Construction Companies Are Often Required to Deal With Restricted Cash Flow
There are many roadblocks to getting paid in the construction industry. But, even when payment is forthcoming these same roadblocks can lead to payment delays, and getting paid quickly is nearly as important as getting paid at all. Pay when paid or pay if paid clauses, scope of work issues, problems or failure higher up on the payment chain, inspection problems, and change orders can all result in a slow down of the construction payment process. In order to avoid these obstacles, companies in the construction industry must have a specific repeatable process for getting paid. Otherwise, they can end up writing off more bad debt than they should, or chasing after payment long after it is due with little hope of recovery.
Regulating and maximizing cash flow is a pressing problem in the construction industry as a whole, and for each individual construction credit professional. A business constrained by a restricted cash flow can easily finds itself in a position where it is forced to chase money by taking unnecessary risks, and going after shakier business. Since the margins in the construction industry are slim write-offs not only have a have a huge impact on business by themselves, but they can also easily snowball into an uncontrollable avalanche of problems. Just one bad project can put a company back on its heels.
Fortunately, however, this problem can be easily controlled and solved. A credit professional can institute an organized, repeatable system to get paid on nearly every project, and to get that payment to come faster. This system, known as a “Payment Funnel”, is a series of steps to regulate the payment process. Every project goes into the funnel at the top, and step-by-step, the number of projects in the funnel and remaining unpaid is reduced and the A/R report improves. Companies in the construction industry are well positioned to create a strong payment funnel because security on construction projects is built right into the law, by leveraging mechanics lien and bond claim rights.
5 Steps to a Well-Structured Payment Funnel
A thorough and well-structured payment funnel can be formulated by a construction company using only 5 steps.
Step One: When each project is started, a preliminary notice should be sent to protect future lien rights. Not only does sending a preliminary notice protect that future lien right, it also works to get companies paid by prioritizing their invoices. GCs and Owners keep track of which parties did or did not send preliminary notice, and then prioritize the invoices accordingly. There are software applications specifically designed to do this, and it makes sense because the Owner/GC has more exposure on invoices that could be secured by a lien.
Step Two: After the invoice has been sent, and it remains unpaid for some specific number of days (set by the company), a Notice of Intent to Lien should be sent. The company specific Credit Policy should specify the amount of time that must elapse before this notice should be sent. However, an important consideration is to leave enough time after the notice is sent to file a valid lien, if necessary. Notices of Intent to Lien are key components of a successful payment funnel. by providing a more successful alternative to the generic demand letter.
Step Three: If the notice of Intent is unsuccessful in prompting payment, the third step in a solid payment funnel is actually filing the lien or bond claim itself. As we’ve noted many times before, mechanics liens are the single most powerful tool in the arsenal of a company in the construction industry to get paid. There are two main factors to consider in determining when this step should be taken: 1) Company Policy – how long the specific company feels comfortable letting accounts simmer before taking the final step in securing the debt; and 2) The law of the project state – all states have mandatory deadlines by which a mechanics lien must be filed, which, if missed, extinguishes the ability to file a valid lien.
Step Four: After the mechanics lien has been filed, it may be time to send the non-paying account to collections, either internal or outsourced. While, in general, collections agencies can have poor reputations, there is still some utility gained by letting a specialist use their time to attempt to get the account paid. Also, having a valid mechanics lien can drastically increase the potential for success in this step.
Step Five: Finally, if the account has made its way all the way through to the bottom of the funnel and still remains unpaid, it’s time to file an action to enforce the filed mechanics lien. Mechanics liens are enforced by a lawsuit to foreclose on the property at issue, and the lien claimant may be paid from those funds.
All projects go into the funnel at the preliminary notice stage, and at each step the number of projects remaining in the funnel, and therefore unpaid, is diminished. Generally speaking, 100% of projects should receive preliminary notice, 5% of total projects will need a Notice of Intent to Lien, only around 2.5% of projects require a lien to be filed, and less than 1% will require an enforcement lawsuit. Implementing these steps on every single project can significantly improve a company’s cash flow, and dramatically diminish write-offs.