,.0f} + stored {stored:,} = {gross:,.0f}")
print(f"Less holdback {holdback:,.0f}, less previous {previous:,} -> due this month {due:,.0f}")

Contract value 16,850,000
Work completed 8,279,340 + stored 110,000 = 8,389,340
Less holdback 838,934, less previous 6,820,000 -> due this month 730,406

The contract value sums to $16,850,000. Work completed and stored to date is about $8.39 million, of which about $839,000 is held back. After deducting earlier payments, about $730,000 is due for month 8. Note that billing is based on the schedule of values at contract prices, so it includes the fee; it is a different curve from the cost-based planned value of Lesson 3.

Checking the claim before it goes out

The pay application is a commercial document, and errors in it cost money in both directions. Overclaiming invites rejection and harms trust with the certifier; underclaiming finances the owner's project with the contractor's cash. Before submitting, the project manager should check the claimed percentages against measured progress (Lesson 4), confirm that stored materials meet the contract's conditions (insurance, protection, title, invoices), include approved change orders as separate lines, and make sure subcontractor billings for the same period are consistent with what is being claimed from the owner.

Billing position: over and under billing

Comparing what has been billed with the value earned shows whether the contractor is overbilled (billed ahead of work done, which helps cash) or underbilled (billed behind, which hurts it). On a lump sum job, the earned contract value is percent complete multiplied by contract value; comparing it with billings to date gives the billing position. Persistent underbilling usually means claims are not being submitted promptly or changes are not being billed; persistent overbilling may mean front-loading, which owners resist and which leaves too little contract value to finish the work. CON-320 explains how the billing position appears in the contractor's financial statements.

The project cash flow curve

Project cash flow is the difference over time between cash paid out (wages, suppliers, subcontractors, equipment, overheads) and cash received from the owner. Three effects make the contractor's cash position negative for much of the job: payment lag, because the owner pays some weeks after the month in which the work is done; holdback or retainage, which is withheld until near the end; and the timing mismatch between paying wages weekly and receiving payment monthly. Subcontract payment terms soften the effect, because subcontractors are usually paid only when the contractor is paid, and they bear their own holdback.

# Monthly cash flow for Riverbend Commons (amounts $1000; illustrative)
cost = [592, 593, 1_224, 751, 1_082, 1_630, 1_630, 1_358, 1_358, 1_358, 810, 810, 810, 1_047, 715, 356]
fee = 0.045
holdback = 0.10
lag = 2                     # months from end of work month to receipt of payment
sub_share = 0.70            # share of cost paid to subcontractors, paid when the owner pays (pay-when-paid terms)
months = len(cost) + 4
out = [0.0] * months; inn = [0.0] * months
for m, c in enumerate(cost):
    out[m] += c * (1 - sub_share)                         # own costs paid in the month
    out[m + lag] += c * sub_share * (1 - holdback)        # subs paid when we are paid, less their holdback
    inn[m + lag] += c * (1 + fee) * (1 - holdback)        # owner pays work less holdback
release = len(cost) + 2                                   # holdback released after completion
inn[release] += sum(cost) * (1 + fee) * holdback
out[release] += sum(cost) * sub_share * holdback
cum = 0; worst = 0
for m in range(months):
    cum += inn[m] - out[m]
    worst = min(worst, cum)
    print(f"Month {m + 1:>2}: out {out[m]:7,.0f}  in {inn[m]:7,.0f}  cumulative {cum:8,.0f}")
print(f"Peak cash requirement {-worst:,.0f}; final cash position {cum:,.0f}")

Month  1: out     178  in       0  cumulative     -178
Month  2: out     178  in       0  cumulative     -356
Month  3: out     740  in     557  cumulative     -539
Month  4: out     599  in     558  cumulative     -580
Month  5: out   1,096  in   1,151  cumulative     -525
Month  6: out     962  in     706  cumulative     -780
Month  7: out   1,171  in   1,018  cumulative     -933
Month  8: out   1,434  in   1,533  cumulative     -835
Month  9: out   1,434  in   1,533  cumulative     -736
Month 10: out   1,263  in   1,277  cumulative     -722
Month 11: out   1,099  in   1,277  cumulative     -543
Month 12: out   1,099  in   1,277  cumulative     -364
Month 13: out     753  in     762  cumulative     -356
Month 14: out     824  in     762  cumulative     -419
Month 15: out     725  in     762  cumulative     -382
Month 16: out     766  in     985  cumulative     -163
Month 17: out     450  in     672  cumulative       59
Month 18: out     224  in     335  cumulative      169
Month 19: out   1,129  in   1,685  cumulative      726
Month 20: out       0  in       0  cumulative      726
Peak cash requirement 933; final cash position 726

Under these assumptions the contractor needs to finance about $930,000 at the worst point, in month 7, and stays cash-negative until month 17, even though the project is profitable; the final cash position equals the fee only after holdback is released. The peak would be far higher without pay-when-paid subcontract terms, and lower if the owner paid faster or released holdback earlier. These are exactly the levers that prompt payment laws and annual holdback release are designed to move.

Financing cost

The net cash requirement is usually funded from the contractor's working capital or a bank line of credit. Either way it has a cost: interest on borrowed money, or the return the contractor could have earned on its own capital. The financing cost is the average negative cash balance multiplied by the interest rate and the time. On a thin margin it is significant.

Prompt payment and holdback law

For decades, slow payment through the construction chain was a chronic problem: owners paid late, contractors waited, and subcontractors at the bottom of the chain waited longest. Prompt payment laws now set deadlines for payment at each tier on many projects, and some provide fast adjudication when payments are disputed. For cost control and cash planning, the main effect is a more predictable payment lag.

In the United States, the federal Prompt Payment Act requires agencies to pay construction progress payments within 14 days of receiving a proper payment request (final payment within 30 days), with interest penalties for late payment, and requires prime contractors to pay subcontractors within seven days of receiving payment for their work. On federal contracts, the FAR allows retainage only when progress is not satisfactory, generally up to 10 %, and it must be released when the work is substantially complete. Most states have their own prompt payment statutes for public work and many for private work, and many states cap retainage on public projects, often at 5 % or allow reduction once the job is half complete. The rules differ by state and contract, so check the statute that applies to each project (CON-220 Lessons 5 and 6).

Cash flow forecasting in the cost report

A cash flow forecast is a natural companion to the cost forecast. Using the cost-loaded schedule (Lesson 3), the forecast cost to complete (Lesson 6), the billing schedule of values and the payment terms, the contractor can project net cash month by month for the rest of the job. Many contractors review this forecast at the company level each month, because the sum of all projects' cash needs determines how much credit the company requires. A project whose cash position is much worse than forecast is often signaling something else: claims not submitted, changes not billed, a dispute with the certifier, or costs running ahead of progress.