The new year has arrived, and that means it's time for companies to make resolutions to get paid more often and write off less bad debt in 2014. To accomplish this goal, a company should take stock of its receivables, reevaluate (or create) its credit policy, analyze its average DSO and grade its collection efforts.
Just like that New Year's resolution to eat better, actually getting paid on more projects is a much harder proposition than just saying you will. However, by evaluating the previous year in the correct way, the data can be used — along with readily available tools, charts and other information — to significantly improve a company's bottom line.
1. Analyze and organize outstanding receivable accounts
The first step to getting paid in the future is to organize outstanding unpaid accounts now. While many companies use specialized software programs to track payments on projects, it's not strictly necessary. A general spreadsheet can be sufficient, provided the correct data is gathered to organize and track the project and any payment received.
For all currently outstanding accounts, the date of first delivery, the date of last delivery, the amount owed and the date payment was due should be entered into your spreadsheet. Once the information is entered, it should be organized in some manner. One useful tip is to organize the projects by days overdue, and then suborganize by amount due on those projects.
With this system, it is easy to see which projects have gone the longest without being paid, and of those, which have the largest outstanding debt. The date information is also useful in determining lien rights or making a decision as to which projects, if any, would still benefit from sending preliminary notice.
After the past-due projects have been catalogued, the next step is to expand your spreadsheet to include all current projects, whether or not payment is overdue. This is a crucial step in overhauling or merely streamlining compliance with a credit policy, because it provides the information and organization necessary to strictly comply with a thorough notice and lien policy.
And, in my opinion, a thorough notice and lien policy is the best protection companies in the construction industry have to make sure they get paid on every project.
2. Analyze average DSO, grade collection efforts, and set benchmarks to measure future improvement
Many companies already know their average DSO because the time it takes to be paid is crucial to a business's cash flow and strategic planning. And, no matter the number, most companies who extend credit want to decrease their average DSO for those same reasons.
If you don't know your average DSO and have many unpaid accounts, that information can be truly eye-opening, and provide the impetus for creating or implementing a complete credit policy. Getting paid in 45 days rather than 90 can significantly alter a business's cash flow, and with it, the ability to go after and accept more business.
If average DSO is unknown, a spreadsheet, as mentioned above, can provide the information needed to make that calculation. Once this calculation has been made for the 2013 data, it makes good sense to set goals marking where DSO should be at the end of next year, and at different points along that path.
For example, if your end goal is to move average DSO from 90 to 45 days, a third of the way through the year average DSO should be approaching 75, and two-thirds of the way through the year they should be approaching 60. This is a significant movement, but strict notice and lien policy compliance, and reliance on a specific collection policy, can really get the ball rolling.
It seems difficult to grade collection efforts sometimes. There aren't many different outcomes:
- You get paid the amount due.
- You get paid a portion of the amount due.
- You don't get paid.
The mutable factors are the time it takes to collect and the amount collected.
Because of the challenges of setting a grade for collections, it is impossible to do so in a vacuum. Determining the efficiency and efficacy of your collections department (or outside collections firm) must be specific to your business expectations.
One general way to get an overall view of collection efforts is to determine the percentage of uncollectable debt (total bad debt written off by the company) as compared to total sales figures. It's worth noting that companies in the construction industry work on extremely tight profit margins, so any uncollectable debt hits hard.
For example, building material supply companies operate on an average profit margin of 1.25 percent, so writing off $12,500 in bad debt requires an extra $1 million in revenue to make up the lost amount.
3. Making changes that matter for 2014
With the 2013 information in hand, it's time to implement some changes to make it all look better next year.
Step 1: Re-evaluate or create your credit policy
The success of any credit department is based on a strong foundation, and the best foundation is having a thorough, written and strictly-followed credit policy. In my opinion, this is the best possible way to make sure that 2014 is better than 2013. Creating a good credit policy is a business-by-business proposition, but, among other information, a good credit policy will include the following:
- Concrete methods to separate those who can and cannot get credit
- Concrete factors to guide the credit manager in determining who must give
- Additional security (personal guaranty, joint checks, etc.)
- When and how lien rights will be used to secure accounts (create a comprehensive notice policy and lien policy)
- How long are your credit terms?
- What is done when a payment is not made?
- What is done when an account goes into default?
Strict compliance, especially with the notice policy and lien policy subparts, is an extremely important factor in making 2014 more financially robust than 2013.
Step 2: If possible, apply notice and lien policy retroactively
Deciding to revamp your credit policy and strictly adhere to it in 2014 is a good start, but what about the debt still outstanding from 2013? For those projects with amounts still outstanding, your project spreadsheet can be used to determine which may still be protected by a mechanics lien (your strongest protection to get paid). Lien rights are complicated, and many states require preliminary notices to be sent in order to secure the benefit of later filing a mechanics lien.
For projects on which preliminary notice is required to be sent prior to filing a mechanics lien, the chart you created above can be used to determine which aged projects could still benefit from sending the preliminary notice. Alternatively, a third-party platform that tracks lien and notice deadlines may be used for this step to decrease the workload.
It should be noted that while some states have strict deadlines for sending preliminary notices, other states have softer deadlines where even a tardy notice may provide some protection. Once the appropriate projects have been determined, preliminary notice should be sent for each one. Further, after the preliminary notices are sent, liens should be filed when possible, either in-house, or by a third-party notice and lien service.
Step 3: Don't forget the projects where retroactive noticing is not possible
Finally, there will likely be some projects that have passed the deadline to send preliminary notice and/or file a lien. These should not be forgotten and automatically written off, however. Sending a demand letter or a notice of intent to lien can provide a huge benefit and help considerably with collection efforts. These documents can be effective in procuring payment, even on stale accounts.
Cleaning up old accounts, setting goals and strictly following a robust credit policy can pave the way for 2014 to be a banner year.
