“Better Materials Planning” is the first chapter of Kojo’s groundbreaking book, “7 Steps to Better Procurement for Trade Contractors.”
The seventh and final step of the procurement process is Payments, which is crucial despite its seemingly simple name. Payments encompasses optimizing pre-payment workflows and approval processes, determining when and how to pay invoices, selecting appropriate payment methods, and ensuring security of payment data. Mishandling this step can lead to late payments, missed discounts, and inaccurate data, all of which can cause significant financial and relational setbacks. However, contractors who have adopted best-in-class payment processes have found ways to avoid these pitfalls while saving money and boosting team productivity. By mastering secure and accurate payment methods and effective cash flow management, contractors can unlock the full benefits of optimized payment processes and establish themselves as top performers in the industry.
The construction industry is one of the last industries where executive approval is required prior to making materials purchases for many contractors. This is because costly mistakes and improperly managing cash flows can put a contractor’s business at risk of failing. The process has traditionally been inefficient. It requires sifting through spreadsheets, emails, and documents to ensure every line item is accounted for.
Another downstream benefit of implementing best practices to streamline and automate 3-way invoice matching covered in Chapter 6 is the positive impact it has on a contractor's payments approval process. If approval processes can be streamlined, contractors will not only reduce overhead costs but they can remove the human errors that come along with manual work.
Despite the construction industry's heavy reliance on checks for payments, this method still creates several inefficiencies that contractors should consider. While checks may seem like a tried and true method, they come with several drawbacks that can hinder your business. For example, the time it takes to draft checks manually can add up quickly, especially if you have hundreds or thousands of them to process each year. This can lead to delays in payments and create cash flow issues.
Security concerns are a major issue when delivering checks by hand or mail to your vendors. Checks can be easily lost or stolen, and this creates a significant risk for your business. By paying with checks, you may also miss out on incentives offered by vendors for faster payment methods such as ACH or credit card
Additionally, vendors may take time to cash checks, and some may even go uncashed for months, which can create complications for managing your books and cash flow. In addition, delivering checks manually takes up valuable time that could be used for more productive tasks.
Managing a paper trail of checks can be a manual and time-consuming process, which can include taking photos and keeping carbon copies. Keeping your ERP/accounting systems up-to-date with check information also requires manual data entry, which is prone to typos and can be a significant time sink.
It's worth noting that many of these issues can be addressed by adopting more modern payment methods, such as ACH or credit card payments, which can streamline the payment process and save time and money. In fact, according to a recent survey, construction companies that switched to electronic payments saw a 50% reduction in payment processing costs.
The risk of payment theft and fraud is a significant concern for businesses today, with the potential financial losses being substantial. According to a report by the Association for Financial Professionals, check fraud resulted in an average loss of $1,541 per payment in 2020, compared to only $312 for electronic payment fraud. As a result, many businesses are switching to electronic payment methods to mitigate the risks associated with payment fraud. However, it's crucial to ensure that the systems you use for electronic payments are secure, especially given the increasing number of reported data breaches.
According to Risk Based Security, a leader in cybersecurity risk management solutions, found that there was a 24% increase in reported data breaches in the first half of 2021 compared to the same period in 2020, highlighting the importance of having robust security measures in place to protect your payment data.
If you don’t migrate your payments and payment processes to an online platform then it’s easier for bad actors from within your company to commit fraudulent behavior and create financial damages to your business.
Additionally, if you don’t have your purchasing, coupled with invoice reconciliation payments in one centralized platform, you lose a layer of accountability and makes it harder to detect internal fraud.
For many contractors, the decision of who and when to pay an invoice is made primarily by two determining factors. One, which invoices are the most past due, and two, are there sufficient funds in the bank to make a payment. Although these are two very important factors to weigh, they’re not the only ones.
Are you taking advantage of vendor incentives? Vendors have their own cash flow challenges so getting their contractors to pay quickly is a top priority. Because of this, they’ll often provide contractors incentives for paying invoices early or on time. However, many contractors fail to take advantage of these incentives because of the challenges of managing multiple invoices from different vendors with varying payment terms and methods. A study by the Institute of Finance and Management (IOFM) found that only 12% of companies are taking full advantage of early payment discounts offered by vendors, missing out on savings that could add up to millions of dollars annually.
Are you not taking advantage of credit cards to optimize for cash flow? There are two reasons for this:
When your business is making payments to multiple vendors using a variety of payment methods, it can be challenging to consolidate payment data into a centralized system. This can result in fragmented payment data that is stored in different places such as email, paper receipts, or electronic files. This makes it difficult to track and reconcile payments, and can lead to errors and discrepancies.
For example, if a vendor sends an invoice via email and you pay it using a credit card, you may have to manually enter the payment information into your accounting system, which can be time-consuming and error-prone. Similarly, if you pay a vendor using a check, you may have to manually record the payment in your accounting system and store the carbon copy of the check for future reference.
According to a survey by Ardent Partners, a research and advisory firm that specializes in supply management, procurement, sourcing, and financial operations, found that 56% of businesses believe that manual data entry was their top accounts payable challenge, while 45% believed that they struggled with data accuracy and 41% with data visibility. By consolidating payment data into a centralized system, you can streamline the payment process, reduce errors, and gain better visibility into your cash flow.
If payment approval processes can be streamlined, contractors can not only reduce overhead costs but they can remove the human errors that come along with manual work. Below are a couple of tips on how to improve your payment approval process:
There are various third party platforms that allow contractors to outsource their bill pay needs. These platforms leverage their vendor network to automate payments, ensure transaction security, track days outstanding, determine preferred payment methods (such as prioritizing credit card payments for cash back), and provide automated remittances to help mitigate billing errors from the vendors’ AR teams. To effectively manage your billing needs, it's important to have a process in place that helps prioritize which invoices to pay first, taking into account cash flow constraints and the potential savings from vendor incentives. Bill Pay tools can help contractors save money and improve vendor relationships by demonstrating a commitment to timely payments.
Managing cash flow and paying vendors on time can be challenging when you’re operating a margin-tight business. Even making payroll in the middle of a large project while waiting for payment from a general contractor can be difficult. In such situations, access to financing can be a powerful solution. However, finding favorable rates for construction-related financing has been a challenge for contractors, which has led to many missing out on growth opportunities.
Historically, lenders have perceived the construction industry as a risky sector and therefore have been reluctant to provide loans to contractors at reasonable rates. This has left many contractors hesitant to take on loans, as they struggle to identify a healthy amount to borrow and are unsure where to find favorable rates. However, with the construction industry moving to digital payment methods, transaction data is allowing lenders to better assess risks and offer more favorable loans to contractors.
For these reasons, financing is becoming a more viable option for addressing cash flow needs. By understanding when financing is necessary, identifying a healthy amount to borrow, and knowing where to find favorable rates, you can unlock growth opportunities. For example, financing can help manage the cash flow complexity of paying multiple crews and vendors while taking on more jobs to grow top-line revenue. Contractors who have successfully navigated financing tools, have found it to be a beneficial avenue to hit their revenue growth targets.