Late payments are more than an annoyance. For the contractor who often has to make payroll or pay for materials long before the client settles the bill, they can be the death knell for an otherwise healthy business. But the solution isn’t just to enable clients to pay more promptly.
A study by leading business-to-business payment platform Fundbox revealed the primary reason American small businesses are owed a staggering $825 billion in unpaid invoices is that the invoice was incorrect.
Profitable on paper, broke in practice
A construction firm can be awarded every contract with good profit margins and yet still face a cash shortage. This is because profitability and cash flow are measured differently. You may have $200,000 in accounts receivable, but you can’t meet payroll on Friday.
The discrepancy between work performed and payment received is the biggest financial problem facing contractors.
You pay for all materials upfront, pay employees weekly, but then clients pay at the end – often weeks or months later. This is the point at which construction companies go under.
The solution is not to work more or be more aggressive with clients. You need to optimize your billing process to shorten the time gap until payment, automate the process and make sure that late payments are the rare exception.
Start every project with a mobilization deposit
It is important that no contractor should start any kind of work without receiving a deposit first. It’s not a matter of trust, but of financial planning.
Before you can even begin working on a project, you have to buy the necessary materials, coordinate with subcontractors, and have your employees spend time and effort. All of this creates costs even before you can send out an invoice.
The average deposit ranges from 10% to 33% of the total contract amount, depending on the size of the project. Smaller residential projects tend to be around 33% while larger commercial projects are closer to 10%. But the rule is the same – you shouldn’t have to finance your clients.
Make sure that the deposit is outlined in the contract, not just agreed on verbally. Make it a condition precedent and don’t start working before receiving it.
Most clients will understand this. If a client reacts angrily to your reasonable request for a deposit, they will most likely be the same clients who will try to avoid paying your final invoice as well.
Structure long-term projects around milestone payments
Collecting full payment upon project completion is not a viable option for any task that extends beyond a few days or weeks, as it likely would jeopardize your cash flow.
The practice of progress billing involves tying payments to specific, verifiable project milestones. This ensures a steady flow of money into your business throughout the project.
Milestones should be clearly defined and easily measurable so that there is little room for misinterpretation. When a milestone is achieved, you can bill for the corresponding work completed.
The client should always have the final say in whether a milestone is reached, which is another reason why they must be tangible and verifiable.
Here is what makes a good milestone: -Tied to a specific due date
- Represents an important event and/or a deliverable
- Uses specific metrics to measure quality and completion
- Provides opportunity for the client/end-user to review and approve
In the building and construction industry, you typically submit a proposal listing the expected material and labor costs and the overall payment schedule for multiple milestones.
As for retainage, which holds back a small portion of the payment until substantial completion, one might expect retainage thresholds to also act as milestones.
The proposal’s payment levels should ideally correlate directly with quality, performance, and quantity/percentage thresholds at which completion can be measured.
Shorten your payment windows
The reason Net 30 is often used in contracting is simply because that’s what everyone else does. But no law says you have to.
For residential work and smaller commercial projects, you should never voluntarily give clients 30 days to pay your invoice. Resize their cash float, not yours.
For uncomplicated scopes of work, move residential billing to Net 15 at most. Consider Due on Receipt if you can, using free invoice templates built specifically for trade services to make sure your terms are clearly stated on every document.
If commercial clients claim they need 30 days to get checks cut, negotiate Net 20 as a reasonable compromise. Every day you shave off the payment window is an extra day of working capital in your account.
Don’t stop at adjusting terms. When you’re the one writing the contract, you’ve got to be a bit more aggressive than that.
Include two new clauses in every agreement: an early payment discount and a late payment interest provision. Make them part of the agreement, not just a term published on the invoice, for them to be legally binding.
Cash-tight clients will hasten to exploit a 2% discount for payment within 10 days if you include an “incentive discount” clause in your signed agreement.
Slow-paying clients will have fewer excuses to dawdle if you add an “interest charge for late payment” clause that specifies a late fee at 1.5% a month.
Fix the administrative bottleneck in your invoicing
Late payments are regularly caused by invoice problems, not client bad faith. A missing line item, an unclear description of work, no purchase order reference, a wrong tax identification number – any of these can trigger an internal approval delay that pushes your payment back by weeks while the client’s accounts payable team waits for a corrected document.
The fix is standardization. Every invoice your company sends should include the same elements: contractor and client legal names, project address, invoice number and date, itemized labor hours by trade and rate, itemized materials with quantities, the payment terms, accepted payment methods, and your tax identification information. If any of those are missing, the invoice is incomplete and delays are predictable.
The goal is to send something so clean and complete that approving it takes less than five minutes on the client’s end.
Late payments cost the construction industry an estimated $273 billion annually, with 37% of contractors reporting that work was delayed or halted due to late payments in the past year (Rabbet, Construction Payments Report). A large share of that comes down to friction in the invoicing and approval process – friction that’s entirely preventable.
Remove every barrier to getting paid
Even if an invoice is well-designed, if a client is restricted to paying by check, and their accounts payable department only processes checks monthly, you’re going to be waiting a while to get paid. This is a significant source of payment slowness that doesn’t get enough attention.
Take ACH transfers. ACH (automatic clearing house) is a method of moving funds directly from one bank account to another. The whole payment process takes 1-2 business days and the fees are a lot lower than with credit cards.
It’s also more reliable than relying on a paper check arriving, being processed, and then clearing the bank – and it’s easier for you to get the money if a payment is ever disputed. Offer ACH through your bank or a payment processor and put your ACH payment details on every invoice.
In addition to ACH, give clients at least one more digital option – credit card, a payment portal, or a digital wallet linkage.
Some clients will pay by credit card specifically because they get points, and if they’re going to do that anyway, passing on the small processing fee to yourself is considered fair game and widely tolerated.
The contractors who get paid the fastest are the ones who make it easy. If a client can quickly open an invoice link on their phone, and submit payment 60 seconds later, that’s often what they’ll do. If instead, they have to dig out a checkbook or wait for an overworked invoice cutter in accounting to get around to them, they won’t.
Build a dunning process you actually follow
Many contractors deal with late payments on a case-by-case, seat-of-the-pants basis – they realize a debt is 60 days overdue, force an awkward and likely unproductive conversation about it, and hope they finally get paid. The dunning process outlined here runs automatically, and ensures a professional, respectful tone at every step.
Here’s the sequence: -3 days: send an automated payment reminder 3 days before the invoice is due. This is just a friendly heads-up, and the invoice attached. 0: if the invoice is still unpaid, immediately send the invoice again with a note that says “Payment due today”.
+7: If the invoice is still unpaid 7 days after the due date, send a courteous but firm email acknowledging the overdue balance and inquiring as to whether there are any issues on their side causing a delay. +14: If the invoice is still outstanding 14 days after the due date, pick up the phone.
Do NOT email; call. +30: If the invoice is still unpaid 30 days after the due date, send a formal written notice of delinquency and late interest charge from your contract.
If a balance is 45 – 60 days old and there is no resolution, and no payment plan in place within the next 15 to 30 days, you will need to consider invoice factoring, formal collections, or a lien against the property in some jurisdictions.
Keep an eye on what’s coming
Forecasting is the final component of an effective cash flow system. You don’t need to use sophisticated software for this – a simple spreadsheet that details your expected payment dates per project along with your known outflows (payroll, materials, subcontractors, overhead) can help you discover if you’ll run out of cash in two or three weeks.
When you have that level of visibility, you can make a choice before the emergency hits: Is it worth accelerating billing on a milestone that’s nearly complete? Do you want to be more aggressive in following up on an aging invoice?
Or do you want to arrange a short-term credit facility for a specific gap? Cash flow forecasting doesn’t prevent problems, but it turns surprises into decisions – and that’s a much better place to manage from.
