Overhauling A/R

The Payment Funnel is an important, and useful, concept that can reinvent your receivables and lead to less bad debt and fewer write-offs. But, before the specifics of the Payment Funnel concept are discussed, a little bit of background on the problem we’re looking to correct should be provided.

Payment Funnel Background: Getting Paid in the Construction Industry Can Be Difficult

Getting Paid is hard, in general. Getting Paid in the construction industry, specifically, is even harder than it is in many others. There are a lot of reasons for this: pay when paid, or pay if paid clauses, the scope of work issues, inspection problems, change orders, and so on. All of these things can create payment problems – and that’s before the fact that failure rates in the construction industry are some of the highest in any market is even mentioned.

So, what do all these obstacles to payment mean for companies in the construction industry? It means that companies that don’t have a specific, repeatable process for making sure they get paid – and who don’t secure all of their extensions of credit – end up writing off more bad debt than they should.

And that’s bad.

The margins in the construction industry are slim so that any write-offs can have a huge impact on a business. The margins in the construction industry are slim so any write-offs can have a huge impact on a business. Every time a company in the construction industry writes off bad debt – the amount of new business that company needs just to break even and offset that loss can become astronomical. Purely for example, if a company is working on a 5% net margin, it would need $200,000 of extra, additional business just to offset one $10,000 write-off. This puts construction companies in hard spots – chasing after bad business to avoid these problems.

Once a job has been completed, or an invoice has been sent, time really starts to fly. This is especially true if there is no specific set procedure for dealing with getting paid. 10 days becomes 30 days; 30 days becomes 60 days, and 60 days becomes 90 days, or more…and the money still hasn’t been paid. Once the debt is overdue by 90 days or more, not a lot of that money is going to be very easy to collect. In fact, collecting much of anything past that point is virtually impossible without some type of security or other leverage.

This means A/R lists getting long and sloppy, and companies getting buried under the debts that start to slip away. So, what can a construction credit professional do to create an organized and repeatable system to getting paid on virtually every project?

You create a Payment Funnel, and you stick to it.

Payment Funnel Defined: What Is It?

Payment funnel thumbWhat’s a payment funnel?

A payment funnel is a defined and repeatable set of steps designed to get construction companies paid on every project. Every project goes into the funnel at the top, and through each progressive step the number of non-paying accounts decreases until, at the bottom, the number of projects remaining unpaid is negligible, and the A/R report looks sparkling. The “secret” trick is that companies in the construction industry can create a strong payment funnel by leveraging mechanics lien and bond claim rights – security is built right into the law.

The first step in the payment funnel is at the beginning of a project: When each project is started, a preliminary notice should be sent, according to the laws of the state in which the project is located, to protect future lien rights. There are multiple reasons for doing this, including 1) lien rights should always be protected because liens get construction companies paid, and 2) the failure to send a preliminary notice can actually be a crime in some circumstances.

The second step in the payment funnel is sending a notice of intent to lien if the account goes unpaid for a certain number of days.

The third step is to file the mechanics lien (or bond claim) itself.

The fourth step is to place the account with collections, either internally or outsourced to a third-party collections company.

And, the fifth, and final step, is to initiate a foreclosure lawsuit to enforce your mechanics lien.

Payment Funnel Defined Step by Step: The Path to Get Paid

The first step outlined above is to send preliminary notices on every project. Why? Two reasons are given, but it really boils down to this: Because it’s the smart thing to do. Not only does sending preliminary notice secure the ability to later file a valid mechanics lien, if it comes to that, but it also provides other benefits to help companies get paid. It’s a fact that sending a preliminary notice will prioritize a company’s invoice over invoices from other companies on the project that didn’t send a preliminary. GCs and property owners know who did and who did not send preliminary notice and prioritize the invoices accordingly. In fact, there are specific software applications available to track exactly this kind of information. Textura is an example of one such piece of software. Textura is a payment managing platform for GCs and property owners – and one of the specific things that it tracks is whether or not preliminary notice has been sent on a project, and when.

A notice of intent to lien…works like a demand letter, but with much more success because it leverages the power of a potential mechanics lien to prompt payment. The second step in the funnel is to send a notice of intent to lien. While it should be sent after payment is due, the specific date on which to send this document can be determined company by company as a policy – just as long as enough time is left after the notice has been sent to actually file the lien itself if the need arises.

A notice of intent to lien is really a pretty remarkable document, it works like a demand letter, but with much more success because it leverages the power of a potential mechanics lien to prompt payment. In fact, based on a recent survey, nearly half of all notices of intent sent secured payment within 20 days of delivery. Considering how easily (and cheaply!) these notices can be sent, they have truly become a no-brainer in securing payment. The notice of intent to lien is “the secret weapon to getting paid in the construction industry” and can be a powerful tool in the payment funnel of every company in the construction industry.

If sending a notice of intent to lien doesn’t induce payment, it’s finally time to file the mechanics lien itself. There are two main factors to consider in determining when the lien should be filed:

  1. Company Policy – how long do the company feels comfortable letting accounts simmer (and how much time did was given in the notice of intent to lien for payment to be made)?; and
  2. The law is the project state. All states have mandatory deadlines by which a lien must be filed – This Deadline Cannot Be Missed.

Mechanics liens are the most potent tool available to a company in the construction industry to induce payment. As a type of security interest in the real property being improved by the project, a valid mechanics lien allows the property to be sold to satisfy the claim – if it comes to that. Luckily for both the lien claimant and the property owner, it rarely does.

It is important to note, however, that after the lien has been filed, the work is not yet over. If payment is not received by the time the deadline to enforce the lien rolls around, it’s time to file a foreclosure lawsuit to enforce the lien. A lien does not stay valid and enforceable in perpetuity, there comes a time (this amount of time is different on a state-by-state basis) when the lien must either be enforced, or allowed to be extinguished. Clearly, for parties who remain unpaid, enforcement is necessary.

Here are some general numbers to illustrate what a general payment funnel can look like:

Payment Funnel Step by Step

100% of projects need preliminary notice, and most of them will be paid with no further steps.

About 5% of projects will need a Notice of Intent to Lien, and that will generally result in payment in about 50% of those cases.

Only about 2.5% or so will ever need an actual lien to be filed,

And less than 1% of projects will generally need to be foreclosed on.

Adding some math to the above results in this:

If, for example, a company’s average account is $10,000, and that company has 1,000 accounts, there is a total of $10,000,000 going into the top of the payment funnel. Once the projects have made their way all the way all the way to the bottom of the payment funnel, approximately $90,000 or less of the original $10,000,000 would require litigation to recover. Even if the story ended there, that represents a stellar 0.9% uncollectable percentage, which is pretty good by itself. But, that’s not the end of the story, all of that $90,000 can still be collected through litigation – after the pros and cons of taking that final step are weighed by the company in question.

The following example provides a unique look at the implementation of a payment funnel, and how it can dramatically change an A/R report. This company fully adopted a payment funnel approach for one aspect of its business, and continues to use its old payment recovery strategy for another part.

The results are dramatic. For the projects subject to the old payment recovery strategy, the percentage of debt still outstanding at certain days past the last date of furnishing were as follows: 56%, 24%, 14%, 5%.

Outdated Payment Funnel

The projects within the payment funnel strategy show a different story. The percentage of debt outstanding after the same time periods were: 46%, 15%, 3%, and nearly 0%.

levelset Payment Funnel

This is strong, strong evidence that a payment funnel leveraging mechanics lien rights is a payment funnel that works for the construction industry.

Use of this payment funnel not only gets companies in the construction industry paid more, it gets those companies paid faster. Every business wants lower DSOs and less bad debt to write off. The payment funnel is a way to make it happen.