8 ways to improve accounts receivable for contractors

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The average time it takes for contractors to get paid stretches to nearly three months. That puts a lot of strain on a construction company’s accounts receivable (A/R). As a result, contractors often leave money on the table in an effort to collect faster – or, in some cases, collect anything at all. According to the 2019 National Construction Payments Report Survey, the majority (78%) of contractors rarely or ever charge interest on late payments. Desperate to get paid at all, over half (55%) of these contractors say they negotiate payment terms or even provide a discount.

That’s the bad news. The good news is that contractors can take specific steps to improve their accounts receivable and reduce the amount of time it takes to collect on outstanding invoices.

Why is accounts receivable so hard?

After you send an invoice or payment application, the amount you are waiting to collect is considered accounts receivable (A/R). Managing your A/R basically means taking steps to get paid as quickly as possible.

The construction industry is notorious for long periods exist between billing and collection. Creating effective credit and other policies can help you train your customers to pay according to your terms.

Delays can be caused by a number of factors. The hiring party may be waiting for documentation or signed lien waivers before they release a payment. Maybe they’re just disorganized, and misplaced your original invoice. Perhaps they aren’t even aware that you’re on the job in the first place!

Below are 8 steps to improving your accounts receivable, and reducing your Days Sales Outstanding (DSO) – the average time it takes you to get paid. You don’t have to adopt every single one. Try them out, and figure out what works to improve cash flow for your construction business.

1. Send invoice reminders before payment is due

When you get caught up in day-to-day operations, invoices slip through the cracks. Make it a point to submit invoices or payment applications on time – and follow up with reminders before they’re due. Don’t assume that everything is going as planned, and wait for your customer to make the first move. Be proactive.

There are many software companies that provide invoicing solutions for construction companies. Online software solutions like Quickbooks for ContractorsFreshbooks, or Jonas Construction can take many of the mundane invoicing tasks off your plate. Levelset also gives customers the ability to send invoice reminders automatically, that keep your request for payment top-of-mind – and at the top of the pile of invoices on the GC’s desk.

2. Get a deposit

The more you can collect from your client before the project starts, the easier it will be to manage your accounts receivable during and after the project. Of course, that’s easier said than done! Up-front deposits are increasingly rare in construction. But that doesn’t mean you should give up on them.

Contractors typically need to purchase materials to use on the project before the first payment comes through. That makes asking for a deposit entirely reasonable. Business owners often get into cash flow trouble by dipping into lines of credit or spending to excess on credit cards.

When a customer hesitates to give a deposit, they’re effectively saying “I don’t trust you.” So help them trust you. Instead of cherry-picking three references, give them contact information for every customer you’ve worked with over the past two years. Publish project photos and testimonials on your website (and invest in a modern, credible website, while you’re at it). Be professional.

If a customer is still hesitant to give you a deposit, try this. Ask them to pay the supplier directly for the materials you need during the first period of the project. If they balk at this idea, or refuse to even consider it, maybe they’re not the kind of client you want to work with anyway.

3. Revisit your credit

No, I’m not talking about your credit score (though that’s important for different reasons). In this step, we’re talking about the credit you’re extending to customers. If you’re not collecting money as soon as your work is done, then you’re effectively giving your clients a loan. That’s not necessarily a bad thing – most businesses offer payment terms to their customers. But you need to be clear about what those terms are, and what you’ll do if they aren’t met.

A good credit policy is essential for any construction business. Every day that goes by without a payment, you are extending terms to customers when collecting on overdue accounts. A credit policy can improve your accounts receivable because they outline the steps your company follows – every time – to deal with slow-paying accounts. Enforcing your credit policy shows your customers that you mean business, and helps to train them to pay you according to your terms.

A well-written credit policy should include your business’s billing procedures. Additionally, you’ll need to have policies in place for dealing with late paying accounts.

You’ll want to communicate this credit policy before the construction project begins, so you set expectations from the start.

4. Use payment penalties and incentives wisely

Late payment penalties and early payment incentives can both motivate a client to pay on time for different reasons.

Early payment discounts improve accounts receivable because it gives clients an incentive to make payments as soon as they get invoiced. For example, you could include a discount for customers that pay within 10 days of invoice receipt.

But don’t go throwing 25% discounts at everyone just to get paid faster. First, you need to understand the value of that faster payment. If you used a business loan or line of credit to meet expenses while you’re waiting for payments, then you’re paying interest. At the very least, getting paid faster is going to save you whatever money you would have spent on interest.

Speeding up your accounts receivable can also create value through a multiplier effect. Getting a payment now can mean cash on hand to invest in another project, which may help your business grow faster. Waiting for a late payment might mean having to say “no” to a new project – and the additional profit that comes with it.

Understanding the true cost of slow payments can help you decide what faster payment is really worth to your company.

5. Understand your client’s accounts payable process

To improve your accounts receivable situation, you’ll also have to understand your client’s accounts payable process. On a large project, it’s not unusual for the property owner and GC to  receive invoices from dozens – if not hundreds – of subcontractors and suppliers. They have time set aside each month to process them. They’ll need to review the pay applications, determine if the request is valid, double-check the work, compare it to the contract, etc. It’s a time-consuming procedure.

Submit your invoices or pay applications on time, and be as exhaustive as possible. If you miss the application deadline, the GC might not accept it until the following pay period. And be complete. The more detailed you are, the easier it is for the hiring party to check for accuracy. Remember: You’re trying to prove that you did the work and deserve to get paid for it. Include a pay application checklist to make sure you don’t forget anything. Make it easy for them to approve your request.

6. Establish yourself as a vendor who gets paid on time

Your customers create a hierarchy of vendors who can and can’t be stalled. They might not write it down, but the person in charge of accounts payable knows who lets them get away with late payments, and who doesn’t. Early in the relationship, build a reputation as a vendor who gets paid on time. Send a preliminary notice on every job. Make your credit policy and payment terms clear, and follow through on them. It doesn’t have to be a contentious process. You can be firm and polite at the same time.

It might feel a bit uncomfortable at first, but what’s more uncomfortable: Telling someone that you deserve to get paid, or looking at a maxed out credit card statement?

Establish yourself as a client who can’t be paid late, and they’ll make a habit of paying you first. Don’t take it from me. Al, a contractor in South Florida, tells a great story about the day he discovered “two stacks of invoices” on his customer’s desk, and how that changed his relationship with them forever.

7. Always get a signed contract

The days of closing a construction deal with a handshake are largely gone. I know some of you are probably scoffing at that, thinking “Not for me. I do handshake deals all the time, because I’m a man (or woman) of my word.” I have no doubt that you are. And the people you do deals with probably are, too. But a lot can go wrong between the handshake and the payment. I’ve heard from so many contractors who believed firmly in the handshake deal – until the wrong one fell apart. They were shocked – and suddenly facing bankruptcy.

Getting a signed contract is good for everyone. It ensures that each party is agreeing to the same work, the same payments, and the same terms. Have your customer sign a contract before you perform the work, and explicitly state the terms of payment in the written contract. For example, “ABC Contractor will deliver invoices upon completion of work. Payment is to be remitted within 30 days. Late payments will be subject to an interest penalty of 1.5% per 30 days.”

8. Leverage your legal rights

Prompt payment laws establish a deadline by which general contractors and subcontractors must be paid. Every state except for New Hampshire has some form of prompt payment law. These laws not only create a payment deadline, but they also add interest penalties to late payments. Some even require the late-paying party to cover attorney fees and court costs. These laws exist to ensure that payments flow on a construction project in a timely manner. Use them.

Filing a mechanics lien (on a private project) or bond claim (on a public project) is another legal safeguard that you can use to improve your accounts receivables. Everyone working on a construction project has a vested interest in avoiding liens or claims on the property. As a result, even the threat of a lien or bond claim can be enough to spur payment.

Your accounts receivable process should include sending prompt payment demand letters and/or a notice of intent to lien. Both remind your customer of their requirement to pay, and the penalties if they delay.

Improving accounts receivable is an ongoing process

Maintaining positive cash flow is critical to the success of every small business – especially in the construction industry. If your accounts receivable spreadsheet is getting crowded with past due invoices, you need to take action.

The easier your invoices are to understand, the easier it will be for your customers to submit payments. Use email notification settings to confirm that your customer has opened and read your invoice emails. Give your customers the option to pay the invoice digitally, by debit or credit card.

Also, don’t be afraid to follow up with your clients. Invoices can be missed or can get buried in emails, so follow up on them. Be proactive. The longer you wait to collect on an invoice, the harder it will be. Following up on an invoice is critical to preventing a “slow-paying” customer from turning into a “non-paying” customer.

Ultimately, to make your accounts receivable as efficient as possible, you need to use all of the tools at your disposal. Understand your legal right to prompt payment. Always get a signed contract. Create a good credit policy – and don’t be afraid to enforce it.