Many contracting companies across the nation are watching with dismay as their accounts receivable climb out of the normal comfort zone.

For any business, every penny counts whether times are good or bad. Probably nowhere is this mindset more prevalent than in the construction industry, where low profit margins require contractors to protect working capital any way they can. Their success, however, often depends on whether they have an effective billing and collection system. Without one, a contractor’s cash flow can quickly turn sporadic and unpredictable. That almost always leads to a siphoning of cash reserves, which in turn leaves a contractor with insufficient working capital and often no recourse other than to seek hard-to-obtain – and increasingly expensive – loans.

Accounts receivable systems, and the cash flow they generate, are the best measurements of a contractor’s overall efficiency. At companies where cash flow is not tightly controlled, overall performance tends to be weak.

When it comes to protecting cash flow, it’s critical for a contractor to have a coherent, reliable payment collection system. However, even good collection systems are doomed if a client is in poor financial shape or has a history of delaying payments. Before signing any agreements, contractors should review an owner’s credit status through reliable report sources.

Once an owner has been vetted and proven trustworthy, contractors need to make certain their accounts receivable systems are efficient. Contractors who don’t have a collection policy that establishes specific actions triggered by specific conditions should develop one. In general, the basics should include establishing when and to whom bills are sent, the type of follow-up to be used and how collection personnel should respond to payment delays.

The best way to avoid payment problems is for owners and contractors to decide at the beginning of a project how and when bills will be paid. This provides the contractor assurance it will be paid on time, and prevents owners from being ambushed by sudden demands. Before agreeing to a payment schedule, contractors need to remember they will be paying wages, overhead and material and equipment costs for the duration of the project. The payment schedule should comfortably cover those expenses.

LESLIE V. GUAJARDO

It is especially important that subcontractors and suppliers are paid with revenues from the projects on which they work, not an unrelated project. Job borrowing – paying from funds generated by previous jobs – nearly always signals that the contractor is experiencing major financial problems.

If the contract does not establish exactly when payments must be made, there are diplomatic ways contractors can protect their interest. One of the best steps is for the accounts receivable staff to call the client a week or so after the bill has gone out and inquire as to whether the invoice was received or if the client has any questions. That’s courteous, not heavy handed. Also, it eliminates any reason for the client to delay payment because of confusion.

If there is no agreed-upon repayment schedule, and the owner is more than 40 days late, another bill requesting immediate payment should be sent. If the check still isn’t received within a reasonable period, contact an attorney or a collection agency. Contractors work for pay. They are not providing interest-free loans.

All contractors need to realize, however, that contact by an attorney or irritating calls from a collection agency may get the check delivered quickly, but it also risks severing a relationship. That’s unfortunate, which is why it’s critical to avoid such confrontations.

In recessionary periods such as the current one, the failure to review a client’s financial history and establish payment guidelines can lead to greater problems than late payments. If a developer files bankruptcy, a contractor with an already high level of accounts receivable may go down as well.

Worst-case scenarios don’t have to occur. In fact, they rarely occur for those who properly organize invoicing and collection components.

Where we see disasters is among those contractors who rush into a project brimming with assumptions instead of an agreed upon master plan for all activities, including payment. Any construction relationship built on assumptions is destined to create financial pain and hard feelings for someone, and that someone probably is going to be the contractor. 

Leslie V. Guajardo is a partner at Padgett, Stratemann & Co. LLP in San Antonio, Texas. She can be reached at Leslie.Guajardo@padgett-cpa.com