There are two ways to set up payment schedules for a typical construction project: Milestone-based billing and Completion-based billing (pay as you go model).
The “Milestone” Model
This is where payments are made when certain project milestones are reached as defined by the contract created by the General Contractor. A payment schedule for a typical residential room addition may read:
Payment #1 – To be paid upon signing of contract as a deposit for construction work yet to be started.
Payment #2 – To be paid upon City approval of forms and steel, pouring of concrete, and stripping of forms; ready for framing.
Payment #3 – To be paid upon completion of rough-in of all framing, utilities, and insulation; and approval by City for close-in (hanging of drywall).
Advantages for the Contractor:
- Ability to “front-load” the payment schedule without the Owner knowing that this is being done. In other words, a way to get paid for work that has not yet been completed that is not trackable by the Owner.
- No need to provide the transparency of a detailed summary of expenses to the Owner.
- No built-in possibility of a “line item veto” by the Owner unless they work hard at making a claim for credits due or delays requested as there are no line items to veto or negotiate.
- Take advantage of the Owner’s naiveté’ of (at least) California state laws which state that a) Deposits shall be 10% of the project or $1,000, whichever is less; and b), That under no circumstances shall money be paid for work that is not yet complete.
Advantages for the Owner:
- None that I’m aware of…
The “Completion” Model
Also a “Pay-as-you-go” model, but with the important distinction being that this payment schedule is time-based, not milestone based. After every time period as defined in the contract (we use every 2 weeks), the Contractor submits an invoice for expenses incurred in that two-week period.
The Invoice Comes in 3 parts
1. One or two-page detailed and completely transparent billing outlining every expense the Contractor has incurred. These expenses fall into the following categories:
- Labor by the Contractor’s employees;
- “Rough” Materials purchased by the Contractor for use by their employees such as nails and 2×4’s;
- Sub-Contractor payments (which are almost always and should be milestone based);
- “Finish Materials” such as doors, windows, fixtures, appliances;
- Outside services or fees required during construction, such as portable toilets, WI-FI services, parking fees, etc.
There need not be any other class of charges in a typical residential project.
2. Supporting documents such as timesheets, materials receipts, purchase orders, sub-contractor invoices, etc. to back up the request for payment and “prove” that they are deserved at the time of billing.
3. Tracking Sheet that tracks each line item of the budget that was agreed to in the contract. This tracking sheet also tracks any and all Change Orders for the project. Each line item in the construction budget is tracked against the agreed amount to show:
- The Contract Amount for that line-item,
- The current amount being billed for that line item,
- The total billed to date in all invoices for that item,
- A percentage complete for that item,
- The balance left in that item.
Columns get added as time and the project marches forward.
This Billing Method as Outlined Above Assumes the Following:
1. That there is a budget to track… That the Contractor has submitted, as part of the contract, a detailed summary of the Project Budget that is broken down by:
- Each and every sub-contractor (or amounts for non-carpentry trades performed by the Contractor’s own employees),
- Amounts budgeted for both labor and rough materials for each separate operation performed by the Contractor’s employees: Framing, Interior trim, Exterior Siding and Trim, Project Management, etc.,
- Finish Materials provided by the Contractor such as doors, windows, skylights, fixtures, etc.
- General Conditions items such as portable toilets, mobilization costs, sidewalk fees (in large cities), etc.
2. That the Contractor has developed at least the rudimentary skills required in Excel to be able to create this kind of information, and that there is a system in place for collecting data at the end of every billing period that is efficient and systematized.
3. That there is a commitment to transparency and information symmetry between the Contractor and Owner.
4. That there is a contractual agreement for the Contractor to act on behalf of the Owner as an advocate in the marketplace and that any savings that might be had over the contract amount (through savings on competitively bidding the subs out, for example) be passed on to the Owner.
Advantages for the Contractor:
- The kind of trust we want to have from our clients when all cards are face-up on the table and the referrals that come from that kind of relationship with a savvy Owner.
- Always knowing exactly where you are on any given project, no more “robbing from job X to pay for job Y” (a recipe for disaster if I ever saw one…)
- The ability to track historical data that can inform future estimates.
- Being incentivized to run an efficient operation.
Advantages for the Owner:
- You always know EXACTLY what you are paying for. Always.
- No possibility of paying for work that is not completed (the number one cause of most horror stories in residential work)
- The ability to say to the Contractor: “I see you have completed everything on this invoice, but I note the paint splatters are still on the window glass and the Painters are asking for their final payment. When you clean those up, I will pay this bill in full.”
- You always know where you stand with any given component of the project.
- You have as much control over the disbursement of construction funds as it’s possible to have (an over-simplification, but mostly true).
It’s truly a win-win. As the Owner who is footing the bill for the project, the salient and most important question is: If you know that you can have everything in the “Completion” model, why in the world would you settle for anything less? There is no doubt that various general contractors will take exception to many of the ideas and practices outlined herein, but I know that I have been billing clients with this method for over 20 years, and there is just no chance I would do it any other way.