How 'bout Them Finances!

I was chatting on the phone with an industry colleague the other day. We two are in different aspects of the flooring business - he is a flooring installation contractor, I am a flooring manufacturer.

Beyond dark-humored comments like, "Write if you get work...," the subject turned to the obscure but ever-lurking danger of working, really extending oneself, for a general contractor, a homeowner, or another flooring contractor, and then not getting paid.

In these trying times, we know some commercial firms will disappear into insolvency. Or not disappear - I know a company that is currently severely insolvent, but still lives, zombie-like, from job deposit to job deposit. If the acquisition of job deposits slows or stops, that final deposit from an innocent and trusting client will be forfeited.

If we stay on top of the commercial insolvents' credit reports, we'll presumably know in time to take evasive action. On the other hand, private homeowners tend not to go broke, but sometimes find excuses, usually irrelevant, to withhold payment for work done.

But my colleague and I were thinking of the client who decides, for no apparent reason, simply not to pay his bill. The proferred hypothetical situation is the client who, unknown to anyone, is down to his final project, has no new projects in the pipeline, has spent all the end-users' deposit- and progress payment monies, and has nothing left to pay us with. The financial damage to us could be upwards of 50% of the contract value, or more.

The question then hanging in the air: what can we do to prevent this from happening?

There are several approaches. The favorite: in California, we file preliminary liens against the owners' properties. But what if your state will not allow this?

Then you have to get creative. Some ideas:

• Contract for a payment bond on the suspect client. Offer to pay for the premium, usually about 5% or so. You may find out right then that the client is not bondable, and thus not financially reliable.
• Contract for payment up front, or at least sizeable deposit upfront with balance due before delivery of the goods.
• Contract for interim payments to minimize the outstanding balances due under the contract, and stop work if the interims are not paid.
• Bypass the suspect contract party, and make your deal with the end-user directly. In this scenario, make sure the suspect contract party can reliably be paid his customary and expected project margin - either by the end-user, as is traditional, or by you.

The ultimate answer may be some combination of the above. But the real solution is to know with certainty the financial status and capabilities of your business counter-parties. This admonition applies equally to suppliers, as it applies to clients. A broke supplier has probably mis-spent your deposit money, or fails to deliver against your time-sensitive obligation to your own client. A broke supplier also lacks the capability to respond to a legitimate complaint about quality or performance, or to spend the money to fix a problem.

In these days, if you don't know the financial status of your counter-parties, you can easily come to understand the awful meanings of "uncollectible account receivable," or "inability to timely deliver."