You completed your latest plumbing project on time, sent an invoice to your demanding client, and are eagerly awaiting payment ... and waiting ... and waiting. Does this scenario sound all too familiar?

For any business, every penny counts whether times are good or bad. Probably nowhere is this mindset more prevalent than in the contracting industry, where low profit margins require contractors to protect working capital any way they can. Success, however, often depends on whether you have an effective billing and collection system. Without one, your cash flow can quickly turn sporadic and unpredictable, leading to a siphoning of cash reserves. This can become a slippery slope that leaves a contractor with insufficient working capital and often no recourse other than to seek hard-to-obtain — and increasingly expensive — loans.

Accounts receivable systems, and the cash flow they generate, are the best measurements of a contractor’s overall efficiency. At companies where cash flow is not tightly controlled, overall performance tends to be weak.

Establishing a policy

When it comes to protecting cash flow, it’s critical for contractors to have a reliable payment collection system. However, even good collection systems are doomed if a client is in poor financial shape or has a history of delaying payments. “Before signing any agreements, contractors should review a potential client’s credit status through reliable report sources,” says Paul Lynch, a business and collections attorney in Boston. “If there are notable flags, it’s important to take them into account and request deposits or upfront payments or pass on the business altogether.”

Once a potential client has been vetted and proven trustworthy, contractors need to make certain their accounts receivable systems are efficient. Contractors who don’t have a collection policy that establishes actions triggered by specific conditions should develop one. In general, the basics should include establishing when and to whom bills are sent, the type of follow-up to be used, and how collections personnel should respond to payment delays.

“The best way to avoid payment problems is for owners and contractors to decide at the beginning of a project how and when bills will be paid,” says Dean Kaplan, president of The Kaplan Group, a commercial collection agency. “This provides the contractor assurance they will be paid on time and prevents owners from being ambushed by sudden demands.”

Before agreeing to a payment schedule, Kaplan notes, contractors need to remember they will be paying wages, overhead, and material and equipment costs for the duration of the project. “The payment schedule should comfortably cover those expenses,” he says.

It is especially important, collection experts note, that subcontractors and suppliers are paid with revenues from the projects on which they work, not an unrelated project. Job borrowing — paying from funds generated by previous jobs — nearly always signals that the contractor is experiencing major financial problems.

If the contract does not establish exactly when payments must be made, there are diplomatic ways contractors can protect their interest. One of the best steps is for the accounts receivable staff to call the client a week or so after the bill has gone out and inquire as to whether the invoice was received or if the client has any questions. That’s courteous and not heavy-handed, and it also eliminates any reason for the client to delay payment because of confusion.

“If there is no agreed-upon repayment schedule and the owner is more than 30 days late, another bill requesting immediate payment should be sent,” says Adrienne Odierna, a business and collections attorney with Lynch, Schwab & Gasparini, a White Plains, New York-based business law firm. “If the check still isn’t received within a reasonable period, contacting an attorney or a collection agency is an option, but it should be an absolute last resort. It may get the check delivered quickly, but it also risks severing a relationship.” 

Though cutting ties with a habitually late-paying client may not be a major concern, quite often a client that’s delinquent on a payment or two may just be going through a short-term rough patch and is not really a bad account.

Collections and credit experts all agree that good communication is an essential ingredient to steering clear of lawyers and collection agencies. If a particular account is having cash flow issues, partial payments and payment plans are options that show good faith, get some money in your hands, and avoid the time, cost, and pain involved in getting lawyers and/or collection agencies involved.

Collection tools

When plumbing contractors are working with general contractors and payments are late despite repeated follow-ups, contacting the owner directly is a viable option. “Contracts with general contractors typically have payment clauses that read ‘paid-when-paid,’ meaning the general contractor is only obligated to release funds once they have been paid by their client,” Lynch says. “But general contractors will sometimes delay payments even after they have been paid, and that violates the contractual terms.”

Lynch says once you have realized the general contractor has indeed been paid, that information can be used to obtain prompt payment. He further notes that if the general contractor still doesn’t provide a date to issue the check, sometimes owners will be willing to contact the general contractor on your behalf.

“That almost always releases money immediately since general contractors will not want to jeopardize their relationship with a client,” Lynch says.

Commercial projects often have payment bonds or mechanics liens as available tools and can be very useful in collecting payment under certain circumstances.

A payment bond is required on many construction projects and forms a three-way contract between the owner, the contractor, and the surety to make sure that all subcontractors, laborers, and material suppliers will be paid, leaving the project lien-free. A mechanics lien is a legal claim that you, as a contractor who worked on a piece of property or provided materials, can file against the title of the property if you remain unpaid for work performed after a certain period of time. Bonds are typically used on public projects whereas liens are more often filed on private projects, though there are exceptions to both.

Odierna advises initially threatening these avenues rather than attempting to invoke them without notice, as they can also lead to a severed relationship in the same manner using collection agencies or filing a lawsuit can.

“Communication is so important with collections,” Odierna says. “Having a good, open dialogue can often avoid going down these more invasive avenues.”