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Comparing construction payments approaches: milestone payments vs. cost to complete

In the world of construction project management and financing, navigating the complexities of payment schedules is critical for maintaining a project's momentum and financial health. Two methods stand out in the industry: milestone payments and cost-to-complete (CTC). Each approach has its mechanisms, benefits and challenges, and significantly impact how contractors manage resources and how clients control project costs. This article delves into the intricacies of milestone payments and CTC, offering insights into their operational differences and practical applications in construction projects.

Understanding Milestone Payments

Milestone payments are structured around the achievement of predefined events or the completion of specific sections of work, rather than adhering to a traditional time-based schedule. This payment strategy ensures that contractors receive compensation upon reaching certain project benchmarks, known as "milestones". The allure of milestone payments lies in the straightforward premise: accelerate work progress to reach milestones promptly, and in turn, secure payments faster.

In practice, this often leads to contractors deploying additional staff and resources, focusing intensely on achieving these milestones swiftly. The intent is to expedite work progress, thereby facilitating quicker payment cycles and improving cash flow. However, this focus on speed can sometimes compromise the quality of work or lead to resource strain if not managed carefully.

In Australia, banks (officially known as Authorised Deposit-Taking Institutions or ADIs) generally adopt the milestone payments for smaller construction projects such as building a residential dwelling. The allocation of payments throughout the various phases of construction typically adheres to the following structure:

• Deposit: 5%

• Slab or base stage: 15%

• Frame stage: 20%

• Lockup stage: 20%

• Fit-out or fixing stage: 30%

• Practical completion stage: 10%

The values above are not fixed and can be changed, if the above allocation complies to Australian law. As an example, for Victorian properties, according to Consumer Affairs Victoria, a deposit cannot be more than:

• 10% if the total contract price is less than $20,000

• 5% if the total contract price is $20,000 or more

The allocation however, follows different laws depending on the state, with New South Wales having a different set of rules as compared to the Northern Territory.

Benefits of Milestone Payments

Cash flow management: Allows contractors to manage their cash flow more effectively, receiving payments as soon as project milestones are achieved.

Incentivizes efficiency: Encourages contractors to work more efficiently to reach milestones ahead of schedule.

Clear payment triggers: Offers a clear framework for when payments are made, reducing ambiguity in payment schedules.

Cost to Complete: A Financial Forecasting Tool

Cost to complete offers an approach that benefits from prudent financial planning, providing a detailed forecast of the total project costs and ongoing costs as the project progresses. When contracts are structured around CTC, payments can be scheduled monthly, based on the estimated length of the project. This contrasts with milestone payments, as the passage of time, rather than the achievement of work milestones, triggers payments.

This setup offers a measure of predictability and regularity in cash flow for contractors, as payments continue as scheduled despite progress on the project. It necessitates a detailed understanding of project finances and requires ongoing cost assessments to ensure accuracy in forecasting the remaining work costs.

When the construction projects are more complex, usually for three or more dwellings, banks and other lenders generally prefer to use the CTC payment method for progress payments. For instance, a construction site could have a CTC of $450,000 on Day 30. If the CTC at Day 60 is $380,000, and assuming there are no variations to the building contract, the reduction in the CTC implies that construction works worth $70,000 ($450,000 minus $380,000) have been completed on the site. The bank or the lender will usually request a Quantity Surveyor to prepare a progress claim report, which reviews the remaining works to be completed and reassess the costs associated with these works. Significant construction cost increases from the date of the original contracted works may affect the new contractors' ability to complete the remaining works as per the original budget.

Benefits of Cost to Complete

Financial clarity: Provides both parties with a clear understanding of the project's financial status and future requirements.

Regular payment schedule: Ensures a regular payment flow, which can assist contractors manage their finances and resources more predictably.

Focus on completion: Shifts the focus from rushing to meet specific milestones to a more holistic view of project completion, potentially improving work quality.

Comparing Milestone Payments and Cost to Complete

While both payment methods aim to facilitate project progress and ensure financial viability, they differ in approach and emphasis:

Focus: Milestone payments concentrate on achieving specific project segments quickly, while CTC is geared towards a comprehensive financial forecast and regular payment schedule.

Project management implications: Milestone payments might encourage a fast-paced work environment, potentially leading to rushed decision making or quality trade-offs. In contrast, CTC encourages ongoing financial management and may lead to a more balanced approach to project completion.

Payment predictability: Milestone payments provide clear, objective triggers for payments but can lead to fluctuating cash flows depending on the project's pace. CTC offers more regular payment intervals, potentially smoothing out cash flow but requiring meticulous financial tracking.

Conclusion

Choosing between milestone payments and CTC depends on several factors, including project scope, contractor and client preferences and the desired balance between speed, quality and financial management. While milestone payments incentivise rapid progress and efficiency, they necessitate careful management to avoid compromising work quality. On the other hand, CTC offers a structured, predictable approach to financial planning, with an emphasis on project completion. Understanding the nuances of each method allows construction professionals to select the most appropriate payment strategy, ensuring project success and financial stability.

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