Generally, invoices are paid before they age enough to cause significant worry. Nevertheless, construction industry participants face an ongoing battle to get paid on time and make sure they get paid for every project.
The necessity of floating payments down the chain while waiting to be paid from above, coupled with the risk of nonpayment, has led to construction having one of the highest failure rates of any industry. Accordingly, construction financial managers or other A/R or credit professionals can have a hard time helping companies manage and collect aging invoices.
While there are two distinct goals for the majority of credit professionals—getting invoices paid faster and reducing the number of invoices that are written off as uncollectable—these goals are fundamentally linked. The longer an invoice goes unpaid, the greater the chance of it eventually being written off. Once an invoice has aged for 90 days or more, the chances of getting paid drop to about half. Because mitigating this risk can have a significant impact, businesses are always on the lookout for tips and tricks to stay ahead of default receivables and make sure money is coming in when it is supposed to. Luckily for businesses in the construction industry, special tools to make that happen are built directly into the law and available to anyone who wants to use them.
Construction A/R Problems and How to Combat Them
Construction payment can be slowed or stopped by both the complexity and structure of the process. Despite problems inherent in the system, steps can be taken to minimize risks. Construction industry participants have a unique opportunity to use both voluntary and involuntary security interests to dramatically reduce the risk of not receiving payment. Mechanics liens, bond claims, personal guarantees, joint check agreements and more can completely reinvent a company’s A/R.
Secured extensions of credit get paid much more often (and more quickly) than those that are unsecured. And, mechanics liens and bond claims were specifically created to alleviate payment issues for construction companies. Nearly every party on a construction project has the right to claim the property being improved as collateral to guarantee payment. This provides a unique ability to combat credit management challenges. Coupled with the other security available to construction participants through the use of joint-check agreements, personal guarantees, etc., slow or non-existent payment should be a worry of the past.
The trick is to fully use the security rights available through the implementation of a thorough and repeatable system. Creating and following a receivables funnel that takes advantage of security rights can result in reducing day sales outstanding and the practical elimination of bad debt write-offs.
Create a Receivables Funnel and Leverage Security to Get Paid
The first step in getting paid on every project is to understand why solvent customers aren’t paying in the first place. The truth is that they are—it’s just that other invoices are being prioritized. Because many companies are required to float significant costs while waiting for payment from other parties, these companies are frequently forced to make decisions as to which invoices to pay on time. There are software programs specifically designed to assist companies in making the determination of which invoices should receive the highest priority and which are more easily allowed to slip.
To minimize financial risk, a company needs to influence the prioritization of its invoices. A particularly effective way to do this is to make sure that all invoices are kept in a secured position and the customer (and everybody else up the payment chain) knows the company is on the project, and that its invoices are secured.
A proper receivables funnel for construction industry participants should contain the following steps:
- At the beginning of the project, send a preliminary notice to protect mechanics lien rights and inform parties of the company’s involvement.
- After an account is in default, send a notice of intent to lien to urge payment.
- If payment is not received within a certain set number of days after the notice of intent is sent, file a mechanics lien to secure the debt with the property itself.
- If a mechanics lien is not paid within a certain set number of days, send to collections.
- If a mechanics lien is not paid within four months, file a foreclosure/lien enforcement suit.
While all steps are important in concept, very few projects will ever make it to the third step before payment is received in practice. And, even fewer will ever reach steps four and five. Companies that follow a receivables funnel approach can expect to actually file liens on only 1 percent to 2 percent of the total project volume.
The process outlined above is a step-by-step checklist to remain in a secured position on every project. This reduces the risk associated with extending credit in the construction industry because the security of a valid mechanics lien allows the property to be sold to satisfy the claim—if it comes to that.
Creating and implementing a thorough and well-crafted credit policy as a whole (with special attention given to the notice and lien policy subparts and the receivables funnel as outlined above) is an incredibly powerful way to collect the money owed on every project. Following a credit policy that incorporates the thorough use of available security interests (both voluntary and involuntary) can be an enormous step in the direction of significantly fewer A/R worries and a considerable reduction of risk.