In an industry where cash reigns supreme, a subcontractor’s accounts receivable (A/R) workflow is crucial in maintaining profitable margins. Therefore, it’s important to have a plan to pursue payments that exceed the contractual payment terms to preserve a healthy cash position. But how exactly do you create an A/R escalation plan? In this blog post, we’ll explore all of that—and then some.
Before we dive in, let’s start by covering some basics, like:
What is A/R aging?
A/R aging is a report that categorizes and organizes outstanding customer invoices based on their due dates. It helps companies track and manage the money customers owe them and how long invoices are outstanding. A/R aging reports are typically separated into buckets, such as current, 30 days past due, 60 days past due, 90 days past due, and so on.
Why is monitoring A/R aging important for contractors?
An A/R aging report is one of the most important reports for billing teams to monitor and manage. Why? Timely collection of payments is vital to the survival of any business. When customers owe you money, it negatively affects your cash flow. This, in turn, hampers your ability to reinvest in your business, pay bills and payroll, and allocate money toward future projects.
That last part is especially important for trade contractors as they are typically the ones fronting the costs of capital, labor, and materials for new construction projects before receiving any payment. Due to the credit-heavy nature of the construction industry, 20% of businesses are cash flow negative after 40 days, according to Levelset’s 2021 Construction Cash Flow & Payment Report. These cash flow gaps can quickly eat away at your margins and can potentially force you to borrow money from the bank. Talk about a slippery slope.
Aging receivables are increasingly difficult to collect.
Regularly monitoring your A/R aging is also essential to ensure you aren’t leaving any money on the table. A widely cited statistic included in this Lockstep article shows that 26% of invoices over three months old are uncollectable. This percentage increases to 70% at six months and 90% at 12 months. In other words, as receivables age, the chances of collecting payment decrease significantly, putting contractors at a higher risk of financial instability and potential business failure.
How do you know when your A/R is aging?
The simple answer to this question is this: whenever payments aren’t received within the agreed-upon timeframe. You should easily be able to track past due invoices in your A/R aging report, along with these other indicators to ensure nothing falls through the cracks:
- Increasing Days Sales Outstanding (DSO): Review your DSO on a monthly basis and compare it to industry benchmarks and historical data. DSO calculates the average number of days you take to collect payment after a sale has been made. If your DSO increases over time, it indicates that it is taking longer to collect payments, signaling potential issues with your A/R.
The formula to calculate DSO is: DSO = (Accounts receivable balance / Net credit sales) x Days in period
- High Percentage of Overdue Payments: Monitor the percentage of invoices that are overdue. If a significant portion of your invoices remain unpaid beyond their due dates, it suggests that your A/R is aging and requires attention.
- Difficulty Collecting Payments: If you encounter challenges in collecting payments, such as frequent delays, unresponsive clients, or disputes, it’s not just a sign that your A/R is aging but also that it may be time to end that particular partnership.
The formula to calculate the average collection period for each client is: Average collection period = (Average accounts receivable / Net credit sales) x 365
How do you establish an A/R escalation process?
Getting your A/R aging report squared away is one thing. It’s an entirely separate (and equally important) thing to create a process for regularly reviewing the report and taking corrective action to collect outstanding invoices. After all, clients aren’t always proactive in letting you know when they’re holding up payment and why. It’s ultimately up to you to make sure money moves in and out as efficiently as possible.
Here are some tips to help you create and maintain a rock-solid A/R escalation process:
1. Establish firm payment terms for clients.
Setting up payment expectations with your clients is a critical first step and is something you’ll outline in the initial contract. These terms should also be included on every pay application so that the expectations remain clear throughout the duration of the project. Avoid vague phrasing like “due upon receipt.” Pick a defined deadline and remain firm on that. This approach protects your best interests if a client is late with a payment. Referring them back to the payment terms substantiates your request and hopefully motivates them into action quicker.
2. Create a protocol for responding to overdue invoices (and stick to it).
The timing and frequency of contacting clients regarding late invoices is ultimately up to your team and its leadership—every company is different. However, taking immediate action is crucial once you identify a late invoice. Delaying action can result in even greater cash flow issues or failure to collect the payment at all. Typically, your project manager (PM) will email the client’s counterpart, including the invoice details (number, amount due, and due date).
Remember that due to the prolonged pay-when-paid system in construction, there is usually a valid reason for delays. Some of these reasons are beyond your control, such as the GC not being paid yet. Others are controllable, like missing lien waivers or expired compliance requirements. (Having billing software like Siteline ensures all controllable factors remain in your, well, control so that payment is never held up due to something on your end.) Regardless, being courteous and keeping a level head will help you resolve the issue sooner—and get payment through the door quicker.
If the payment issue remains unresolved after the initial contact, it’s important to create a clear list of subsequent actions—paired with specific time intervals—to be taken to ensure clients are held accountable for overdue payments. Some things you’ll want to consider when structuring this include:
- How frequently your team will send follow-up emails to the client in the coming weeks.
- When it’s appropriate to escalate this outreach to phone calls.
- When it’s time to involve other individuals in the process (e.g., A/R teams, operations managers, executives).
- When it’s time to file a lien and get lawyers involved. (This is a last resort, as doing so can get messy and expensive. Hopefully, this guide will help you avoid this altogether.)
3. Assign roles for each step of the way.
This is closely related to the previous point. For every step in the protocol, ensure that there is a clearly designated owner responsible for that action. The specific roles may vary depending on your company's structure or the client involved. However, it is crucial to maintain this document as a central source of information for your team. This will help ensure that everyone knows their responsibilities related to following up on payments and when to take action—making it much more difficult for outstanding invoices to slip through the cracks.
Here’s the typical game plan I’ve observed subcontractor billing teams enact:
- The chief financial officer (CFO) will establish the escalation process.
- The A/R specialists act as the first line of defense. They monitor the A/R aging report, check for late payments, and ask the PMs to initiate the first follow-ups on overdue payments. (Depending on your organization, you may prefer that the A/R team initiates the first follow-ups before handing it over to the PMs.)
- Operations managers and executives are involved as the situation escalates, and additional leverage is required to collect the payment.
I’ve included some specific examples of A/R escalation processes below to provide a clearer understanding.
4. Notify executives at the start.
One common mistake I frequently observe in these situations is the delay or failure to inform executives about outstanding payments. Now, I'm not suggesting that executives must take immediate action—as I mentioned earlier, their role comes into play later on. However, it is crucial that they are aware of the issue and understand the steps taken to recover the payment. This will enable them to assist the team in finding workable solutions and ultimately determine the best course of action when their intervention is required.
5. Clearly communicate expectations to your team.
Once the steps are mapped out and roles and responsibilities are assigned, it’s important to clearly communicate this information to everyone who may be impacted by it—finance, CFOs, controllers, PMs, A/R specialists, etc. If they’re expected to help chase down payments, they must understand when and how to do this. Your team will appreciate the heads up and feel more confident in their roles in managing outstanding payments.
I also highly recommend documenting this protocol. Doing so will help prevent confusion and finger-pointing. It will also serve as a reference point for existing and new employees.
There is no universal protocol for what an A/R escalation process looks like in construction. Rather, it depends on your company size, the number of people on your A/R team, and the structure of your finance department. That said, here are a few examples to get your mind turning in the right direction from folks we’ve talked to within the industry.
This example was provided to us courtesy of an Operations Manager at one of the top 39 Electrical Contractors and Electrical Construction Companies.
When an invoice is:
- Within 30 days past due, outreach is owned by the PM
- Between 31-60 days past due, outreach is owned by the operations manager
- Past 61 days, outreach is owned by the president or CEO
This example was shared by Stephanie McShane, Director of Maxim Consulting Group, at the 2023 CFMA Annual Conference.
When an invoice is:
- Within 30 days past due, outreach is owned by the project coordinator (PC)
- Between 31-40 days past due, outreach is owned by the PM
- Between 41-55 days past due, outreach is owned by the A/R team
- Past 56 days, outreach is owned by an executive
This example was provided by a Construction Manager at one of the top 33 Mechanical Contractors to watch in 2023.
When an invoice is:
- Within 90 days past due, both the PM and A/R team own the outreach (and must communicate with one another to ensure follow-ups have been completed)
- Past 91 days, business unit managers (who are essentially like the company’s VPs) have owned the outreach
As you can see, the process doesn’t have to be overly complicated. Find a plan that works for your team, get everyone’s buy-in, and follow through with it!
How can you seamlessly monitor your A/R escalation process?
To effectively monitor your A/R and improve cash flow, it is crucial to have access to real-time data on your aging accounts. This lets you stay informed about when to expect payment for your services. Using software like Siteline can provide you with cash flow forecasting and a dashboard that prominently displays your days sales outstanding (DSO), helping you:
- Establish a defined and consistent practice for managing collections;
- Stay on top of your A/R to avoid wasteful delays; and
- Maintain good financial hygiene to improve your cash flow and financial position.
By leveraging Siteline, you can save your team significant time in managing collections through manual processes. Offloading this task to a solution that can handle it frees them up to focus on more valuable tasks—such as chasing down late payments—while ensuring your A/R process runs smoothly.
Sound intriguing? Book a demo of Siteline today to see how it can help enhance your cash flow.