This month Quantum Executive Director, David Kelly, discussed a topical issues affecting the construction industry; the downside of advanced payments.
In any business, a healthy profit is always good. Similarly a strong balance sheet makes company owners and shareholders happy. However, of more importance is a company’s cash flow. ‘Cash is king’ as the saying goes.
Anything that impacts the cash flow of a company will have a dramatic influence on the company’s ability to deliver, regardless of contractual obligations. The regime of advance payments in construction contracts in Qatar is, I believe, having an adverse impact on the industry. It has been argued that the advance payments are to assist the contractor to mobilise and establish the project.
Advance payments of 10% are not unusual. These advance payments are then repaid via the regular progress certifications at the same rate. The result of these issues and the nature of the industry in Qatar is that advanced payments are now being used to make up for cash flow challenges from previous projects.
The consequences are that on any current project, the contractors effectively have only 90% valued of what they have actually completed. If you consider a contractor’s profit margin may only be 5% for a project, then every month he is falling behind by 5% on his expenses. In addition to this, contractors frequently have a 10% retention taken from their valuations as well, which reduces their cash flow accordingly.
“The regime of advance payments in construction contracts in Qatar is, I believe, having an adverse impact on the industry”
Finally, most contractors fund projects by invoice discounting, whereby banks lend against a contract and pay only a portion of their certified value, perhaps only 80%, to the contractor.
This reduces the contractor’s cash at hand to effectively only 60% of the true value of works completed. Of course if the contractor is paid regularly, to a degree this affect is mitigated. The physical consequences of this situation are that progress is slowed because the contractors are forever juggling their finances to complete their contractual obligations.
They also compromise on quality to try and reduce their exposure. This situation has gone on for so long now, that contractors are in a situation whereby they are in a cycle of ‘robbing Peter to pay Paul’.
Of course you can argue that the contractors should price for this risk in their tenders or bids, however the cycle has become so prevalent that they are now tendering in a race to the bottom to try and survive.
“Anything that impacts the cash flow of a company will have a dramatic influence on the company’s ability to deliver, regardless of contractual obligations”
Of course contractors in Qatar are big boys and enter into their contracts with their eyes wide open. So they cannot really complain and, while the consequences of the cash flow situation should not occur and no-one will openly say the consequences are real, logic and basic understanding of human nature dictate that it must have an impact.
Several countries have understood the consequences of cash flow on a contractor. Australia for instance, has the security of payments system which, in simple terms, means that should the contractor not be paid a certified valuation within the contractual timeframe, they can take immediate action through an adjudication process to force a payment, unless there is a good reason for not enforcing it. Likewise the notion of pay-when-paid has been outlawed by the same system.
Qatar is a relatively young economy. This is both an advantage and a curse. However, companies with experience in the management of construction claims issues can help these problems be understood by those involved in the construction industry here, and accommodated accordingly.
David Kelly, Executive Director
David Kelly, a Quantum Executive Director, has over 28 years of experience of both local and international construction project disputes; David is an eminent construction industry professional, possessing a background in quantity surveying. In 2015, David was awarded the prestigious “Construction Executive of the Year” award from Construction Week Qatar magazine. QGS is acknowledged as one of the leading management consultancies dedicated to serving the interests of national and international construction and engineering organisations.
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This article was previously published in the July 2015 edition of Construction Week Qatar