Prevailing business wisdom holds that the way to reduce credit risk is to limit credit lines, be stingy in allowing credit and freeze orders on past due accounts. This line of thought posits that it is generally impossible to lower “bad debt” losses without adverse consequences to sales and business expansion.
While it is clear that basic credit principles dictate creating and strictly following a credit policy, avoiding some well-defined category of high-risk accounts and picking a cut-off date beyond which work must be stopped when credit remains unpaid, these factors do not necessarily mandate being stingy in allowing credit or taking on business with accounts that under some definitions may be higher risk. By using the tools available, companies in the construction industry are well-positioned to increase business by accepting higher-risk accounts, and even aggressively pursuing such business.
Conflict Between Credit and Sales
In order to grow revenue and acquire new business, sales and marketing departments are constantly working to bring in new customers. However, obtaining new customers is only part of the battle. To make sure these new customers pay for the labor or materials they are provided, companies must set up credit departments. While sales and marketing are bringing in new parties (with perhaps a less-than-desired inquiry into credit-worthiness), the credit department is responsible for managing financial risk and collecting unpaid debts.
It’s easy to see why these two functions are generally assumed to be at odds. Because sales departments are charged to “sell, sell, sell,” get paid by commissions and are reviewed based on the company’s revenue, they are laser-focused on the hunt and closing the deal. Credit departments, on the other hand, don’t care about the numbers of deals closed; they care about the percentage of customers paying on time and who have the ability to ultimately pay for all credit extended.
The Construction Industry, Mechanics Liens and the Ability to Secure Extensions of Credit
While the construction industry is not immune to credit problems, slow or non-existent payment, or other financial risks, the industry benefits from credit protection built directly into the law. By realizing this, and using it as it was designed, a savvy credit professional can increase business without increasing risk.
Mechanics lien and bond-claim laws were conceived to remedy that exact problem. The construction industry is full of financial risk, but is a critical aspect of the economy. In order to protect construction industry participants from the financial risk inherent in the credit-heavy construction payment process, mechanics lien and bond claim laws were developed to provide much-needed security. Now, through the constant use of these tools, construction industry companies can reduce financial risk exposure to basically zero.
Proper and thorough use of the protections built into the law for construction industry participants can basically eliminate the financial risk associated with the extension of credit. This is because mechanics lien rights don’t end with the company contracted with, but instead obligate the parties all the way up the contracting chain and even encumber property itself. This means that the credit-worthiness of one specific party is only one small aspect of the calculation to determine whether that party can become a customer. Even “risky” customers no longer seem like such bad bets to the credit department when the extension of credit is secured by an interest in the property being improved and many other parties are also responsible for the debt.
Mechanics liens are only one aspect of the credit decision for construction companies. While complete use of the protection provided can nearly eliminate credit risks, there may some reasonable hesitation in fully exercising these rights. That decision does not put a company back into the credit vs. sales conundrum, though. There are other potential remedies and mitigating factors that allow companies to do business with potential credit risks. Some of these additional protections are personal guarantees, joint check agreements, letters of credit and credit insurance.
Companies that are reluctant to extend credit due to a limited appetite for risk are likely evaluating the problem without considering the factors in their favor. The protections against nonpayment available to parties in the construction industry make the decision to pursue business with traditionally “risky” parties a much easier decision.