How Do Construction Contracts Affect Project Finances?
Construction contracts are agreements between two or more parties to execute construction work. These contracts typically outline the scope of work, schedule, and payment terms. Construction contracts can have a significant impact on project finances, as they can dictate how much money is spent on labor and materials, and when payments are made.
In some cases, construction contracts may also include provisions for liquidated damages, which are designed to compensate the owner if the contractor fails to complete the work on time. If liquidated damages are included in a contract, they can have a significant financial impact on a project, as they can add up quickly if there are delays.
Construction contracts can also be used to finance a project. In some cases, contractors may be willing to provide financing to the owner, using the contract as collateral. This can be a helpful way to get a project off the ground, but it can also put the owner at risk if the contractor defaults on the loan.
In this blog, we’ll go over all you need to go about construction contracts and how they affect project finances.
What are the Different Kinds of Construction Contracts?
There are many different types of construction contracts, but the most common are lump sum contracts, cost-plus contracts, and time and materials contracts.
Stipulated Sum Contract
Lump sum contracts are agreements where the contractor agrees to complete the work for a fixed price. This type of contract is often used for simple projects, or when the scope of work is well-defined.
Cost Plus Contract
In cost plus pricing, the cost of goods and services is marked up to arrive at the selling price. For this approach, you add together the direct material cost, direct labor cost, and overhead costs for a product, and then add a markup percentage. Cost-plus contracts are agreements where the contractor is reimbursed for their actual costs, plus a fee. This type of contract is often used for more complex projects, or when the scope of work is not well-defined.
Design-build contracts are agreements where the contractor is responsible for both the design and construction of the project. This type of contract is often used when the owner wants a single point of responsibility, or when the project is too complex to be accurately scoped out in advance. The entity, Design-Builder manages all contracts with subcontractors, equipment vendors, and materials suppliers.
Time and Materials Contract
Time and materials contracts are agreements where the contractor is reimbursed for their actual costs, plus a fee for their time and materials. This type of contract is often used when the scope of work is not well-defined, or when the project is complex.
What are the Challenges of Construction Accounts and Payables?
One of the biggest challenges with construction accounts and payables is managing the timing of payments. In many cases, contractors will request progress payments as work is completed, which can put a strain on cash flow if not managed properly. In addition, many construction contracts include provisions for retainage, which is an amount of money that is withheld from each progress payment until the project is completed. This can further complicate cash flow management, as owners may need to front the money for retainage and then wait to be reimbursed.
Manual Data Entry
Another challenge with construction accounts and payables is the need for manual data entry. In most cases, invoices from contractors will need to be manually entered into accounting software, which can be time-consuming and prone to errors. This can lead to delays in payments, and can also make it difficult to track spending.
Complicated Internal Processes
Another challenge with construction accounts and payables is the need for complicated internal processes. In many cases, construction projects will involve multiple contractors and sub-contractors, which can make it difficult to keep track of who needs to be paid and when. This can lead to delays in payments, and can also make it difficult to manage cash flow.
Another challenge with construction accounts and payables is managing change orders. Change orders are requests from the contractor to make changes to the scope of work, which can impact the budget and schedule. If not managed properly, change orders can add significant cost and delays to a project.
What are some tips for managing construction accounts and payables?
Some tips for managing construction accounts and payables include:
- Establish a system for tracking progress payments and invoices such as inBuild
- Review invoices and progress payments regularly to ensure accuracy.
- Stay on top of change orders and communicate with the contractor to ensure they are within budget.
- Have a solid understanding of the payment terms in the construction contract.
- Work with a reputable and experienced construction accountant to manage the finances of the project.
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