How bad is when you don't get paid?

[rockstar.esq]

I recently received a "dear colleague" letter from a client explaining that they're teetering on the brink of insolvency.  While the tone and the content of the letter was well-crafted to elicit patience and empathy, the business reasons behind the move were clear to me.  They needed to generate good-will to buy time for their next move which is probably filing for bankruptcy.

For context, this is a firm that's respected for being straight-arrow honest for it's 25 years in business.  Unfortunately, we've only done one small job with them, and it went very poorly.  It cost us more than our contract amount to build the job because of their egregiously bad management.  The job was "finished" over six months ago and none of our invoices were paid.  Our managers weren't particularly diligent about Accounts Receivable on this project because it was "small" and this was our first project with a contractor which had a stellar reputation.

When we received the letter, it put everything into a different light.  My co-workers continued to think of it as a "small" job, that wouldn't hurt us since we're currently busy with several projects that are literally ten times larger.  I suspect that a lot of people would have come to the same conclusion.  But it's grievously wrong.  We're in deep trouble.

To illustrate what I'm on about, we need to lay out some numbers and relationships. 

For starters, let's say the job in question is worth $50,000.  While I strenuously disagree with using a percentage for overhead, let's simplify and say that every bid has 10% of overhead applied to the subtotal.  To keep things simple, let's assume that every bid has 5% of profit on the subtotal plus overhead. 

I've met lot's of people who would mistakenly assume that means the bid had $5,000 in overhead, and $2,500 in profit because that's what you'd get by calculating 10% and 5% of $50,000 respectively.  That's completely wrong.

The profit is actually $50,000- ($50,000/1.05) which = $2,380.95

The overhead is actually ($50,000- $2,380.95)- (50,000-2,380.95/1.1) which = $4,329.00

OK, so that was a bit of extra math that "only" came to a few hundred of difference here or there.  The error here overestimates the profit by 5%  and the overhead by 13%.  Granted, I'm talking about percentages of percentages, but this stuff stacks up.

As I mentioned earlier, this job actually cost us much more than the contract amount of $50,000.  For the sake of simplicity, let's say our total cost was $55,000.  There is no profit in that amount at all.

OK, so $55,000 sounds bad, but I mentioned that we're full-up with jobs that are ten times that size.  That's true but size is measured in revenue i.e. the contract amounts.    The money we stand to gain for all that work is (net profit) isn't 5%, it's more like 4.7% when everything goes well.

 

[Jackdawg]

Is there more coming? your post just seems to stop.

I understand your country has very lenient bankruptcy laws, so I don't know exactly what your remedies might be - but here I would immediately be going to debt collection, indeed your company should have done so when the invoices came up to 3 months overdue. They should have also attempted to reclaim the work if at all possible.

But $50k is enough of a debt to force the wind up of a company that doesn't pay here, get court orders to seize property and assets. Although more than likely you will find yourself just one small unsecured creditor among a long list, and lucky to get a cent on the dollar.

 

[Steve Sells]

I had a call to repair some emergency lighting for a local branch of a chain sports store.  I never got paid,   I found out later they filled and closed the business soon after, needed the EM lighting working to sell the building.  T real clinker is  they filed for bankruptcy 2 months before they hired me to do the work, and I was listed as a creditor on those pages filed the 2 months prior to boot.  talk about a set up. but nothing I could do about it. It would have cost more to fight than the bill total, and I may not have won anyway.

[rockstar.esq]

Jackdawg,

Sorry about that, I thought I was still in "edit" but when I went to post it, I got an error.

Debt collectors, bankruptcy and lawyers are all fall-back conditions we're exploring but nothing is free. We're liening the building which is generally a more direct and forceful means to secure payment.  The contractor can't afford to be sued by an angry landlord who's holding 100% of the cards against them.  Still, we're going to take a drubbing.

Picking up where I left off,

The question becomes, how much revenue do we need to earn sufficient net profit to pay for this $55,000 project?

$55,000/.047619 = $1,155,001.16

This means we bid on a job hoping to make less than $2,500 and now we're staring down approximately $1.2 Million of revenue to break-even for the cost of a singe unpaid job that's one-tenth the size of our average contract .  Seriously, if your average job was half a million, would you worry about the $50K job that didn't go well?  It's really easy to feel ten foot tall and bulletproof when there's a lot of big jobs on the books.  

Things get this way because most of the time even crummy clients pay a goodly percentage of their contract.  It's like catching yourself on a wobbly ladder.  Sure it was scary, but you didn't really get hurt.  Eventually it seems like no big deal. OSHA reports that most ladder fatalities come from falls that were under 10'.  Most people who fell off a ladder admitted they'd done something similar in the past without injury.

As a parting thought, I'd like entrepreneurs to take a hard look at their annual net profit.  Any unpaid contract equal to or greater than that amount represents an extinction-level event.  In competitive markets where profitability is kept low, not getting paid for the average contract amount can be an insurmountable loss.

 

[rockstar.esq]

27 minutes ago, Steve Sells said:

I had a call to repair some emergency lighting for a local branch of a chain sports store.  I never got paid,   I found out later they filled and closed the business soon after, needed the EM lighting working to sell the building.  T real clinker is  they filed for bankruptcy 2 months before they hired me to do the work, and I was listed as a creditor on those pages filed the 2 months prior to boot.  talk about a set up. but nothing I could do about it. It would have cost more to fight than the bill total, and I may not have won anyway.

Steve,

It seems like their attorney could face consequences for filing a creditor who didn't exist at the time.

I'm not a lawyer and don't pretend to be but I understood that there are strict rules about this sort of thing.  Your invoice may seem cheap in comparison to what it could cost them.

 

[Marc1]

When profit margins are slim, and overall job cost are high, the risk factor becomes a real issue. Remind me never to do anything in a highly competitive market. It's not worth the hassle. 

Steve, I had similar stories of unpaid jobs, not a set up like yours though,  took it on the chin and wrote it down on the experience ledger. 

A carpenter friend of mine had a different approach. He was called to install a large double front door for a new building belonging to a doctor who was building his new surgery. 

He installed the doors with the best hardware and two massive "parliament" hinges each side.  

The doctor told him he wouldn't pay him because the doors needed 3 hinges. (They didn't )

So he put the back of his truck against the door and smashed the lot in and went his merry way.

[SLAG]

R-Star,

That smells like (is) fraud. You may be able to sue the beggars. Says the SLAG.

Legal action of both the criminal fraud; and the civil variety.

It might have been a substantial case, big enough to interest an attorney in working on a contingency retainer.

Speed would be of the essence. Some of the potential defendants would be the principles that hired out the work, (both as corporate officers &/or individuals) the bankruptcy trustees, the auction house that may have been hired to dispose of the goods.

The state Attorney General's office would probably look into the matter for criminal and civil fraud reasons. 

If the situation was attended soon after it happened, a court could issue a forward injunction stopping sale of the assets. (e.g. auctions and private dispositions of the assets of the estate).

Speed is of the essence in these sordid matters.

There is another way to go. Totally illegal. Sell the debt, for collection, to one of the "1%" motor cycle gangs. (oops associations). The going rate, a decade, or two back then, was one third  of the value of the debt for the collection services rendered. Recipient's salvage amount was two-thirds of the moneys owed. Which is much better than nothing. 

Of course the SLAG was never involved in such disgraceful matters in ANY way! I was an intellectual property and licensing lawyer. Furthermore, these days I am a humble, honorable retired attorney:   and the statute of limitations has most probably run out.

HAH!!

 I am only repeating the vicious rumors which came from highly credible sources.

As sergeant Schultz, of Hogan's Heroes, used to say, "I know NOTHING  !!"). I have heard that some chapters of the largest such group, specialize in such dreadful services.

Somehow, I suspect that above screed will be of little practical value for things past but could prove valuable for future "events".

We always ran a Dunn & Bradstreet on all potential clients. Including the very large corporations. Before rendering ANY invaluable services.

Regards,

SLAG. 

[Kozzy]

1 hour ago, rockstar.esq said:

 

The question becomes, how much revenue do we need to earn sufficient net profit to pay for this $55,000 project?

 

Glad you said that as that's the real trap.  It's not about losing the "profit", it's about gross sales needed to make up losses if that job goes sour.  Mistaking that kills many small businesses that simply can never make enough sales in a reasonable time to cover one loss.

Speaking of weasels, Tomorrow's project is to hammer on a customer that referenced his own files wrong and ordered about $ 30K of the wrong CUSTOM stuff---now he refuses to pay for his mistake and says he wants to return it.  Fortunately we have all the paperwork to back things up---that doesn't mean you get paid, just that you have a fighting chance.  

When people ask me about steps in starting a business I ALWAYS start out with recommending the boring back-up paperwork and procedures.  You need a system to make sure you do credit checks, get written P. O.s and signed construction drawings, and have a collection process in place BEFORE you make your sale.

[rockstar.esq]

Slag,

I've often wondered if we'd ever get to a point where enterprising lawyers would pursue the common fraud that's going on in the construction industry on a contingency basis.  What Steve did is understandable considering how high a lawyers hourly rate can be.  In my career I've witnessed hundreds of thousands of dollars worth of work that was basically "stolen" by individuals who were banking on the threat of high attorney fees to shield them from prosecution.

Basic stuff like collusion is absolutely rampant, especially on government work.  If there was a way for lawyers to capitalize on going after the cheating in construction, the first adopters would be sitting on a gold mine.

Kozzy, thanks for the comment.   My business classes didn't spend any time on policies or procedures to mitigate risk.  I'm not sure that credit checks or Dun and Bradstreet would have thrown up any warnings about this firm.  A whole lot of construction companies go under from a single bad job.  Not just little guy's either.  Huge multi-national firms with 50+ years of history can fold up in a matter of weeks.  

It doesn't take many bad actors to inflict serious damage to a company.