Construction professionals at work

Good News: The construction industry has been rebounding from the recession-fueled decline 0f 2008, and has been growing for the past decade. And, with construction spending and the number of new projects up around the country, that trend looks to continue, and strengthen in the near future.

Bad News: The growth has been modest, and a recovering construction sector can be even worse for some contractors than the recession was.

How Economic Recovery Can Be Bad For Contractors

It seems counterintuitive, but failure rates for parties in the construction industry are higher during economic recovery periods than they are during recession periods.

It seems counter-intuitive, but failure rates for parties in the construction industry are higher during economic recovery periods than they are during recession periods. In fact, the failure rates during recovery periods can be 3 times higher. In order to understand why this may be, it is important to know the dangers associated with, and springing from, an economy recovering from a recession or stagnant period. The dangers come from the fact that a growing economy requires companies to grow into the new demand for business, and growth takes cash. This is a problem, because the recession predating the recovery made many companies cash-poor. This is where the trouble lies – companies will struggle to meet the cash demands of growth with the limited cash reserves on hand. Companies can grow themselves into failure.

Because of this, it’s very important for companies to keep an eye out for, and be open to, new opportunities, while being careful not to overextend. This can create tension between the credit and sales departments (stop me when this starts to sound familiar). The new sales opportunities presented by a growing economy can energize the sales team, and provide many new potential customers. The risk of overextension, however, mandates the need to stick to a tightly controlled credit policy. The credit vs. sales battle handcuffs both departments, and doesn’t help anybody.

So, how can a company take advantage of the growth opportunities responsibly, without overextending the business?

Using Security Rights Helps Responsible Growth and Improves Cash Flow

Some of this overextension risk can be mitigated, and more cash can be made available more quickly, by good credit management practices. And, specifically, by using the security rights granted to parties in the construction industry. Using the security devices already built into the law companies are able to lower DSOs, reduce aging projects, and gain a more consistent and predictable cash flow. The most powerful security device available for construction industry participants is the mechanics lien.

The first step to gaining the benefits of the mechanics lien protection afforded to construction companies is sending a preliminary notice. By sending preliminary notice on all projects, companies are able to drastically improve the time in which they receive payment, as well as go after business that, absent the security provided, would not be accepted by the credit department. Notice is a powerful tool to get companies paid, and to get companies paid faster. The added bonuses of being able to accept more business and giving the sales team a looser leash are additional benefits.

the average DSO for non-noticed projects was 48% higher than it was for projects on which notice was sent.

In a recent evaluation of more than 100,000 invoices sent over a 1-year period by a large global building product manufacturer, the difference between projects on which preliminary notice was sent and those on which it wasn’t is striking. 21% of projects on which notice was not sent remained unpaid after 90 days. If a preliminary notice was sent, however, the percentage of projects unpaid after 90 days dropped to 7%.

This information provides a strong incentive to companies to send preliminary notices to keep themselves in a secured position. The truth of the matter is that maintaining a secured position not only relatively guarantees eventual payment, it also dramatically  improves cash flow and shortens Days Sales Outstanding (DSO) by keeping invoices prioritized. (Days Sales Outstanding is a ratio that measures the average number of days it takes for you to collect payment from your customers. The lower your DSO, the better: It means you’re getting paid faster.) The same evaluation mentioned above found that the average DSO for non-noticed projects was 48% higher than it was for projects on which notice was sent.

Simply by sending a preliminary notice, a company can be virtually assured of payment, and know that the payment will be made within a reasonable amount of time. This knowledge will enable sales people to sell more, and allow the credit department to sleep easily. It also happens to be a simple step to take to guard against the (very real) dangers of a recovering economy.

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