Construction businesses usually start small. As a company grows bigger, some tasks and processes become more complicated than normal. One such task is payment collection.
In a small- to mid-sized company, one or two people can be sufficient enough to collect payments from clients. In bigger companies, there is usually a dedicated team that manages credit and payment collection.
- What is a credit and collections department?
- Why is a credit and collections team relevant in construction?
- What are the functions of the credit and collections team?
- What are the goals of credit departments in construction?
- What makes a strong credit and collections department?
- How to build a strong credit department in construction?
- Best practices in managing a credit and collections department
What is a credit and collections department?
A credit and collections department is the team in charge of managing credit that is awarded to clients. Managing the clients’ credit portfolios includes setting the credit limits, awarding the approved credit amount, and collecting payment for the borrowed amount.
Not all companies have a dedicated credit and collections department. Smaller construction companies tend to have fewer clients, which makes credit management a relatively simple task. There is usually just one or two people who approve credit sales and who collect payments after the invoices have been sent out.
As a company becomes more successful in the industry, it will naturally acquire more clients, which makes credit management more complicated. You will attract clients with varying financial capabilities, and so you need to pay thorough attention to their financial status before approving a certain credit limit. You will also make more credit sales, which means that you will need to collect more payment.
Why is a credit and collections team relevant in construction?
Having a strong credit and collections department is important in construction because of the following:
Construction sales are usually made on credit.
In construction projects, you need first to provide the labor and materials to the project before you get paid. For example, if a client orders $10,000 of materials from your supply company, you need to deliver those materials first before they hand you the payment. These materials may be delivered in a single trip, or they may need to be delivered in separate batches.
In any case, you can only bill your client after the order has been delivered. Credit departments are therefore relevant in construction to ensure that no client orders services for an amount that they cannot afford to pay.
Late payments are extremely common in construction.
There are various reasons why late payments frequently happen in construction. The reality is most construction businesses have to deal with missed payments, which makes a credit and collections team significantly important in big construction businesses.
If, for instance, you have 10 clients and 6 of those clients have missed their payments, you will likely have issues with your cash flow. You will not have the money to fund your operations, and you may even miss out on bigger projects because you cannot afford to take them on. Credit and collection teams must make sure that you never find yourself in this situation.
Payment recovery options are limited in construction.
Even though the construction industry has a perennial late payment problem, there are not many options available for you to recover your payment. The best option you have is filing a mechanics lien, which is a legal payment recovery method that is exclusive to the construction sector.
However, filing a mechanics lien comes with a list of strict requirements that you need to follow. For instance, most states require that you serve a preliminary notice on the property owner and the general contractor before you can file a mechanics lien. Credit departments must ensure that your lien rights are protected if you ever need to exercise them.
What are the functions of the credit and collections team?
- Ensure that credit sales are awarded to credit-worthy clients
One of the most important functions of the credit and collections department is to ensure that you are working with credit-worthy clients. If not, the credit department must ensure that there are protections in place so you do not get duped by your customers.
Credit departments analyze the financial status of every client to determine how much they can afford to borrow. They also set the appropriate credit limits to ensure that the clients you are working with are those who can afford to pay what the services they buy.
- Minimize risk and losses due to bad debt
Risk assessment is another key function of every credit and collections team. Risk analysis is done not only on potential clients but also on current and loyal customers to ensure that they remain in good financial standing.
The credit and collections department is also responsible for studying why late payments occur and for flagging potential issues before they turn into major financial problems. For example, if an otherwise reliable client suddenly misses a payment, the credit team conducts an investigation to understand what are the possible reasons behind this delinquency.
- Manage payment collection
All credit and collections teams are responsible for keeping the accounts receivables low. The credit department must implement a robust credit policy and must streamline the payment collections process so cash inflow is regular and payments are collected promptly.
A good credit team has a clean and effective process for sending out invoices, reminding clients of impending payment deadlines, making collection calls, and setting priorities according to the severity of the debt.
- Organize and maintain all credit-related paperwork
Credit and collections teams are also in charge of making sure that all the pieces of information in the books are current and accurate. Being disorganized has no place in a credit and collections team. You need to update the data you have on your clients, and you need to make sure that all sales are properly closed once payments are in.
Failing to organize the data can be detrimental to a construction company or any type of company that makes credit sales. You can lose track of the invoices and the payments, which can potentially cause disputes and financial losses in the long run.
What are the goals of credit departments in construction?
Reduce risks and instances of bad debt
One of the goals that a credit and collections department must have is to reduce the instances of bad debt. You want to reduce instances of payment delinquencies, including late payments and non-payments. You can always try to file a mechanics lien to recover payment, but keep in mind that filing a mechanics lien requires time and resources.
There are many ways to avoid bad debt. You can set a strong credit policy to ensure that you make good judgments when setting the payment terms with your clients. You must be extremely thorough when studying a client’s financial records. Also, make sure that you speak with professional references to understand how a client has performed with other contractors or suppliers.
You can also consider imposing late payment fees or early payment discounts to discourage your clients from paying late. Make sure that these fees, as well as the other payment terms, are clearly stated in your contracts.
Streamline billing and payment collection practices
If your company has grown big enough to have its own credit and payment collections team, then you must make sure that there are clear billing and payment collection policies and practices that the team can follow. Having a dedicated credit department is quite useless if the team members are left to do their tasks as they see fit.
Streamlining the billing and collection practices starts with setting out the steps that need to be completed when you bill a client. For instance, here are some questions to ask when managing invoices for billing or when streamlining your payment collection practices:
You need to understand all these details in order to have standardized procedures in managing credit and payments.
Keep late payments at a minimum
The credit and collections department should also strive to keep late payments at a minimum. As mentioned earlier, you should consider setting late payment fees to discourage clients from paying beyond the agreed deadline.
You should also keep in mind that one of the biggest reasons behind late payments is payment disputes. Sometimes, a client will miss a payment simply because there are ongoing disputes on how much they need to pay.
Disputes can happen for many reasons. Sometimes, invoices can have the wrong information and amount, which can further delay the payment. This is why it is imperative for you to verify your invoices and make sure that they are accurate.
Disputes may also occur due to miscommunication. In every construction project, you need to be transparent with your clients to ensure that everything is communicated properly. Make sure that communication lines are established at the beginning of the project.
What makes a strong credit and collections department?
- A strong credit department works hand-in-hand with the sales department.
Credit departments manage everything related to credit – from setting credit limits to collecting payment – but the sales teams are the ones who clinch the sales. Sometimes the credit and sales departments may clash, and it is usually because the sales team has sold way more than what the credit team thinks is appropriate for a client.
A strong credit and collections department must therefore work hand-in-hand with the sales team to avoid potential issues. It is the responsibility of the chief financial officer to ensure that these two teams work in accordance with each other.
The credit department must also keep in mind that while it is their responsibility to reduce financial risks due to bad debt, they are also still part of the business that needs to make money. This consideration is important when credit managers make day-to-day decisions on the job.
- A strong credit department is organized.
A strong credit team cannot afford to have the data and information all over the place. Being organized is a chief requirement in every credit department. When a client orders more materials, for example, the credit department should be ready to crunch the numbers if the client can afford to order more or not.
Being organized is also important when doing payment collection calls. For instance, if a client is two months overdue and you need to give them a call, you must have all the details regarding their account. How much do they owe, including late payments? When was the invoice sent out? Has a preliminary notice been served? The credit team should be able to gather all these bits of information quickly.
- A strong credit department understands the important quantitative credit metrics.
Credit and collections departments must make use of the necessary key performance indices or KPIs. For example, if you want to know how much it takes you to collect payment from your clients, you should be able to pull up your days sales outstanding or DSO and know what the numbers imply.
There are other useful KPIs available, and a good credit team should be able to analyze and maximize these metrics for their purposes. While the numbers do not always tell the full picture, they can always help you understand how effective your processes and policies are.
Using KPIs and regularly analyzing the numbers can also help you flag potential issues. If, for example, your collections effectiveness index has decreased, it should tell you to look into possible causes behind this change and address the problem before it gets worse.
How to build a strong credit department in construction?
Hire people with excellent communication skills.
There are many skills that you should look for in a potential member of the credit department. They must be financially literate, they must be familiar with how the construction industry operates, and, most importantly, they must have good communication skills.
Being part of the credit team means having to work with clients in different capacities. It is a client-facing role. You communicate to your clients what the payment terms are, and you also talk to them when you need to collect the payment.
A good credit team member should also be able to express in explicit terms the necessary payment provisions in the construction contract. Payment disputes are often solved right away if the contract is clear and robust.
Hire people who understand the hierarchical nature of construction payments.
Late payments happen all the time in construction, and a good credit team understands this reality. They must be familiar with how a construction project operates because this familiarity will help them build strategies to minimize the risks of late payments.
A good credit team should also understand the available remedies against non-payments. Credit policies should ideally include provisions on how mechanics liens are handled. Credit teams are also encouraged to come up with lien policies to ensure that the company’s lien rights are protected in every project.
Keep in mind that filing a mechanics lien is one of the most effective tools against non-payment. Even though properly filing a mechanics lien requires meticulous work, it can be your company’s only recourse to recover payment from non-paying clients.
Ensure that the team thoroughly understands the company’s credit policies.
A strong credit team understands the ins and outs of your company’s credit policies. The credit policy should reflect the company’s values and goals, and the credit team must know how to take these values into account when making tough decisions.
Having a credit policy is important in approving credit sales, setting credit limits, collecting payments, among other credit management tasks. Without a robust credit policy, the credit department will crumble as every member will just do what they think is best without any organizational guidance.
Best practices in managing a credit and collections department
Ensure that the department is working as a team
There is no point in forming a credit department if the people in it do not work as part of a team. When managing a credit department, encourage a culture of teamwork. Being a team player is also important when working with other departments such as the sales team. Everyone is part of the same company so everyone should be able to work harmoniously.
Conduct regular training and performance evaluation
Skills and leadership training are important, especially for the credit and collections team. Many companies are starting to use available software to streamline their credit management processes, and the credit team members must be trained on how to use these technologies. Credit department members must also be evaluated so they can keep improving on their jobs.
Streamline processes by implementing robust credit policies.
Having a robust credit policy is a requirement if you want your construction business to keep thriving. The credit policy guides your credit team in making sound decisions about your clients. Even if your credit department has highly skilled members, they can only do so much if your company’s credit policy is flimsy and has many gaps.