Cash flow finance for construction businesses

A groundworks firm pays its gang every Friday, its builders' merchant at the end of next month, and the plant hire company on 30-day terms. Its main contractor pays once a month, after valuing the work, deducting a retention and, for a subcontractor, taking CIS deductions. Even on a profitable job, the firm can be tens of thousands of pounds out of pocket before the first payment lands.

This guide explains where the gap comes from, why mainstream lenders find construction awkward, and the kinds of funding built for it.

How payment works on a construction contract

Most commercial construction work isn't paid on a simple invoice. It runs on a cycle of claims and approvals:

• Application for payment. At set intervals, usually monthly, you claim the value of the work done so far, often including materials delivered to site.
• Valuation. The payer, or a quantity surveyor acting for them, assesses the work and decides what it's worth. That figure can be lower than what you applied for.
• Payment certificate or payment notice. The agreed sum is confirmed in writing, and a final date for payment is set by the contract.
• Payment, less retention. You're paid the certified amount, minus any retention and, if you're a subcontractor, any CIS deductions.

In England, Wales and Scotland, the Housing Grants, Construction and Regeneration Act 1996, usually called the Construction Act, sets ground rules for most construction contracts. Among other things, contracts expected to last 45 days or more must provide for interim or stage payments, "pay when paid" clauses are generally unenforceable except where an upstream payer is insolvent, and you can suspend work for non-payment after giving notice. Work for homeowners on their own homes is mostly outside these rules. Northern Ireland has its own equivalent. Our guide to your rights when customers pay late covers what you can do when payment doesn't arrive.

Retentions

A retention is a percentage of each payment that the payer holds back as security against defects. Retentions are commonly in the range of 3% to 5%, though your contract sets the figure. Usually half is released at practical completion and the rest at the end of the defects period, which is often 12 months later.

That means part of your profit on every job is sitting in someone else's bank account, sometimes for well over a year. Two practical points:

• Track every retention. Many firms lose money simply by not chasing releases on time.
• Retentions are at risk if the payer fails. If a main contractor becomes insolvent, retention money owed to you is usually treated as an ordinary unsecured debt, and you may recover little or none of it.

Most lenders won't lend against retentions, because they're contingent: they depend on the work passing the defects period.

CIS deductions

Under the Construction Industry Scheme (CIS), contractors must deduct money from payments to subcontractors and pass it to HMRC. The deductions count as advance payments towards the subcontractor's tax and National Insurance. They apply to the labour part of a payment, not to materials. The rate depends on whether the subcontractor is registered with HMRC.

For your cash flow, what matters is when you get the money back:

• Limited companies can usually set CIS deductions they've suffered against the PAYE and CIS they owe HMRC each month, and claim a repayment of anything left over.
• Sole traders and partners usually get the deductions back through their self assessment tax return, which can mean waiting many months.
• Gross payment status lets a subcontractor be paid without deductions. You have to apply and meet HMRC's tests on turnover, compliance and how you run the business.

The rules and rates are on GOV.UK's guide to the Construction Industry Scheme. Since March 2021, the VAT domestic reverse charge applies to many construction services supplied to another VAT-registered business under CIS: the customer accounts for the VAT instead of paying it to you. That removed the short-term cash boost some subcontractors used to get from holding VAT until their return was due, which is worth allowing for in a forecast.

Why ordinary invoice finance often says no

Invoice finance advances most of an invoice's value within days, and it's a useful tool for many businesses. See invoice finance vs a business loan for how it works. But many mainstream providers exclude construction, or limit it heavily, because:

• An application isn't a fixed debt. Until the work is valued and certified, nobody knows exactly what's owed.
• The payer can reduce or set off. Contra-charges, disputes over defects, and claims for delays can all shrink a payment.
• Retentions and CIS deductions mean the cash received is less than the face value of the application.
• Stage payments depend on completing the next stage. If the contractor fails mid-job, a funder may struggle to collect for unfinished work.

Specialist construction finance

Specialist providers do fund construction, because they understand the contracts and price in the risks. Arrangements vary, but they can include:

• Construction invoice finance or application finance, which advances money against applications or certified valuations, often at a lower percentage than standard invoice finance.
• Contract-specific funding for a single large job, sized to the contract and its payment schedule.
• Revolving credit facilities that you draw on as costs build and repay as payments arrive.

Expect a provider to read your contracts closely and check your main payers. Some also help with collections, which matters when a payment is short or late.

Other ways to ease the gap

• Supplier credit. Trade accounts with builders' merchants and suppliers, typically on 30-day terms or longer, are often the cheapest funding you have. Pay on time and ask for higher limits as you grow.
• Plant finance. Buying plant on hire purchase or a lease spreads the cost instead of draining cash, and refinancing plant you own can release cash tied up in it. See plant and machinery finance.
• Better contract terms. Negotiating shorter payment periods, a lower retention, or a retention bond instead of cash retention reduces the gap before you borrow anything.
• A VAT or short-term loan for one-off bills, sized and timed around the payments you expect.

An illustration. A subcontractor applies for £60,000 at the end of March. The quantity surveyor values the work at £55,000, after a dispute over one item. A 5% retention holds back £2,750, and suppose CIS deductions on the labour element come to £6,000. The firm receives £46,250, at the end of April. Meanwhile it has paid four weeks of wages, a merchant's invoice and plant hire. A specialist facility advancing against the certified valuation could release part of that money earlier, and a merchant account on 60-day terms would mean the materials are paid after the cash arrives. These figures are illustrations, not quotes.

What funders look at

• Your contracts. Payment terms, retention terms, set-off clauses, and whether you're working directly for a client or as a subcontractor.
• Who pays you. The financial strength of your main contractors or clients matters as much as your own.
• Your history. Past valuations, disputes, and how often you're paid less than you applied for.
• Your accounts, aged debtors and order book, plus management accounts if your year end was a while ago.
• Your CIS and VAT position, including whether you have gross payment status and are up to date with HMRC.

Lending to limited companies and LLPs is generally unregulated. If you're a sole trader or small partnership borrowing £25,000 or less, the lending is regulated by the FCA, so fewer business lenders offer it.

Common mistakes

• Pricing jobs without pricing the cash gap. Retentions and payment terms cost money. Build the cost of funding them into your tender.
• Not reading the payment terms before signing. Long payment periods and high retentions can make a profitable job a cash flow problem.
• Missing your own deadlines. Late applications or missed notices can delay payment or weaken your position in a dispute.
• Forgetting to chase retentions. Diarise release dates and ask on time.
• Relying on one main contractor. If most of your work comes from one payer, its problems become yours.

Questions people ask

Can construction companies use invoice finance?

Yes, but many mainstream providers exclude construction or limit it, because applications for payment can be valued down, set off or disputed. Specialist construction finance providers do fund applications and certified valuations, usually advancing a lower percentage than standard invoice finance.

What is a retention in construction?

It's a percentage of each payment held back by the payer as security against defects, commonly 3% to 5%. Usually half is released at practical completion and the rest after the defects period, often a year later. Your contract sets the exact terms.

How do I get CIS deductions back?

Limited companies can usually set CIS deductions against what they owe HMRC in PAYE and CIS each month, and claim back any excess. Sole traders and partners usually reclaim them through their self assessment tax return. GOV.UK explains the current process.

Can I finance a construction contract before I've been paid?

Yes. Options include specialist construction finance against applications or certified valuations, contract-specific funding, revolving credit, and supplier credit for materials. The right one depends on your contracts and who you're working for.

What does "pay when paid" mean in construction?

It's a clause saying you'll only be paid once the contractor above you has been paid. Under the Construction Act, such clauses are generally unenforceable, except where a payer further up the chain is insolvent. Check your contract and take advice if you're unsure.