Dispatch #67 - How Best-in-Class Contractors Get Paid Quickly
Collecting accounts receivable (A/R) means you can make payroll, pay suppliers and subcontractors, and cover monthly overhead. It can make the difference between a worrisome state of reactive cash constriction and enjoying the mental space to plan ahead, plant seeds, and watch the business grow.
Billing and collections are so critical to contractor cash flow that every now and then it’s worth taking stock of the entire pay cycle. Over a few Dispatches, I’ll share best practices; pick one or two for improvement, then move onto another.
Small changes can make a big difference. For example, a $5 million residential contractor that works one-day jobs coached its office staff and field crew leaders to collect payment from the customer on-site before the crews left the premises. Result: almost $100,000 higher average daily bank balance.
Measure success
Let’s start at the end: how do you measure successful billing and collections?
Track Days Sales Outstanding (DSO): it’s the average number of days it takes to get paid. The lower the better.
· A one-day drop in DSO builds your bank balance by one day’s worth of revenue. For a $9 million company that’s $25K of free money.
· Yes, benchmark your firm against industry peers (56 DSO was a recent finding for the construction industry), but more importantly, benchmark against your own performance over time.
· A quick search will yield how to perform the calculation, and if you have questions let me know and I’ll show you how we do it.
Another key performance indicator (KPI) to track is the percentage of A/R that’s more than 90 days past due. Like DSO, lower is better.
Sell work that pays quickly
Now let’s jump to the beginning of the pay cycle: sales.
□ Target customers who pay quickly. Track DSO by customer. What factors differentiate the fast vs. slow payers?
□ Target jobs that pay quickly. For example, performing familiar work in a familiar location with proven crew leaders and skilled tradespeople is less likely to go sideways and trigger payment delays.
□ Negotiate pay-friendly contract terms. A clear pay application specification and schedule, change order procedures, retention rules, and prepayment of materials are just a few of the many contract terms that support timely payment and help cash flow.
□ Generate enough qualified leads so you’re in a better negotiating position: you can choose the faster-paying, most profitable customers and jobs. Absent choice, we’re stuck with what the market offers us. That’s a tough spot to be in.
Protect your profits by examining your collections efforts and taking a full-cycle approach. Sell the work, do the work, and above all, get paid.
Need help with this or other financial matters faced by construction contractors? Let’s talk!
David Stern CFO makes every effort to provide useful and accurate information. This content, however, is not intended as a substitute for specific business-related financial advice. We disclaim all warranties and liabilities from its use.