Collections is one of those topics that many people don’t like to talk about, but as McNeill Stokes pointed out in this article, it is very important to your business survival. The advice dispensed here may or may not work for you. However, if you are challenged with collection issues it is worth some consideration.
By McNeill Stokes of Stokes, Shapiro, Fussel & Genburg, Attorneys at Law – Atlanta, GA
The cash-flow needs of most contractors require that they vigorously pursue their right to payment. It is the nature of construction work that contractors perform dollar volumes many times in excess of their working capital. The subcontractors and those general contractors who actually perform work must pay on a weekly basis for their labor and on a current basis for their materials and overhead. If they are unable to collect payments on time, they have immediate cash-flow problems. Therefore, it is important for contractors to understand the various remedies available in the construction industry to ensure collection of money for work performed.
Establish Standard Procedures
Contractors should establish standard procedures to prevent collection problems from arising. One of the best ways is to have a tough, consistent collection system – a bill collected now cannot turn into a bad account or a lawsuit later. The contract is never complete until the payment for performance is collected. The contractor should establish a “date certain” for payment of amounts as they become due. If payment does not arrive on that date, take action immediately. Set up a system where accounts are systematically supervised. Collect every single account every month. Send notices and initiate collection procedures whenever necessary. A reputation for collecting fairly and consistently every month can be of great value.
One of our clients is a subcontractor who does a business of $4-$5 million per year and never builds up more than $300-$400 worth of bad debts! Their approach is simple: They set a date in their contracts when they are to be paid. Their bookkeeper automatically calls the account the day after the payment date and demands payment. They’re not interested in why payment has not been made. If an excuse is offered, they say: “I’ve heard all the excuses before and I’m not interested in your excuses. I am sending someone over to pick up the check this afternoon!” And they get it. They are even more respected by their customers because of their consistent business approach to collections and they get all the repeat work they want.
Pursuing Collection
Drafting and checking contracts for legal pitfalls is the first and most important stage of collection. Contracts should be drafted to avoid the need for collection activities. Firm dates for when the contractor is to be paid should be established in the contract. A payment clause is not complete without a specific payment date. Similarly, final payment should be due within a set number of days after substantial completion of the contractor’s work (less a reasonable hold back for any uncompleted items). Of course, the contractor should always strive to reduce or eliminate retention to improve cash flow and cut down on the heavy risk of final payment.
It is amazing how a small sum of money, only a fraction of total sales or capital investment, can spell the difference between being solvent or not. The typical contractor has only enough working capital, or “net quick,” to carry through 30 days of operation without revenues coming in. In fact, 60 days worth of working capital is about the most any contractor carries. So, if a few big payments are missed on contracts, it can wipe out a contractor almost overnight. Staying in business, therefore, demands as much ability to collect bills as it does ability to do the work skillfully and economically. Some contractors fail because they are not able to manage their collections.
One family-owned firm had been doing business for over 80 years when it lost its entire net worth of $1 million within a matter of months. Several of its contracts had fallen delinquent on very large progress payments. The company was headed for bankruptcy because of the failure of the firm to get its money. While the family was considering liquidation, a key employee asked for a chance to get the company back on its feet in return for its almost worthless stock. Figuring there was nothing to lose, the family agreed. Seven years after the employee had taken over operations, the firm’s net worth was back at $1 million, even thought the company had been forced to write off almost all the outstanding accounts receivable. The key to this remarkable accomplishment? On a sales volume of $15 million, he had managed to collect all of his payments. Not one dollar was written off.
Credit goes to what he significantly calls his million dollar form. The bookkeeper sends this form to the firm’s project managers in every situation where an account receivable has not been paid by the 20th of the month. The form is actually quite simple. It asks only three questions: (1) What efforts have you (the project manager) made to collect this account receivable? (2) What is the real reason you have not been able to collect on it? and (3) What action do you recommend – stopping work, filing of liens, or what?
The man at the top requires that the form be back on his desk by the 25th of the month, in time for him to review it before the next bill goes out. But the fact is, the form never comes back. Rather than face the boss with their inability to collect the payment, the project managers just go and get the check.
A firm no-excuses policy like this one will always be more effective in the long run than legal action. Law suits are slow and expensive. And they are not always won. If possible, payment due dates should be written into the contract. If not, contact the customer as soon as the first invoice is received and ask whether everything is in order. If the customer says no, immediately find out why not. If everything is in order, ask for reinforcement that payment can be expected on such-and-such date. Either way, the contractor is managing and controlling the situation. And, the contractor will normally be able to make the collection before the account becomes a bad debt. A payment collected cannot become a bad debt. Collection of accounts must be managed currently and consistently. FBN