For this week’s Guest Post Friday here at Musings, we welcome back Scott Wolfe. Scott is the CEO of Zlien, a company that provides software and services to help building material supply and construction companies reduce their credit risk and default receivables through the management of mechanics lien and bond claim compliance. He is also the founding author of the Lien Blog, a leading online publication about liens, security instruments and getting paid on every account. Scott is a licensed attorney in six states with extensive experience in corporate credit management and collections law, with a specific emphasis on utilizing mechanic liens, UCC filings and other security instruments to protect and manage receivables. You can connect with him via Twitter, LinkedIn and Google+.
Managing account receivables in the construction and building material supply industries presents unique challenges and unique solutions. This post reviews the industry-specific reasons why accounts will age and go unpaid, as well as the industry-specific credit and collections solutions available to controllers and credit managers.
Reasons Why Your Accounts Receivables Age Or Go Unpaid In The Construction Industry
Everyone in the accounts receivable management space struggles with aging and unpaid receivables. It’s a fact of life in business. Nevertheless, there are causes for A/R problems unique to the construction and building supply industries.
Pay When Paid and Pay If Paid Clauses
Pay-when-paid and pay-if-paid clauses are kryptonite to credit and collection policies. These controversial contract provisions get nestled into most construction contracts (but few supply contracts), and create big cash flow challenges to everyone connected to a project.
The below illustration is an example of how a “pay when paid” clause can create cash problems for suppliers and subcontractors.
Project-Level Delays And Disputes
Construction projects can be very complicated and involve a lot of different parties. Further, it is rare when a project breaks ground and gets all the way to final completion without some hiccups or disagreements. Every hiccup and disagreement follows a unique path, but they all result in at least one problem: delay.
Construction delay is so prevalent it has its own Wikipedia page. From an accounts receivable perspective, the problem with construction delay is that it causes banks and developers to hold onto more cash than usual until the delay or dispute is resolved. This cash holding trickles down through all of the trades and suppliers, causing accounts to age.
Tools Available To Help Your Construction Or Building Material Supply Company Meet ARM Challenges
The construction and building material supply industries have unique credit and collections challenges, but to balance this, unique devices have been created to mitigate and solve these challenges.
Mechanics Liens and Bond Claims
Mechanics lien laws and bond claim laws are by far the best tool to mitigate credit risk in the construction and building materials supply industries. In fact, Thomas Jefferson invented the mechanics lien device over 200 years ago for this express purpose.
The concept is simple. Just as a bank requires collateral to make a loan, contractors and suppliers who furnish materials or labor to a project on credit may use the construction jobsite as collateral for that account.
Think about this for a second. Proper use of these instruments would transform the construction industry from being extremely risky (one of the riskiest in the country, in fact) to being extremely safe. Why in the world would companies not take full advantage of these protections?
One reason is because the laws are convoluted and fragmented, but this objection is being eroded from new technologies offered by companies like Zlien that help organizations manage mechanics lien and bond claim compliance.
Joint Check Agreements
Joint check agreements are not unique to the construction and building materials supply industries; anyone can create and use one of these agreements. Practically speaking, the instruments are exclusively used by these industries because that is where they are most needed.
The joint check concept is simple, and it works great in the scenario contemplated by the above illustration that exists when pay-when-paid clauses are causing receivable woes.
In these instances, the party waiting for payment at the end of the payment chain (i.e. the supplier) gets the party(ies) above their customer (i.e. The GC and the Owner) to sign a contract guaranteeing that when payment is made, it will be made in joint check form payable to the Customer and the party at the bottom of the chain.
While Joint Check Agreements can be wonderful, they can also be a royal mess. Be careful, and check out a blog series we put together on the Lien Blog about joint check agreements.
Finally, a quick note to remind you of something you already know: accounts receivable management requires discipline. Followup with aging accounts, set firm rules and stick to them, and by all means do not let your mechanics lien rights expire.
Discuss credit issues unique to the construction industry on our LinkedIn Construction Credit Group.