Cash is king, especially in uncertain times. Managing and preserving cash can make operating easier, and not managing cash correctly has caused companies to fail. Right now, with margins being eroded by labor and supply shortages, managing your cash position is critically important.
Oftentimes companies treat cash management as an afterthought. They think winning the work is the important thing and everything else will just work itself out. However, it can end up costing companies in additional interest and opportunities, not to mention that bad accounts receivable (AR) collection practices can lead a company to not collecting on work that it rightfully performed.
Proper AR collections begin before any work has even started. They start with a proper bid process (if one is required). It makes no sense to win work that will not be profitable or not profitable enough. Having profitable jobs provides a cushion to cash flow compared to the stress that low-performing jobs place on cash flow. After that, it is important to get a proper contract of what work will be performed and how the owner will be billed. Getting clear terms upfront make collection easier due to there being less ambiguity. In addition, before the contract is even signed, it is important to perform due diligence regarding the creditworthiness of your customers. You may want to put in levels of credit for which there are additional levels of due diligence. This could include running a credit report, checking with references, asking for financial statements, or even asking for audited financial statements if the company has them. Once the contract is signed, get a deposit upfront. As a contractor, you will have a large outlay in materials to get the project going. If the contractor does not receive a deposit, that outlay of materials will have to be paid by the contractor either out of available cash or through other means. Now, accounts payable from vendors will be part of the solution, but those vendors will want to be paid as well. Eventually contractors will have to pay on accounts payable before they are paid by the customer. That may mean the contractor will have to dip into the line of credit from the bank to pay those vendors. Borrowing from the bank means additional interest, and the economy is in a stage of rising interest rates to help combat inflation.
Another good practice is to bill regularly during the project. It is typically easier for a customer to pay a lot of smaller bills versus one large bill. Also, you want to bill when you have completed change orders or additional work. Billings close to the time of completion of an item help because the work is fresh in the customer’s mind. It is important to get the project manager’s approval as part of this process. They are on the front line and understand what has happened on the project. They also are the first person the owner will contact to inquire about the billing. Invoices should be clear for the work that has been completed. Vague billing language brings questions and delays to payment on the invoices. After the invoice has been sent, be proactive on collection. The squeaky wheel gets the grease. Send reminders before the payment is due. Set the tone early that you are a company that needs to be paid on time. Staying current is key. Once an invoice gets stale, it gets harder to collect, not to mention you have already stretched out the operating cycle past where you wanted it to be, putting stress on your cash position.
In addition to the processes listed above, it is important to perform a regular analysis of AR to see if there are any underlying problems. Check the days receivable by dividing AR by annual revenue and multiply that by 365. If you calculate 60 days outstanding in AR, and your terms are net 30, that is a problem. Also, review old receivables and be more proactive on collecting them. Look at receivables over 60 days and start making inquiries. The longer it takes to collect a receivable, the more of a chance there will be a default.
Do not be worried about having financial statements that show large overbillings. Even though it is a liability, it is seen as a good liability. It shows the contractor is able to collect on the work. Cost in excess of billing can create doubt regarding whether the contractor will ever be paid for its work.
If you have questions about AR practices or need assistance, please reach out to a professional at FORVIS or submit the Contact Us form below.