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Published on April 30, 2025
The construction industry has unique characteristics that influence its financial environment. Which ones?
Specificities related to the construction sector
Progress billing
Construction projects are often billed in stages, according to work completed and milestones achieved. This billing method helps manage cash flows based on the progress in the project. However, this can result in complications if invoices are not approved on time (due to a disagreement with the client regarding milestones achieved or quantities invoiced, for instance), which can in turn delay payments and impact a company’s liquidity.
Contract holdbacks
Under the terms of construction contracts, it is common practice to hold back a portion of the payments until the end of the project (generally for a period of 12 months after work is completed). These holdbacks are used as security to ensure the quality of work and compliance with contractual specifications and to make sure that subcontractors are paid, among other concerns. They often represent a significant part of the contract’s gross margin, which defers access to valuable liquidities for several months.
Unbilled work in progress
Work completed but not yet invoiced can make cash flow management challenging. This work represents costs incurred (therefore work done) before any specific milestones are reached, so that a contractor or subcontractor cannot bill the client for such work. It is crucial to follow work in progress and to invoice it as soon as possible to maintain stable cash flows.
Termination of contracts
Suppliers that have terminated their contracts have a priority claim on payments (legal construction hypothec) and even take precedence over short-term lenders (such as banks). A contractor or subcontractor’s client will need confirmation that such suppliers have been paid (receipts) before it can issue any payment. This means that amounts due to such suppliers must be settled before accounts receivable can be collected, which leads to increased pressure on a company’s liquidities.
Priority claims
Certain debt obligations, to the Commission de la construction du Québec (CCQ) or to the Commission des normes, de l’équité, de la santé et de la sécurité du travail (CNESST) for instance, also have priority over short-term lenders. Once again, a business must prove to its client that such obligations have been met (compliance letters) before any payment can be issued.
Technical complexity
The technical and complex nature of construction projects adds another layer of difficulty to their execution and financing. Construction projects require meticulous planning, careful coordination between the different actors and rigorous resource management. The level of complexity of these projects can result in delays and cost overruns, which may impact their profitability and financial viability.
How do banks manage risk?
Banks adopt various strategies to manage risks related to providing funding to companies doing business in the construction sector.
Deducting priority claims
Banks deduct amounts due to suppliers that have terminated their contracts and other priority claims when calculating the company’s borrowing capacity. This approach helps reduce the risk that the value of trade accounts payable financed by the bank is impacted by priority claims.
Excluding contract holdbacks
Contract holdbacks are very rarely taken into account when calculating the borrowing capacity. Banks consider such holdbacks as amounts that carry risk, since a client could claim compensation for issues regarding quality, compliance or unpaid subcontractors. Therefore, they consider the value of such holdbacks as uncertain and do not grant them any loan value.
Excluding work in progress
Unbilled work in progress is not included in the borrowing capacity. Banks consider such costs incurred as difficult to collect, since the clients have not formally approved the work and no invoice has been issued.
Personal guarantees
Banks often require personal guarantees or guarantees from other companies to secure loans. Such guarantees help reduce the risk of non-payment by ensuring that the loans are secured by personal assets or additional guarantees.
Evaluating management
Significant weight is given to the quality of the management team and the accuracy of the financial information provided. Banks evaluate the competence and experience of the management team to ensure that it is able to manage construction projects efficiently and profitably.
Estimating the equity value
Banks prefer to finance companies that have a significant equity value and thus carry lower risk. A high value ensures that the business has adequate resources to handle unexpected costs and financial challenges.
Positioning within the chain of execution
Banks deem that the risk is higher for subcontractors involved closer to completion of work than those involved when construction starts. Indeed, should there be cost overruns, funds available for the last subcontractors to carry out work may often run out.
Availability of additional assets
To reduce their exposure to risk, it is not unusual for a bank to ask for guarantees on additional assets, such as a building held by a holding company.
Factors that increase your chances of obtaining financing
Proven profitability
Consistent profitability over several years is an indicator of success. To secure lenders, it is crucial that you demonstrate the ability to generate profits regularly and sustainably.
Respecting budgets
Your capacity to respect the bid’s budgets is paramount. You must be able to manage costs efficiently and respect the agreed-upon budgets to avoid cost overruns.
Contract history
The fewer problematic contracts you’ve had in the past, the better. It demonstrates an ability to both manage projects efficiently and avoid litigation and contractual issues.
Types of contracts
Fixed-price (or lump-sum) contracts vs. cost-plus contracts, as well as putting in place clear mechanisms to handle potential changes in work (extras) decrease the level of risk related to contract completion.
Quality of financial information
Accurate and reliable financial information is key to securing lenders.
Management team’s competence
An experienced and competent management team, in particular regarding financial matters, is a determining factor. You must demonstrate the management team’s capacity to manage both projects and the company efficiently and profitably.
Equity value
A business with a high equity value will be perceived favourably, as opposed to a company that chose to give its shareholders a significant portion of past profits.
Understanding these characteristics and adopting the right strategies will provide construction companies with the tools they need to successfully navigate the complex environment of construction financing.