Accounts Receivable – A Necessity That Must Be Managed With CareTomChilders
As we all know, Accounts Receivable are a necessary part of any business that must be managed with diligence and care (we are assuming accrual basis in this discussion.) Extending credit which creates your accounts receivables is often necessary because you want the work and must agree to some kind of payment terms with the customer. Manage your receivables with diligence and care, because if they get out of hand, they will put you out of business.
The full cycle typically looks like this. You make a sale, start the job and provide material, labor and oversight to install the job. You bill the customer when the job is complete or as the job progresses. Once you bill the customer, the time between the billing and the receipt of cash is the time spent classified as a receivable. Ideally, you would bill the customers and receive the money before your material invoice(s) are due and your payroll processed. But as many contractors know, the cash conversion cycle does not work that way in this industry.
In reality, some contractors pay their invoices and payroll before receiving 100% of their billed invoices for the same jobs. In essence, they are financing some of the job for their customers. While most contractors run into this at some point and in some small amount, if the amounts gets too large or the cycle is repeated too many times, the contractor will run into serious cash flow problems. So what's a contractor to do? Demand payment on completion of all your work and/or keep the jobs small enough to complete before any cash is laid out of your pocket? While some contractors do in fact try and go this route, by and large it is not the business model of most contractors and other measures need to be taken.
While there are a number of steps and measures to help minimize the adverse impacts of receivables, below are a few of the common measures that a contractor can take starting today to help manage receivables and minimize the negative cash flow implications. The first four are from the SBA's website section on Extending Credit To Your Customers and the last four are testimonials from the school of hard knocks.
1. Determine to whom you will extend credit such as individual customers or other businesses. Run credit checks on all customers before you agree to extend credit.
2. Develop clear, consistent payment guidelines. Your bills should indicate when payment is due, when it will be considered delinquent, and who to contact with questions.
3. Determine how you will bill or invoice customers. Will you or your employees mail requests for payment yourselves, or will you hire another company to handle invoicing?
4. Create a plan for collecting late or defaulted payments. Regardless of the type of application or documents you use for credit transactions, be sure to get all of your customers' information in writing. In return, provide them with a copy of your payment policy, which spells out how penalties will be applied to late payments and how you will handle unpaid bills. It's important to have this documentation in case a fraudulent or delinquent credit transaction occurs.
5. Make sure all contracts clearly specify requirements in detail including payment terms. The devil is always in the detail and making sure all parties are in the know on the details will minimize unpleasant surprises and help keep collections smooth.
6. Use preliminary lien notices whenever applicable and know your state's lien laws and timelines, and use them when you need to! Do not allow idle threats or the fear of no future business from a general contractor or customer allow you to run your business haphazardly.
7. Make sure your invoice is 100% per the contract and correct. Some people will use an errant invoice as a reason to delay payment and that is hard to debate without correcting and resubmitting.
8. Never lose sight of the fact that credit risk is a major challenge in our industry. Follow up on slow payers regularly (minimum weekly), and if you are dealing with someone who does not have final invoice approval authority, politely ask to speak with the person that does.
While this a great start, it is not an exhaustive list by any means. Talk to others, i.e. contractors, lawyers, accountants, research it and benchmark with other trades. The Independent Electrical Contractor's website contains a great resource ... read this article on how to get paid faster. Receivables are big deal and a major component of the cash conversion cycle which ultimately impacts cash flow. We all know how important cash flow is in the industry.
For a full discussion on cash flow and ways to manage and improve, see section entitled Cash Flow.