This morning I came across an article written by Michael Dennis of Covering Credit today titled “It’s A Trap.” It examines a hypothetical scenario when a company’s new CFO approaches the credit manager wanting to lower bad debt losses without impacting sales and administrative costs.
“It’s a trap” warns Dennis because “in order to reduce credit risk, you have to limit credit lines as well as hold orders on past due accounts.” This post explains why I strongly disagree with this, vigorously disagree.
Agree: Reducing Credit Risk Means Making Tough Decisions And Saying No
Someone commented on this post and said that these “are basic business credit principles,” and the commenter is correct. It’s business credit 101 for a company to create (and stick to) a credit policy, avoid high-risk accounts, and stop performing work on past due accounts.
Every organization that extends credit experiences friction between credit and sales departments. The sales departments are constantly pushing the envelope to take more and more business, and the credit departments are always looking for the safest customers.
The reason why is clear: Salespeople get paid for revenue, and credit people get paid for profit and avoiding losses.
I agree with Michael Dennis in his “It’s A Trap” article that reducing bad debt loss history requires a commitment to taking less risk. However, I disagree when it comes to the construction industry.
Disagree: Construction Industry Can Use Lien Rights To Take More Business And Reduce Credit Risk
The funny thing about my disagreement here is that the construction industry is perhaps the most at-risk industry for credit problems. As explored a few weeks ago, the construction industry has some of the highest debt ratios in the nation. This is especially true for building supply companies.
If the construction industry has some of the highest debt ratios in the nation and reducing bad debt loss requires a commitment to taking less risk, how in the world can I disagree with the “It’s A Trap” article and conclude that those in the construction industry can reduce their bad debts while increasing sales and avoiding administrative costs?
The answer is in the mechanics lien laws.
Mechanics Lien Laws Were Created To Solve Credit Challenges In The Construction Industry
Credit challenges are nothing new for the construction industry. In fact, they existed more than 200 years ago when our nation was building itself from scratch. Thomas Jefferson took a look at the problem and proposed a solution to the Maryland legislature: mechanics lien laws.
The original idea behind mechanics lien laws was to protect contractors and suppliers who were throwing money into an unstable credit market to help build the nation’s infrastructure and private developments. Since the credit market was wonky and payment not guaranteed, the mechanics lien remedy was thrown in to secure every single construction project.
Preserving Your Lien Rights Practically Guarantees Your Payment
If you properly preserve your mechanics lien rights you will very rarely be burned with credit. Let me repeat that, if you properly preserve your mechanics lien rights you will very rarely be burned with credit. Emphasis on very rarely.
First, because mechanics lien claims can work in a number of different ways to get your company paid. Take a look at the 17 Ways A Mechanics Lien Works To Get You Paid article for a list of some of the most common ways a mechanics lien influences folks to pay a construction debt.
Second, and this is included in the “17 Ways” article above, is because mechanics lien claims are not concerned about your client’s credit. Every time you extend “credit” to a customer you are making a decision about how worthy that particular customer is to receive the credit. There is a lot of room for error there, as any credit manager will attest. Mechanics lien laws, however, allow you to disregard your customer if you’re not paid and go after payment directly from the property owner, the general contractor and /or the property itself.
Getting burned on a project requires a credit catastrophe taking down your customer, the prime contractor, the developer and the property itself. Possible, but highly unlikely.
How To Preserve Your Mechanics Lien Rights With No Sweat
Sure, you’ve heard of these mechanics lien rights, but you contend they aren’t any help because compliance with the regulations is a very tall order. Is that true?
It is true that mechanics lien laws are hypercomplex. They change from state to state and project-to-project. The requirements to maintain lien rights on a residential project in a state where you’re supplying to a prime contractor may be completely different from a requirement on the very same project in the same state if you were just one tier down (i.e. supplying to the subcontractor).
Multiply this complexity by 50 states, 5-7 different types of projects, and a dozen or more tier scenarios, and you’re looking at a very fragmented compliance system.
However, there are services out there like Levelset that can help your company completely manage its mechanics lien compliance needs. Levelset has proprietary technology that takes your project and A/R data and figures out what needs to be sent, when it needs to be sent and to whom. It’s completely hands-off for your company. You just provide the project data, and then glow in your new ability to increase your sales and decrease your risk.
Your credit and sales departments will become friends.