Owners, developers and general contractors get a lot of notoriety for construction projects, especially in these infrastructure-focused times. However, the subcontractor is truly the one under the microscope, as this group requires the most care and attention to ensure the owners and operators are able to meet accelerating demand and public expectations.

The challenges in the current environment are many. Inflation and supply chain disruptions are highly detrimental to specialty trades in the mechanical, electrical, plumbing, drywall and other areas. Reports show that the construction industry, in particular, has seen an increase of over 20% in the cost of supplies and building materials in the last year alone and, in some cases, over 90% since the start of the pandemic. While these costs are passed along to the owner, the subcontractor still retains significant cash flow risk. This truth is amplified in a volatile market. As if the cost was not enough, equipment and material shortages coupled with rising interest rates only compound the problem—and tenfold for small businesses.

Subcontractors are likely to feel the greatest pressure from supply-related issues. Inflation combined with supply chain shortages require subcontractors to prepare earlier for projects and, when possible, purchase materials upfront. However, the consequence of this preliminary preparation equates to further strains on cash flow. In an effort to remain aligned on schedules and budgets, subcontractors frequently buy all of a project’s materials as soon as a contract is signed—if not before.

It’s a huge cash expenditure for a segment of the industry that is notoriously cash poor; it’s common to see a subcontractor with over $100 million in annual revenue struggle to make payroll. The response from the subcontractor has been to take on more projects, each bleeding into the subsequent one and paying for its equipment and materials. The risks are high if those payments are in any way delayed—and a big reason why studies reflect contractors failing more often in good times than bad. Without cash, subcontractors have to use business savings, lines of credit or even personal savings to get projects moving forward.

Options are few for this group, which is held responsible for meeting schedules and budgets while often being the last to get paid.

So what’s the answer? Subcontractors are a bellwether of industry success—it’s time to take better care of these essential partners.

Contractual Adjustments

One of the first areas of adjustment has been in the contractual terms between the general contractor and trade partners. The days of pay-when-paid, pay-if-paid, and similar contingency provisions are not going to cut it if the industry wants to maintain and strengthen the subcontractor supply chain.

Smart general contractors are having intense conversations with favored subcontractors to incorporate contractual terms that are agreeable for both parties. For instance, mobilization fees are working their way back into many contract terms. These fees help cover a wide net of provisions, including transportation, fuel, equipment rental, initial materials, tools as well as site prep activities. When provided in advance of a project start, mobilization advances can help maintain a subcontractor’s cash flow.

Now is also a good time for subcontractors to review retainage policies contracts. Reducing retainage is a great way to speed up cash flow.

For general contractors, assuring cash flow is often a balance between state regulations and availability. For example, contractor and supplier diversity requirements, especially on public projects, are expanding. In many states, payment terms for small-, minority-, women-, veteran- and LGBTQ+-owned businesses are set by law and can require weekly payments. This can cause general contractors to prioritize one group of subcontractors over another, exacerbating subcontractors’ risk of cash flow challenges.

Relationship Focused

When it comes to paying for materials, subcontractors can work closely with suppliers for longer payment terms. They can also borrow money from credit lines, which works, but will also put additional strain on the businesses if there’s a lull in project start times. Beware of rising interest rates, though. Investigating credit card cash-back programs might be an option.

Receivables financing is another strong option. This method leverages an owner or general contractor’s credit position to pay subcontractors in days instead of weeks and months. It’s not a loan and, therefore, it’s not a debt. One of the biggest benefits is that it allows for much greater predictability around cash flow with no interest accumulation and fees that are much lower than conventional bank loans.

Some general contractors are even enrolling their favored subcontractors in a receivables financing program, and paying the associated fees, to strengthen subcontractor relationships and build trust.

Inflation, continued supply chain issues and even workforce shortages are real challenges—and contractors of all types and sizes are buckling up for a couple of tough years.

As the bellwethers of all trends, good and bad, subcontractors are essentially the heart of the construction industry. Their cash flow problems affect every facet of the industry, from the suppliers to the general contractors, owners and developers. The owners and general contractors that find a way to support and strengthen those project partners will see the greatest success in the next few years and beyond.