The AEC industry is facing unprecedented demand for what we do. If there was ever a time to say that slow-paying clients are not acceptable, it is now.
I was talking with my 10-year-old daughter’s friend’s father this weekend when he dropped her off for a play date. He is assuming more of an operations role in the architecture firm that he is employed by. Inevitably, our discussion turned into one on the topic of unbilled WIP and collection of accounts receivable. He mentioned that they have some clients that take as long as a year to pay their bills. At the same time, they are having difficulty staffing up to meet the demands of their clients.
My first thought was if his firm wasn’t as old and as large as it is, they could never afford to do that!
The working capital problem is one that a lot of people in this business don’t understand. It’s a huge problem, and one that needs a lot more attention and education if AEC firms are going to deal with it.
Per Wikipedia, “Working capital is defined as current assets less current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit and negative working capital.” They go on to say, “A company can be endowed with assets and profitability but may fall short of liquidity if its assets cannot be readily converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.”
While normally accounts receivable would be considered part of an AEC firm’s current assets, when clients take a year to pay their bills, you can hardly call it that. No bank would normally allow you to borrow on an accounts receivable-based line of credit for anything over 90 days old.
So what are the implications of that? The firm will need to have enough cash to keep paying all of its people and all of its other overhead for the time it takes their clients to pay them for their work. That’s a tremendous amount of money. If you have a $20 million annual revenue firm and your operating expenses are $18 million, you need $1.5 million of liquid cash for each month of your average collection period. So a 90-day average collection period means you need $4.5 million in liquidity just to keep your doors open. If it is a year, you would need $18 million in liquidity to cover that.
If you are an owner in your firm, you don’t want to have to leave that kind of money in the till. If you are organized as an S-Corp, LLC, or other type of legal pass-through entity for tax purposes, you need to be able to allow your owners to extract enough distributions to cover your taxes. That usually means at least 35 percent to 40 percent of your profits have to go to owners, unless they want to dig into their own pockets to meet their tax obligations from the money they make on their firms. In the above example – for a $20 million revenue company with $18 million in expenses and a $2K profit, they would have to pay out roughly $800K to owners at a minimum just so they can meet their tax obligations. If their clients take 90 days on average to pay their invoices, that means they need $4.5 million in working capital and with $2 million in profit less $800K in owner distributions. That means they would have to make $2 million a year for FOUR years – paying NO bonuses to employees and paying only enough in distributions for owners to meet their tax obligations and nothing more. If clients take longer than 90 days to pay, this number goes up. That’s crazy!
AEC firms must stop tolerating these kinds of slow-paying clients. We cannot afford to finance the other guy’s (or gal’s) business. We – as a group of companies or “industry” – are facing unprecedented demand for what we do. If there was ever a time to say that slow-paying clients are not acceptable, it is now. You cannot keep working this hard for so little payout just to fund your working capital needs. Put the spotlight on the problem and get tough NOW!
Mark Zweig is Zweig Group’s chairman and founder. Contact him at firstname.lastname@example.org.