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Home-builder’s dip into the red a painful lesson

Luxury custom home-builder Derek Nicholson.

J.P. MOCZULSKI/The Globe and Mail

The houses that contractor Derek Nicholson builds are not your everyday, cookie-cutter suburban homes.

His Toronto-based project management firm, Derek Nicholson Inc., works with well-known architects to build and renovate custom homes in the modern or contemporary style. They're the types of buildings that are often written up in magazines and garner awards, and the specialization has helped Mr. Nicholson, a former senior manager at the City of North York's parks and recreation department, build a healthy nine-employee firm.

This year, however, after 17 years in business, Mr. Nicholson's company ran into a problem it had never faced before: It ran out of cash.

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The problem wasn't a lack of clients – the firm was working on multiple projects at different levels of completion.

But when payment for three large projects wasn't received on time, his company went into the red.

Mr. Nicholson was forced to use his line of credit for several months. With an interest rate of 5.7 per cent, he ended up shelling out nearly $20,000 in interest.

Several unusual incidents spurred the cash-flow shortage, including a delayed project and another where his firm underestimated the costs, but Mr. Nicholson says clients paying late is a constant problem.

Some don't understand that he needs to pay his suppliers and contractors quickly to keep projects moving forward; other clients are waiting for bank appraisals and paperwork to access funds.

The situation is stressful for Mr. Nicholson. He must juggle money to pay his bills, and he also has less money on hand to fuel his company's expansion.

Mr. Nicholson has managed to pay off the line of credit, but he wants to prevent this situation from happening again. His contracts with clients specify timelines for payment and interest on unpaid bills, but Mr. Nicholson has generally been reluctant to "get legal" for fear of damaging relationships.

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He's wondering, however, whether he should consider new tactics, such as sending follow-up notices to bills, enforcing interest charges on late payments or discussing delayed payments with clients early in the process.

"If I had to look back at my experience, I would say I was not aggressive enough in billing clients and trying to collect money from them," says Mr. Nicholson.

We asked Andrew Zakharia, a chartered accountant and founder of Toronto-based AZ Accounting Firm, how he could resolve the situation.

Expert advice

While Mr. Zakharia says the interest rate Mr. Nicholson is paying on his line of credit is good, he thinks a few simple strategies could help the home builder avoid using it again. "It all comes down to being more pro-active than reactive," Mr. Zakharia says.

First off, he advises Mr. Nicholson to set up his accounting software to send automated reminders to clients. The e-mails, sent from the company's accounting department rather than his own account, will remind clients when bills are coming due and update them every five or 10 days when bills remain unpaid.

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Meanwhile, his project-management software should be used to closely track all project costs and staff hours, giving Mr. Nicholson an early warning about potential cost overruns.

Mr. Zakharia suggests offering clients discounts for early payment – for example, 2 per cent if they pay within 15 days. Interest could be applied to accounts unpaid after 30 days, along with e-mails notifying the client that interest is about to start accruing. Further e-mails showing the amount of interest owing could prompt the client to phone Mr. Nicholson, who could then offer to waive the charge if payment is sent promptly.

While that might work for clients who have the money, another approach is needed to deal with those awaiting bank financing. Mr. Zakharia suggests Mr. Nicholson screen for clients who will be likely to experience delays in financing at the onset of the deal and price it into the job.

"He has to think of himself as a bank," says Mr. Zakharia.

"The person who says, 'I'm relying on money from a third person,' that's someone who is going to take longer to pay, and he needs to price it accordingly."

The way the contract is set up could also help. Instead of four milestones requiring clients pay 25 per cent of the total cost, eight milestones of 12.5 per cent might be easier for clients to handle.

In regards to Mr. Nicholson's fears about negatively affecting client relationships with aggressive billing, Mr. Zakharia says the key is setting expectations when you're first discussing a potential project. "Discuss what your process and procedures are right up front and be very open and honest about it. You're not gonna lose a customer if you set expectations at the onset."

Derek Nicholson Inc. by the numbers

May

Beginning cash balance: -$15,947

Expenses: $527,488

Revenue received (seven clients): $525,773

Revenue unpaid (three clients): $327,725

Ending cash balance: -$17,662

June

Beginning cash balance: -$17,662

Expenses: $641,620

Revenue received (eight clients) $685,350

Revenue unpaid (four clients) $394,465

Ending cash balance $26,068

July

Beginning cash balance $26,068

Expenses $438,559

Revenue received (nine clients) $673,855

Revenue unpaid (three clients) $221,664

Ending cash balance $261,364

Expenses consist of wages, office expenses and payment to suppliers and subtrades.

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