by Scott Applegate, CapitalPlus Equity
Have you ever considered how the creditworthiness of your customers can impact your bottom line? How about how their cash flow can impact your bottom line? When you consider that according to a survey by RocketLawer, 43 percent of small businesses have customers who are more than 90 days late on a payment, it might be something you should give a second thought to.
For subcontractors who are looking to take on new jobs to maintain and grow their businesses, assessing the risk associated with the project should be considered every bit as much as estimating the job costs. As a subcontractor you are already aware of the risks associated with estimating and pricing the cost of a job, so what other risks are associated with the project that aren’t cost related? How about the creditworthiness of the GC and the owner? How long is it going to take them to pay you? Are you going to need to hire other subcontractors? Does their creditworthiness matter? How can I better assess these risks to protect my business?
Creditworthiness of GC and Owner
The fact that your clients’ creditworthiness directly impacts their ability to pay you may be obvious, but many subcontractors and construction companies often overlook it. When you bid on a project do you look, or even know where to look, to see if the GC has any liens or judgments? Do you know if they have any tax liens? Do you know how long the GC is taking to pay their other subs (called days beyond terms)? Does the owner already have financing in place? All this information has an impact on when you get paid, and when you get paid has everything to do with your cash flow. You can get this information in a credit report, which gives you information on the business’s trading, credit, and financial histories. It also provides a credit rating and suggested credit limit. All of this can prove to be invaluable information when assessing if you want to work with the client and what payment terms you want to extend. Unless you are getting paid in advance, you are offering terms once you pay for your labor and material and send the GC or owner an invoice. The “term” is how long it takes them to pay you for those materials and services.
So where can you get these reports and are they easily interpreted? You can’t just log online and pull credit reports on people or companies. You will need the help of your bank or financial partner or a financial services company, such as a factoring company, that works with constructions companies. There are all types of reporting agencies that offer all types of information. The basic information that you want to look for is: how long has the company been in business, are there any liens or judgments, and the most important thing you want to know is how long it takes them to pay their bills (that’s you). Remember, it’s important to pull a report on the owner as well as the GC because it’s the owner that has to pay the GC before you get paid.
Another way that the creditworthiness of your client can impact your bottom line is if you use your A/R as collateral for a line of credit or if you work with a factoring company as your source for working capital. The reason for this can be summed up in one word: risk. The more creditworthy a company is the less risk for someone to advance you money on the expectation of getting paid. The same philosophy is used in business as with individuals wanting to buy a car or house. If you have good credit the lower your interest rate.
How Long They Take to Pay
How long your clients take to pay you impacts your bottom line because it impacts your cash flow. Since there are many expenses, such as materials and payroll, which subcontractors and construction companies have to cover in advance of being paid by your clients, you must manage your cash flow closely. So when your clients stretch out the payment terms and don’t pay for 45, 60, 90 or more days, you are stuck having to cover those expenses and stress your cash flow. It’s important to determine if the owner has financing or the cash in order to complete the project. Also, understanding the process in order for you to get paid is important. If the owner has bank financing the bank will typically do an inspection before issuing a draw to the GC. Every additional step in the process tends to delay you getting paid, so understand the process it takes to get paid.
Once you have determined the length of time it takes you to be paid, you then need to determine the cost of that length of time. Do you have a bank line of credit to cover the costs? If so, the cost of interest should be included in the project cost. If you do not have a bank line of credit you will need to be able to either, fund the upfront costs on your own and carry those costs until such time as you are paid or there is another option of working with a financial services company that provides factoring services for commercial construction companies. When using a factoring company, you typically sell your invoice to the factor and he or she will advance a percentage of the invoice amount for you to use for payroll or materials. The amount of the discount will depend on the amount of time it takes the GC to pay the invoice.
There is also a common misconception that the bigger the company the better their credit rating and the better they pay. I’m not going to make a global statement that all large companies pay slow—that’s not the case. I can tell you that there are a lot of large GCs that use their size to extend payment terms as long as they possible can. The longer they extend payment, the more it costs you to carry the expense of the invoice and the more it impacts your bottom line. If at all possible negotiate payment terms in advance and put them in your subcontract agreement.
Does Creditworthiness of Your Subcontractors Matter?
As long as we are discussing creditworthiness, let’s talk about your subcontractors. If you hire subs you also need to determine their creditworthiness. If you have two subs bidding on a job for you and they appear to be very similar except one bid is 10 percent cheaper you probably go with that sub. But what if you could look at the creditworthiness of the two subs and you could see that the cheaper sub has numerous judgments and tax liens? This may be because they do not complete projects they start. Would it be worth it to know this before you are midway through a project? That extra 10 percent for the other sub might look like a bargain, especially if the credit report would have shown you in advance they did not have any financial difficulties.
How to Protect Your Business
One option to protect your business and arm you with the information you need to determine what clients and potential clients are creditworthy and to get paid more quickly is to partner with a financial services company that specializes in commercial construction. When you partner with a financial services company, such as a factoring company, they work with you to determine risks associated and the continued due diligence needed on an ongoing basis. They do this by conducting credit checks that can provide the information you need to make the best decision about which clients you want to work with. They will also work with you to provide immediate access to the funds from your unpaid invoices, allowing you to more easily manage your cash flow.
Scott Applegate is the chief operating officer for CapitalPlus Equity, LLC, a financial services company providing factoring and other back-office support services in assisting construction companies with their cash-flow needs. For more information, visit CapitalPlus Equity at www.capitalplus.com or call (865) 670-2345.
