Combating slow payment (and nonpayment) in the construction industry
Thursday, April 02, 2015
Most of the time, invoices get paid. In the vast majority of cases, invoices are paid well before they age enough to cause a significant worry. Despite this, however, there is an entire industry of credit and financial managers who are dedicated to helping companies manage, and ultimately collect, those problem invoices.
Typically, these parties are focused on two distinct areas of concern with respect to credit management: getting invoices paid faster and reducing the number of invoices that are written off as uncollectable. While these are separate goals, they are fundamentally linked — not just in how they affect cash flow and the bottom line, but also in how they can be combated.
The longer an invoice goes unpaid, the greater the chance of it eventually being written off. While this conclusion seems obvious, it can still be surprising to learn that, according to a recent survey, 52 percent (by value) of the receivables more than 90 days overdue were eventually written off as uncollectable. This means that if a company is not paid in 90 days, there's a 50-50 chance they won't be getting paid at all.
Construction payment problems
As noted above, both of these areas of concern for construction financial and credit managers relate directly to a company's cash flow. Cash flow is always a crucial area of concern for construction companies, and especially for subcontractors or suppliers who are forced to float the project costs.
Because of payment challenges common in the construction industry — such as convoluted projects with many participants, the desire to obtain lien waivers, change orders or work disputes, etc. — the difficulty of collecting outstanding invoices presents a thorny problem. There are many reasons invoices go unpaid, or are paid late, but the reasons that are endemic in the construction industry require specialized tools to combat.
It seems that the entire structure of the payment process in the construction industry is built to result in slow or nonexistent payment. When this is combined with the well-documented risky financial position of construction industry participants as a whole, it's no wonder that payment issues are all too common.
Despite the risks inherent to the process, however, construction participants can take steps directly designed and implemented to provide protection from these challenges.
Avoided or overcoming these problems
The general guide on how to minimize credit and default risk is well known, well used and normally effective. However, many of the traditional steps are less effective in the construction industry than they may be otherwise.
This is not the end of the road for the construction financial manager, though. Tools available in the construction industry, and specifically designed to protect construction participants from the risk of nonpayment, are available — and extremely effective when used properly.
The most obvious, well known and ultimately effective method to combat the risk of nonpayment is the mechanics lien document. Mechanics liens are security instruments that give the lien claimant an interest in the improved property itself.
This means that an unpaid project participant with a valid mechanics lien can force the sale of the property itself to satisfy the debt. While this foreclosure process is rarely needed, it clearly provides a strong incentive for the property owner (and everybody up the chain from the lien claimant) to pay.
The structured and complete use of security rights can be transformative to a construction industry company's A/R. For the reasons described above, secured extensions of credit get paid much more often than unsecured extensions of credit, and remaining in a secured position generally results in invoices being paid more quickly.
The ability to secure all extensions of labor and/or materials on credit on each project through the use of the mechanics lien document provides construction industry participants with a unique tool to combat credit management challenges.
The thorough and systematized use of industry-specific mitigation tools available to industry participants — mechanics liens, bond claims and joint-check agreements, to name a few — can help companies get paid faster and eliminate bad debt.
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