Mastering Construction Payment Terms

Payment Terms in construction

What does Payment Terms mean?

“Payment terms” refer to the conditions under which a vendor is paid by the buyer. These terms specify the amount of time that the buyer has to pay the amount due and may also provide discounts if the buyer pays before the due date.

Here are some common payment terms and their explanations:

  1. Net 30: Payment is due in full 30 days after the invoice date or the delivery of goods/services.
  2. Net 60: Payment is due in full 60 days after the invoice date or the delivery of goods/services.
  3. 2/10, Net 30: The buyer can take a 2% discount if they pay within 10 days of the invoice date. Otherwise, the full amount is due in 30 days.
  4. Net 7: Payment is due in full 7 days after the invoice date or the delivery of goods/services.
  5. COD (Cash on Delivery): Payment is due when the goods are delivered.
  6. CIA (Cash in Advance): Payment must be made before the goods are delivered or the service is performed.
  7. EOM (End of Month): Payment is due at the end of the month in which the invoice is received.
  8. Letter of Credit: A commitment by a bank on behalf of the buyer that payment will be made to the beneficiary (seller) provided that the terms and conditions stated in the letter have been met.
  9. Installments: Payments are divided over a period of time. For example, a buyer could pay in 4 monthly installments.
  10. Consignment: Payment is made only for those goods that are sold. Unsold goods can be returned to the seller.
  11. Down Payment: A portion of the total amount due is paid up front, with the remainder due at a later date or upon delivery.

Remember, payment terms can be negotiated between the buyer and the seller. The terms chosen often depend on the industry, the relationship between the buyer and seller, the size of the purchase, and the creditworthiness of the buyer. It’s crucial for businesses to clearly state and understand the payment terms to ensure smooth cash flow and avoid misunderstandings or potential legal issues.

What is Advanced Payment?

“Advanced Payment” refers to the money paid by a buyer to a seller before the goods are delivered or services are rendered. It’s a pre-payment, made ahead of the usual payment schedule or before the completion of the work.

There are various reasons for requesting advanced payments:

  1. Risk Mitigation: Especially for customized goods or services, sellers might want an upfront payment to reduce the risk of non-payment after the order is completed.
  2. Cash Flow: Advanced payments can provide the seller with the necessary funds to start the work or to purchase materials required for the job.
  3. Commitment: It ensures that the buyer is committed to the transaction.
  4. Creditworthiness: If the buyer has questionable credit, sellers might require an advanced payment as a measure of security.

While advanced payments can be beneficial to the seller, they might pose risks to the buyer, such as the potential non-delivery of goods or services. It’s essential for buyers to ensure that they’re dealing with reputable sellers when agreeing to such terms.

What is Progress Payment?

“Progress Payment” refers to a series of partial payments made by the buyer to the seller based on the progress or stages of the work completed, rather than on its completion. These payments are usually predefined and laid out in a contract, ensuring that the seller receives funds during the course of a project or contract, which can span weeks, months, or even years.

Progress payments are common in industries where large-scale or long-term projects are the norm, such as:

  1. Construction: As different phases of a building project are completed (e.g., foundation, framing, roofing), payments are made.
  2. Manufacturing: For custom or large-scale manufacturing projects, payments might be tied to the completion of specific production milestones.
  3. Government Contracts: Governments often use progress payments when contracting private companies for large projects or services.
  4. Software Development: Payments can be made after the completion of specific development milestones or phases.

The benefits of progress payments include:

  • Improved Cash Flow: Sellers don’t have to wait until the end of the project to receive payment, aiding in covering ongoing expenses.
  • Risk Reduction: Both parties are protected as the buyer can ensure satisfactory progress before making a payment, and the seller receives regular payments.

However, the exact terms, including the amount and the timing of progress payments, should be clearly defined in the contract to avoid misunderstandings or disputes.

What is Certification Time in terms of payment?

“Certification Time” refers to the duration or period allocated for inspecting and approving the work that has been completed. It’s the span during which an authorized party, such as an inspector, supervisor, engineer, architect, or another designated professional, evaluates the finished task or project to ensure it meets the specified standards and requirements.

For instance, in construction, after a particular phase of the project is completed, the work might undergo a review during the “Certification Time” to ensure it adheres to the plans, codes, and quality standards. Once the work is certified, the subsequent processes can continue, which may include releasing progress payments or moving on to the next phase of the project.

It’s essential for both the client and the contractor (or service provider) to have a clear understanding of the expected “Certification Time” to manage timelines, expectations, and payments effectively.

What are CDC (Current Date Cheque) and PDC (Post Date Cheque)?

CDC (Current Date Cheque) and PDC (Post Date Cheque) refer to the dates written on cheques which determine when they can be cashed or deposited:

CDC (Current Date Cheque):

  • This is a cheque that has today’s date on it.
  • The cheque can be presented for payment immediately.

Using CDC (Current Date Cheque) in a Construction Project

Let’s consider a scenario in a construction project where a CDC (Current Date Cheque) is used.

Scenario: A real estate developer, “Skyline Properties,” is working on constructing a residential building. They have contracted “Sturdy Foundations,” a construction firm, to execute the work. As per their contract, upon reaching certain milestones, Skyline Properties must release payment to Sturdy Foundations.

Milestone Reached: Sturdy Foundations completes the foundational work of the building, which is one of the payment milestones.

CDC Use: Upon the completion of the foundational work, Sturdy Foundations submits a progress report along with an invoice to Skyline Properties. Skyline Properties reviews the work, and once satisfied, they decide to release the payment immediately.

Instead of transferring funds electronically or waiting for another mode of payment, Skyline Properties issues a CDC (Current Date Cheque) to Sturdy Foundations as an immediate payment for the work done. The date on the cheque is the current date, indicating that Sturdy Foundations can deposit the cheque right away and access the funds as soon as the cheque clears.

This CDC serves as a quick and efficient way for Skyline Properties to fulfill its payment obligations promptly, allowing Sturdy Foundations to maintain its cash flow and continue its operations without delays.

Using a CDC in such a context provides assurance to the contractor that payment is not only approved but also immediately accessible. This can be especially valuable in industries like construction where maintaining cash flow is crucial to keep the project running smoothly.

PDC (Post Date Cheque):

  • This is a cheque on which the issuer has intentionally put a future date.
  • It can’t be cashed or deposited until the date specified on the cheque.
  • PDCs are commonly used as a form of deferred payment. For instance, a landlord might require post-dated cheques from a tenant for each month’s rent in advance.

Using PDC (Post Date Cheque) in a Construction Project

Let’s delve into a scenario in a construction project where a PDC (Post Date Cheque) is used.

Scenario: “Horizon Developers” is constructing a commercial complex. They’ve engaged “MegaBuilders,” a construction firm, for the construction work. They have an agreement that certain amounts will be paid to MegaBuilders based on the completion of specific stages of the project.

Upcoming Milestone: MegaBuilders is approaching the completion of the structural framing of the building, a significant milestone. However, Horizon Developers know they will have incoming funds from a major tenant’s lease starting two months from now, but they’re currently tight on liquid cash.

PDC Use: To ensure that they can guarantee payment to MegaBuilders while managing their own liquidity challenges, Horizon Developers and MegaBuilders come to an agreement. Horizon Developers issue a Post Date Cheque (PDC) to MegaBuilders with a date set two months in the future, which aligns with the expected inflow of funds from the new tenant lease.

This PDC assures MegaBuilders that they will receive their payment on the specified date in the future, while Horizon Developers can strategically manage their cash flow without defaulting on their obligations.

By the time the date on the PDC arrives, Horizon Developers have received their expected funds from the tenant and have sufficient balance in their bank account. MegaBuilders then deposit the PDC on the given date and receive their due payment.

In this construction context, using a PDC allows both parties to maintain a level of trust and financial strategy. The developer can align payments with their cash flow, and the contractor is assured of future payment. However, such arrangements also come with risks, especially if the issuer’s account does not have sufficient funds when the cheque is eventually presented for payment. Proper communication and trust are vital when using PDCs in such scenarios.

It’s important to note that the acceptability and practice related to post-dated cheques vary by country and bank. In some places, a bank might inadvertently (or even purposely, based on its policy) process a post-dated cheque before the date on the cheque, while in others, doing so may be illegal. Always be cautious when issuing or receiving post-dated cheques and understand the related local regulations and bank policies.

What is Collateral in terms of payment?

In terms of payment and finance, “collateral” refers to an asset or property that a borrower offers as a way to secure a loan. If the borrower defaults on their loan payments, the lender can seize the collateral and sell it to recoup some or all of their losses.

Here’s a breakdown of how collateral works:

  1. Security for the Lender: Collateral acts as a security measure for lenders. By having something of value that can be taken in the event of non-payment, the lender’s risk is reduced.
  2. Enables Borrower Access: Collateral can often enable borrowers to get loans they might not otherwise qualify for, especially if they have a low credit score or unsteady income. Additionally, secured loans (those backed by collateral) often come with lower interest rates compared to unsecured loans.
  3. Types of Collateral: Almost any asset can be used as collateral, as long as the lender agrees to accept it and it’s legally permissible. Common types of collateral include:
    • Real estate (houses, land, commercial properties)
    • Vehicles (cars, trucks, boats)
    • Savings accounts or certificates of deposit
    • Stocks, bonds, or mutual funds
    • Machinery and equipment (for businesses)
    • Inventory (for businesses)
    • Valuables and collectibles (e.g., jewelry, art)
  4. Loan-to-Value Ratio (LTV): This is a metric that lenders use to determine how much they’re willing to loan relative to the value of the collateral. For instance, if a borrower offers a house worth $100,000 as collateral, a lender might only be willing to provide a loan up to $80,000 (80% LTV).
  5. Risk of Loss: If a borrower defaults on a loan, the lender has the right to take possession of the collateral through a legal process. Once seized, the lender can sell the collateral. If the sale doesn’t cover the outstanding loan amount, the borrower may still owe the difference.
  6. Release of Collateral: Once the loan is fully repaid, the lender’s claim on the collateral is removed, and full ownership and rights return to the borrower.

It’s crucial for borrowers to understand the terms and conditions associated with putting up collateral for a loan, as there’s a real risk of losing that asset if they’re unable to meet their repayment obligations.

Using Collateral in Construction Projects

The use of collateral in construction projects is quite common, especially when large sums of money and significant risks are involved. Here’s an illustrative example:

Scenario: “Urban Vistas,” a real estate development company, plans to build a new high-rise residential complex in the city center. The project is estimated to cost $50 million, but Urban Vistas currently has only $10 million in liquid assets. To finance the remaining $40 million, they decide to approach “CapitalBank” for a construction loan.

Collateral Use:

  1. Land as Collateral: Urban Vistas owns the plot of land where the high-rise will be constructed, which is valued at $20 million. They offer this land as collateral to CapitalBank. By accepting the land as collateral, the bank reduces its risk of loss in case Urban Vistas defaults on the loan.
  2. Additional Assets: In addition to the land, Urban Vistas also offers their office building, valued at $15 million, as additional collateral to ensure they can secure the full $40 million loan.
  3. Terms and Conditions: CapitalBank agrees to the loan on the condition that if Urban Vistas fails to make their scheduled loan payments, the bank can take possession of both the plot of land and the office building.
  4. Benefits to Urban Vistas: By offering these assets as collateral, Urban Vistas secures the necessary funds at a competitive interest rate. This allows them to move forward with their ambitious project without seeking equity partners or selling off assets.
  5. Project Completion and Loan Repayment: The construction proceeds smoothly, and the high-rise residential complex is built. The sales of apartments in the new building generate significant revenue for Urban Vistas. They use this revenue to repay the loan to CapitalBank over the agreed period.
  6. Release of Collateral: Once the loan is fully repaid, CapitalBank releases its claim on the plot of land and the office building, returning full ownership rights to Urban Vistas.

In this example, the use of collateral was instrumental in facilitating the funding for the construction project. However, it’s crucial for both parties to conduct due diligence and establish clear terms in their agreement to ensure the project’s success and the protection of their respective interests.

What Software uses for Management Construction Payment Terms?

Managing payment terms and the associated financial intricacies in construction projects often requires specialized software. These software solutions not only handle the financial aspect but also integrate project management features, ensuring seamless operations and accurate billing based on project milestones. Here are some commonly used software solutions for managing construction payment terms:

  1. – Enterprise Software Solution for construction companies. The solution includes quotations, project management, customer invoicing, purchasing and vendor bills, accounting, budget management, etc.
  2. Procore: Procore’s construction management software includes financial tools that handle invoicing, change orders, and payments. It facilitates communication between project stakeholders and ensures everyone is on the same page regarding payment terms.
  3. Oracle Aconex: A cloud-based construction management software solution, Oracle Aconex handles project-wide collaboration, including the management of payment applications, invoices, and financial documents.
  4. BuilderTREND: Tailored for homebuilders and remodelers, BuilderTREND includes tools for billing, invoicing, and managing payment terms, ensuring timely payments and clear communication between contractors and clients.
  5. CoConstruct: This software is designed for custom home builders and remodelers. It offers budgeting, invoicing, and expense tracking features that align with project milestones and payment terms.
  6. Viewpoint: Viewpoint’s suite of products includes financial management solutions tailored to the construction industry. It integrates project management and accounting, ensuring that payment terms, invoicing, and financial reporting are seamlessly connected.

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