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

For any business, every penny counts in good times and bad. Perhaps nowhere is that more prevalent than in construction. Low profit margins require contractors to protect working capital any way they can. An effective billing and collection system is critical. Without that, cash flow can turn sporadic and unpredictable. That almost always leads to siphoning of cash reserves, which leaves insufficient working capital and often no recourse but 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. There is almost always a lack of focus and foresight.

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

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Does the owner has a history of litigation? Know what type of reputation the owner has. If it isn’t good, think twice about bidding.

Once an owner is proven trustworthy, contractors need to make certain their accounts receivable systems are efficient. Establishe a collection policiy that specific actions triggered by specific conditions. The basics should include when and to whom bills are sent, the type of follow-up used and how collection personnel should respond to payment delays.

The best way to avoid payment problems is 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 for money. 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.

Subcontractors and suppliers should be paid with revenue from projects they work on. Job borrowing—paying from funds generated by previous jobs—nearly always signals a contractor is experiencing major financial problems.

When billing, pay attention to details. Include copies of approved change orders.

Because most contractors want to build relationships, they don’t always require payments be received within 30 days. After all, providing a little flexibility is a good way to strengthen a relationship. Some owners take advantage of the flexibility and stretch out payments.

If the contract does not establish exactly when payments must be made, there are diplomatic ways to protect a firm’s interest. Accounts receivable staff might call the client a shortly after the bill was sent to inquire if it was received and/or if there are any questions. That’s courteous, not heavy handed.

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. A follow-up call to ask when to expect payment is appropriate. An offer to pick up the payment can be made. If the check still isn’t received within a reasonable period, contact an attorney or a collection agency.

Realize 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, failure to review a client’s financial history and establish payment guidelines can lead to other problems. If a developer files bankruptcy, a contractor with an already high level of accounts receivable may go down, too. The industry’s history is littered with the remains of small and mid-size contractors that placed too much faith in what appeared to be well-financed institutions.

Firms running collections with competence tend to run business overall the same way.

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 industry relationship built on assumptions is destined to create financial pain and hard feelings for someone, and that someone is likely the contractor.

Leslie V. Guajardo, CPA, CCIFP, is a partner at Padgett, Stratemann & Co. LLP in San Antonio. She can be reached at 210-253-1530 or Leslie.Guajardo@padgett-cpa.com.