The topic for this month's discussion may seem elementary but actually is much more complex: what's the best way to get paid for your remodeling services? Our participants, Lynne and Jeff, give some valuable insight as to how they manage their payment schedule.
Tom: Jeff, I'm going to start with you. We'll take the typical job that you're saying is design/build. This could be a kitchen or bath, a big lower-level remodel or room addition. How do you get paid by your customers? How is the payment schedule structured?
Jeff: Probably 50 percent of our jobs are either designed in-house or through one of two to three third-party architects/designers who we routinely work with. The other situation of course would be the client coming to us with plans in-hand or at least with some variation of a plan already in hand with some degree of being complete. Depending on that, we would execute either a professional services agreement for a job, where either the plans weren't already complete or needed some detailing or what have you, or a professional design agreement, which is essentially the same document. What we would do, typically, is on the order of anywhere from $1,500 to $5,000, depending on the scope and complexity of the job. The design agreement is designed to do two things: it's to get us the money upfront for the design, estimating, research, development of specifications, etc.; it's also to get the customer to commit to us in some way financially so we have a commitment from them and we're not out there spinning our wheels.
Tom: Touch upon the highlights on how it's set up once this job is design/build and you have a professional design service agreement. How do you structure your payment?
Jeff: The execution, we call it a start up payment. As part of our contract there is an attachment that is a hybrid document. It's actually a production schedule as well as a draw schedule. The draws are shown as key milestones on that schedule. That is given to the customer at a very early stage. We have a draft production schedule that goes out very early on that indicates about what it will cost and about how long we think it will take. They know early on. Once they sign the contract, we finalize the draw schedule and the production schedule and dates. The dates vary; if there's a foundation involved we have a different draw in there. Typically, it will be: a start up draw at the top of execution; a foundation draw at the completion of slab; a rough-in or pre-drywall after all mechanical, electrical and plumbing inspections are done; then a trim draw and a final draw. The difference would be like in a kitchen and bath; if there is no foundation, it would boil down to four: start up, rough-in, trim and final.
Tom: Lynne, let's talk about what you've found to work as far as your payment schedule structure.
|Lynne Stephenson, Co-owner
Lynne: I would say our payment schedule is atypical of the industry. We do not do progress payments or payments based on a percentage of completion. We do a projected job schedule early on. When we actually have a definitive start date the client has already seen the payment schedule. That payment schedule is essentially based on payments for the project development procedure that we go through. That's based on 7 percent of the projected budget for the project. That's the first payment that appears on the payment schedule. The second thing, if it's a kitchen, bathroom, or anything that involves cabinetry, the cabinets are paid for in full. There may be another payment on there that shows payment for special order materials. All those things would be generally collected prior to the start of the job. Then, we take as many weeks as the job is going to take — say it's a kitchen that we will do in six weeks — we have a start payment, a payment that is dated for each week of the project and then a final payment, called a completion payment, which is generally 5 percent of the job. We're looking at essential completion, and we essentially have been paid for the job, with that 5 percent outstanding for anything that needs to be finished at that point.
Tom: You're saying that what you do basically is set out a project. Before you design it, do you set a projected price, and is that what the 7 percent is based on?
Lynne: We'll look at a project and, because of the experience that we have, we know when we do a particular project that someone is talking to us about, we can basically say the project will be between X number of dollars and X number of dollars. We'll give them a range. They will say they "want to target this budget," — say it's a $100,000 budget. That's what we'll base the project development agreement upon, and it would be 7 percent of that $100,000, which is our good faith money.
Tom: $7,000, and you really haven't designed anything yet.
Lynne: I haven't done anything.
Tom: What you've done is made a scientific guess on how much you think the project will cost. Basically you're getting a budget from the customer. Based on your $100,000 example, you would charge them $7,000.
Lynne: Correct. That's for the design of the project, going through the entire selection process with them, and also getting to a final budget. Then we're ready to pull the permits and start the work.
Tom: Then you set up $93,000, and you think that project is going to take about how long, just for example?
Lynne: Let's make it up that it's an eight week project.
Tom: You'd take that $93,000, and divide it by 8, is that right?
Lynne: My cabinet number is going to come off that as well. They're going to pay me up front for the cabinets that I'm going to make.
Tom: Let's say the up-front for the cabinets would be $20,000, is that a fun one to make up?
Lynne: That's perfect.
Tom: You're left with about $75,000 to $80,000.
Tom: $73,000 to be specific on that. And then you divide that by the eight weeks?
Lynne: When I look at it, I take the $73,000 and work backwards.
I only want to be out 5 percent at the end of this payment schedule. Actually, I determine 5 percent of the $73,000, and that is my completion payment. Then I take the eight weeks of the job and make it into nine payments. So I get a start payment and then a payment at the end of the first week. We don't make them even payments. We just make them differing amounts, enough so the client can keep track of which payment it is.
Tom: So, it's not $8,300 every payment?
Lynne: It's too confusing.
Tom: It could be off a little bit.
Lynne: Yes. You go up a little at the beginning, and down a little bit at the end. It keeps the money even. We're working there every day. They're just paying us every week. We're not worried about whether the drywall is on or if there's rain and we can't get the foundation in, etc. We'll adjust the payment schedule if there's a glitch. A lot of time, we're actually ahead of our payment schedule. We tend to make that payment schedule in the beginning longer than we think the actual work will take. Then, we'll go through and adjust it.
Tom: Interesting. To follow up on that, because that is atypical of what I've heard, which is fine, let me ask you this because we've had this happen to us. There's a room addition, and you're waiting for some special order items, and the trade contractor doesn't get on there, or something happens and you don't even work on it. No one is on the job for a week. Has that ever happened?
Lynne: No. Maybe a day or two. Generally, the way our jobs are set up there are contingents. We can do something else on the job.
Tom: But if it rains, and you get wiped out for a whole week.
Lynne: Then you adjust your payment schedule. You don't get a payment that week.
Tom: So you'd move it back a week or whatever.
Lynne: Yes. And most of the clients we've dealt with have really loved the payment schedule. They feel like the money flows evenly in both directions. We can adjust the payment schedules or adjust the work schedules. It's very predictable in terms of cash flow for the company. We've had very good responses from people — even architects who we've worked for personally in their own homes. They look at the payment schedule and think it's odd. Then they look at it again, start doing percentages and some of them have even started working with it on their own.
Tom: Jeff, it sounds to me like you have a little bit up front and you set them up with a start-up payment. Then, based on a production schedule you have four to five draws: the start-up, of course, and after that the foundation and drywall and trim draw and the final draw. Have you changed the way you structure your payments at any time during the life of your business. In other words, have you ever done it any differently? If so, why and what effect did it have? Have you ever changed the way you've structured your payments?
Jeff: Yes, we have. As a relatively young company, we've gone through a couple different approaches to this. Probably the biggest influence on our decision to be where we are now has been a result of CGR classes, continuing education classes and Remodeler's 20 group — just having the benefit of being around professionals like Lynne. You can collaborate; I've learned a lot from Lynne about how she's doing things.
Tom: How did you do it before? What effect did it have on you?
|Jeff Hunt, Owner
Heritage Construction Services
Jeff: As far as doing it before, we used to, because we now keep our books in QuickBooks Contractor Edition, we used to just do a weekly progress update consistently. We'd give people invoices. We'd get into squabbles with people and disputes over an item on the estimate and then all of a sudden they want to argue about the cost of one individual item. After getting your teeth kicked in a few times on that, we decided we're not going to show any more line items on it — we're just going to come up with a very simplified draw schedule that's based on some milestones, based on completion of certain items, and we'll lay it out up front. Initially, I had some reluctance to do it. I felt like we were asking for a 20–25 percent start-up payment and we would hear horror stories from the industry about contractors walking off the job with the payment and going to Mexico or whatever. We just take the time during the sales process to really impress upon the client our level of professionalism in the things that we do and the processes that we have in place to execute the job properly — the safeguards that we have and the reasons why. You want a kitchen or bath; you've got a lot of expensive fixtures and cabinets, as Lynne points out, to order up front. A lot of that money goes — even on a room addition, you've got a lot of money going into the ground right up front. We educate the consumer on why we do it that way as opposed to a weekly draw or a bi-weekly draw or some other calendar based type of draw schedule. Does that answer the question? The only other way we've done it is to go off an invoice per se that we'll bill you in a week or two. Being young we've kind of gravitated into this method that seems to be working now for the last year, year and a half.
Tom: Yes. Our experience with the ones where they show an itemized invoice, in every case, most folks who do that have a difficult time making proper markups. They have to get into the labor side and also by "smoke and mirrors," and the customer is too smart for that. Lynne, have you had this system all 10 years or have you gradually found this to work. In the lifetime of the company, have you had any other structure that you used?
Lynne: Actually, Mark fell into remodeling almost by accident. When he was doing the first job, we were working for someone who was very wealthy, and spent a lot of time out of town. He was actually the one who came up with payment this way while Mark was doing a fairly large job for him. He used Check-Free at the time, which is electronic banking. He just sent Mark a check every week. It was put into the system before he left town. The money was there when you needed things and it was very predictable for the client. It was easy to project all the payments up front. That's actually how we got the idea to do this. When Mark did the first job, and it was a significantly large job for another client, he just suggested that as a payment schedule. The client embraced it because the money was predictable. They knew what they were going to pay, what week — they could transfer the funds. We've done jobs actually where we were paid by the bank, and they used our payment schedule.
Tom: OK. How do you handle getting paid for change orders? Now, we call them Additional Work Authorizations, just because we don't like the word "change." Whatever you call it, it's still additional work that the client has authorized. Some are small — "I want you to paint this room" — or larger — "I want to add a deck" or "I want crown molding throughout the house" — but it's an order outside the original contract. How do you handle that, Lynne? How do you handle getting paid for the change orders?
Lynne: First of all, we call them Additional Work Orders as well. There's something about "change" for people that's difficult to accept. We try and be very thorough up front that if there is a possibility that anything could be added we want to get that into the initial contract. Once we do an additional work order, it's very hard to get your markup and for the client to feel it's justified to pay what you're going to have to charge them. We avoid that if we can, but if the client wants something additional done, then our lead carpenters in the field have forms that are printed in triplicate. They can actually write out the work order in the field, they know what the markup is. They have the client sign it and they get paid at the time the client signs the work order. We don't typically do any additional work until we actually have been paid in full for it.
Tom: Jeff, how do you do change orders, and how do you get paid for them?
Jeff: We do call them change orders. The way our contracts are written, we have an 11-page contract. That contract has a very specific paragraph about change orders. What we would do whether it's an additive or deductive change order. In either case, the contract clearly states that in the event of a change order, the money for that change order is due at the time the change order is executed. We don't proceed with that particular item of work until that change order has been signed off by both us and the client.
Tom: And paid — or signed off?
Jeff: Paid off and signed.
Tom: So, you require them to pay 100 percent of the change order up front before you make the change.
Jeff: Yes. When we sign the contract, Tom, we go through that paragraph specifically with them. There are a couple of things we point out, early in the process, in our proposal template, there is a copy of our blank contract. When they see that contract from the early stages of the sales process, they understand what our terms are. One of the terms we specifically talk about is change orders. And as Lynne pointed out, we try to explain to the client that we want to go to great lengths to bring up all the things: "Mr. & Mrs. client, in our experience, we've typically seen customers like you in this situation who ask us about the availability and wisdom of doing X, Y and Z. We're only bringing this up, Mr. & Mrs. Client; we're not trying to oversell; we don't really care if you do or don't. What we don't want to have happen is get six weeks into the job and have us look like we don't know what we're doing because you went into some design studio and see something and think 'Well, why didn't Heritage think of that?.' We're going to bring up some things during this proposal and estimate development process, Mr. & Mrs. Client, just suggestions. We want to minimize change orders. As soon as we get to the job; you want us there and gone. And the feeling is mutual. We want to be gone; we don't want to be on your job longer than we projected, it costs us money. Change orders disrupt our schedule and your schedule, and we want to minimize those. But, in the event of a change, there will be not only the cost of the materials and labor in question and the normal markup of those items. In addition to that, our contract allows us a 10 percent administrative fee on the price of the change order including markup, for administrative purposes. We typically don't use that 10 percent fee. It's there, but we don't want you to think we're going to beat you in the head with it every turn of the wheel. It's there for customers who get unruly. It happens from time to time — you're probably not one of those. We have had it happen, where a job gets into 40 or 50 change orders and we have an administrative nightmare on our hands just in keeping up with the changes. We have to be paid a premium over and above our standard markup for that". They know that — from the very early phases of the job. No. 1 we're going to try to minimize change orders and work with them to not have change orders. Let's be realistic. There hasn't been a job done yet that hasn't had at least a couple of small change orders. But they are paid for at the time the change order is executed.
Tom: Jeff, do you itemize your change orders?
Jeff: No, we don't. I just give them a final number that the change is going to be $2,700.42.
Continuation of the discussion
Tom: I will also share with you that we say that we have a fee for a change order, but we don't pay for it. It's ambiguous. We tell them we have this $39 or $59 charge but tell them we really don't like to use it. It's been our experience that when we say we really don't like to use it that for ever and ever we were never able to use it.
Lynne: May I address that? We used to have that in our contract. We took it out, that administrative charge. We don't itemize a change order or an additional work order. The reason we took out the mention of the administrative fee. You can charge it if you want to. You can add it into whatever you say the additional work is. As soon as you say that you're charging an extra fee, it starts up a confrontational situation that I don't like to be in. Then they start to question everything else. "Well, how much are you charging me for this, and how much for that." I'm real up-front about what my overhead charge is for the contract. We've never had a confrontational issue with a client once we took that little caveat out of the contract. They can do the work order, or they cannot do the work order. But, I'm not going to argue with someone about why I'm charging them a $100 or $200 fee or anything like that. We took it out.
Tom: You don't say "take it or leave it," but that's what's implied. Lynne, lets talk about what I call the cousin of the change order: allowances. You took the liberty of sending me some of your forms. I have not gone through them word for word but stopped at a couple of things, Lynne, on yours. You do use allowances.
Lynne: I do.
Tom: How do you get paid for overages of allowances, and how do you maintain margins on the overage?
Lynne: In the contract it does say that for anything above the allowance I will charge an additional 20 percent handling fee. I don't get questioned on that one because they're going to get that in their final proposal.
Tom: Nobody really balks about the 20 percent, do they?
Lynne: No. They consider that an industry standard.
Tom: You deal on higher gross margins, I would suspect.
Lynne: Yes. I do.
Tom: So, how do you do the overages? This is a big thing.
Lynne: It is. I never low-ball a contract. I would prefer to be honest with what I think people are going to spend. To low- ball a contract to get it and then have to get back to someone and say, "Your $20,000 bathroom is really going to be $40,000." But I'm never going to get the markup. I'd rather say upfront "This is going to be $40,000" and have legitimate allowances in there. I know I'm asking the question: "Are you going to put in a cast iron tub?" "Do you expect to have this tiled?" Ask all those questions so that you give the client an honest, realistic estimate of an allowance. In my initial proposal, I will tie it to a specific item. I put in that we're putting in a Kohler Devonshire tub — it's cast iron, it's white. I specify it and then I attach a price to it.
Tom: Which is the retail price?
Lynne: No. Because nobody pays the retail price anymore. These clients go online; I have to be a little more realistic.
Tom: The way it used to be, you didn't have to. You could show them the retail book where you were going to get 40 percent off or 20 or 10 off. Today, you can't do that.
Lynne: I will show the tax, I will show the freight, and I'll include all those things and I'll say so. If I'm going to pay a $75 freight fee for a particular item, I will actually put that into my contract.
Tom: Do you bid against people one-on-one on very many jobs, Lynne?
Lynne: Never. Well, I won't say never.
Tom: I understand; but not very often?
Lynne: Correct. We don't typically bid. When a call comes in, we all have the sheets on our desks where we'll talk to the client and bond with them. When they've told us what their project is, we'll say that our clients — not that you have to spend this — but our clients typically spend between $30,000 and $40,000 for a whole bathroom. If on the other end of the phone they say, "Well, that's what we thought we were going to spend," then we continue from there. We typically do not have to bid.
Tom: Jeff, do you have that luxury?
Jeff: As a young company we joke we were going to name our company Anything for A Buck.com. About 45–50 percent of our jobs are non-bid situations, and the other ones are. As we develop our reputation and acquire some awards and show people, they're more relaxed. They'll take our word for it and not go out and get three or four bids. Because of the commercial end of things that I grew up around, you don't do anything without competitive bids, or hardly. We've learned how to educate consumers on the value of hiring a professional — someone who carries national certifications like Lynne and I do versus "Joe pick-up truck remodeler and my brother-in-law's yard guy's cousin does remodeling and he'll give us a price, too." It's not even an apples-to-apples comparison. We probably bid, I'd say, about half the jobs, typically. We are in a little bit of a luxury now after developing a little backlog in the last year or two. When people call in and we find out that there will be four other bidders, the only way in which I'd even engage in that situation is if I at least know the bidders are Michael Strong or Dan Bawden, somebody I know who's qualified and on a level playing field. I'm not going to get into a bidding war with "Joe's pick-up truck Remodelers Inc." or whatever.
Tom: There's a caveat to that. That's why I'm asking about the competition. In the real world out there that has the competition, allowances can be dangerous. If you put in too much, your price is higher. Sometimes, the customer just looks at the bottom dollar and says, "Wait a minute, you're way too high!" On the other hand, if you're too low on allowances, you may have a good bottom dollar total amount, but when it comes to reality, you have not put enough in there for that. That's why, Lynne, I jumped at the chance, and I'll do this in the summary, probably. You are using very specific model numbers and not generalities. You're not saying, "We're going to install a cast iron tub;" you're saying, "We're going to install a specific brand name and model number," so you have a price point that you can get at. At best, you can get the cost; product, tax, freight, delivery, whatever the case may be. Your labor may be the same or may vary on a few different ones if there is a little bit more labor, but for the most part it's just the product. At that particular point, what you're suggesting is that you can get 20 percent of that but you wouldn't mark it up, say, 50–60 percent.
Lynne: It's probably not that clear cut in the course of things. When we're giving them those allowances, we don't have a final proposal. We don't have other things built into it. We're not line-item oriented in the total proposal where they could pick out whether I was marking that up 40 percent or 20 percent.
Tom: Jeff, what do you get on your allowances? If you have a $4,000 allowance in there for bath fixtures and it ran $6,000, how do you get paid that additional?
Jeff: We would write a change order; same process. We work pretty hard to get down to where the only allowance items typically are maybe just going to be a tile selection or a carpet selection. We know, based on the location of the property in the neighborhood, the value of the home and talking to people, and kind of get a sense of where they're going to be allowance wise. If we've got a $3 per foot porcelain person or a $6 per foot travertine person or whatever we've got, we'll try to take every opportunity to nail down specific selections.
Tom: You have an allowance for tile or plumbing. How do you get paid? What does your company do to get paid for the overage of that?
Jeff: It's over or under. You go either way.
Tom: Do you put any markup on that? My example was: you've got a $4,000 allowance and the product is $6,000 cost, all over cost. You've allowed $4,000 and now they've spent $6,000. What do you do with that $2,000 additional?
Jeff: It's marked up the same way. We don't put a bottom line markup on a job. We markup every single line item with a blanket percentage. Every now and then there are some tweaks to that. Typically there's a standard markup on every single item of labor, material, permits, whatever it is, all the way down to trash hauling. It's no different for a change order. Whatever that amount was for that job, the markup is 50 percent, 60 percent, it goes to the change order in the additive or deductive fashion. If I have $2,000 worth of tile budgeted and I've got my profit at a 50 percent markup or a 33 percent gross margin on that tile, the material and labor and someone spent $3,000, then the bottom line when I run my job cost report, the bottom line material price on that job, if I don't put that markup on it, then I've missed my 33 percent gross margin. I won't say we've had some creative ways: if the customer is going to pay for a certain element of the job outside of our contract, we've allowed them to do that from time to time to keep it in budget. But, I explain to them that if it runs through my system, runs through my books, every dollar gets marked up the exact same way.
Tom: And they know that that markup could be as much as 50 percent. If they have an allowance of $4,000 and you have that marked up somewhere else, but that's the cost they're given, and they spend $6,000, that's $2,000 additional over your allowance, then you're going to write them an invoice or ask them to pay approximately $3,000 for that. Is that correct?
Tom: If they know the invoice is $6,000 and they know it was $4,000 and you're going to charge $1,000 because they just went and picked out one color of tile or one style of tile different than another, no additional labor, just material. You've never had a problem with that?
Jeff: At that point in the discussion, I explain that everything in the job has a standard markup on it. I don't necessarily talk 50–60 percent, I tend to talk in terms of gross profit margin.
Tom: We were able to do that, but now what we find is they can go online to get their information.
Lynne: We never really get to that point. We're making selections with the client all the way along. We're not getting to the point where there's a final budget and they've gone over their allowance. We're taking that and we adjust. We give several proposals all the way through. It never really gets specified. People will say to me, "Am I OK with this allowance?" For a shower, I might put in $1,500 for a tile allowance, or tub surround. With my cost, that's a pretty substantial allowance.
Tom: Is that your cost or is that markup?
Lynne: Even at my cost that is allowing for a markup.
Jeff: If I could just interject. I've got a change order right here in front of me on a master suite that we're just wrapping up. We gave the customer an allowance of $1,100 for a shower tile and tub, and she knew that. She went out and picked out some tile and said "Am I going to be able to budget?" I said, "A little bit. Don't know exactly but probably in the order of $700 to $800." So the change order No. 3 shows the day it was requested, and the subject is "shower tile"; detail says the tile selection was in excess of contractual allowance — the tile supplier who is the vendor; no scheduled delay. The cost change was $792. That includes our markup and everything. I gave them the change order and said, "The payment is $792." He said "Great, where do I sign?"
Lynne: That's what I've found, too. If the client has gone over the allowance and you tell them what it is, they want it! So they will pay whatever you tell them it is. They're not asking what the percentage of markup is. They're not asking you anything like that.
Jeff: It's something like a granite or tile that they're really in love with.
Lynne: If it's less than $1,000 they'll say, "Oh, I've spent so much, I want what I want!"
Jeff: Exactly. "I want what I want!"
Lynne: We don't get to the point where we're giving a final contract and we're changing an allowance because all the selections have been made. Our additional work orders are simply for something that is added. It's not for a change in the allowance. It's not, "While you're here, could you put crown molding in the kid's bedroom?"
Tom: Yes, I understand. That's an extra. That's a change order.
Lynne: The piece that I sent you was actually just changes to allowances in the previous contract. It just went up and down. Typically, I'll say, "OK, you went under on this allowance minus so many dollars and then up on this one."
Tom: One more question. Jeff, what if a customer delays a progress payment?
Jeff: I've only really had that happen once or twice. In one instance it was probably related to a debate over whether a list of items were actually complete. In the other case, we had a guy that, I hate to say it, but as long as Lynne's been in business she's probably run into it, and probably you have too. We had a guy that was trying to roll us over a barrel and he had no justification. We actually notified him legally and properly that he was in breach of contract for non-payment. He had 10 days to resolve that or we would cancel the contract as our right. And we did. We cancelled it and walked off the job. Let me add this; on our final payment on that hybrid draw production schedule, final payment is shown as the second to last item. Contractually, final payment is due at substantial completion, defined as the addition, or whatever — the remodeled project is suitable for use for which it was intended. Everything has been installed, it does not include punch list. We do not even make a punch list until we receive final payment, and we explain that to customers upfront. The final payment is due and then we will begin the punch list. We typically have two to three days in the schedule, and the very last schedule item says "punch list items." They understand upfront that we get final payment because we've got vendors to pay, and we only have good relationships with suppliers and vendors because we pay our people on time or early. Substantial completion means final payment. We've gotten beaten in the head with that with the punch list that never ends.
Tom: We've can be up front with that, too. But if we're not finished with the job in the customer's eyes, we have a hard time getting final payment. That's where it looks to me that you might be developing a little conflict there in the end.
Jeff: We're very fair about it. We don't come up and ask with the final draw in hand until we're down to the point that there's just minor cosmetic touch ups, paint touch ups, scrape some paint off a window, touch up a door knob, tweak a cabinet hinge, whatever. We don't show up and ask for that payment until we know that we are truly substantially complete. We don't try to jump the gun there. They know that when we come in we're usually down to every last piece of flooring, trim, paint, fixtures, everything is hooked up, turned on. That's when we show up and say, "We're ready for final draw."
Tom: Lynne, what do you do when a customer delays a progress payment? Did that ever happen?
Lynne: It has happened, but generally it's just an oversight. Because our payment schedule is dated, and they tend to pay on a certain day of the week, it might be a Monday or a Friday depending on when we started. It might be a Thursday. They just have a habit; they know to leave the check on Thursday morning.
Tom: They leave it.
Lynne: Yes. We run an open company. If I can't trust the guy to bring me the check, I can't trust him to make decisions that are costing thousands and thousands of dollars.
Tom: I applaud you for that! Let's touch on final punch list and final payment deal.
Lynne: We work with zero punch list. Two weeks before the end of the job the guys are going through the job with the client. They are looking at zero punch list. That 5 percent is really just good faith. Because I ask for good faith money up front, it's important that I do a reciprocal thing. I have that 5 percent completion at the end. It's not going to hurt me if I have to walk away from it. I never really had to. Generally, it's that last day, we're walking out the door with no punch list. They're paying us our final payment and our completion payment. Also the completion payment may be paid because we went back for an hour on a particular day because something needed to be finished or something like that.
Tom: One final question and we'll get to the summary. Lynne, what is the worst situation you've ever had regarding getting paid for a job?
Lynne: The worst one was when a woman agreed to a substantial upgrade of a bathroom cabinet. It was a custom cabinet and we designed it. The budget was $4,000. She went to a $9,000 cabinet. I sat there, an interior designer was there, and she agreed to it. I went to the lead carpenter and said, "Write up the work order for this and get her to sign it." He didn't do it. At the end, the client came back and said, "My wife didn't agree to that. You don't have anything signed." And he didn't pay. And he was right. That lead carpenter no longer works for me. That was a good lesson to me, because my expectation is that, for the most part, people want to pay you. I always look at things that way. People want to pay me for what I do. The woman kept saying to me how honest she was! When someone tells you how honest they are that many times, well, they're telling you something you need to know!
Tom: Jeff, tell us the worst situation you've ever had regarding getting paid for a job.
Jeff: It's a situation I mentioned earlier. We had — primarily due to lack of decision on the customer's standpoint — some unfinished items. There was a brick that needed to be matched, and there was no brick that matched exactly. We were down to two or three choices to try and make it match. He wouldn't make a decision and then went off on tangents changing other things along the way. "Let's move this," and "Do this differently." There were a bunch of change orders, and we documented and signed them all. At that point, we were presenting a draw according to our schedule that he had. He said, "My wife's got the checkbook today, and I'll have to wait until she gets home." We kept getting excuses, "I need to look through these change orders and reconcile them with my wife and make sure we're in agreement with everything here before we sign off on these." One excuse after the other. We finally said "We're way overdue here, and we've had some schedule delays that were largely your fault, and some that were our fault, and we tried in good faith to have it work and get caught up. We've now caught up and on track and we're waiting for you on payment and decisions. We need payment, and we're going to be in breach of contract here." The funny thing was, the guy was an attorney. I don't think the guy thought I read my own contract documents very well, or thought I'd fight him on it. We've got a legal council that is the best in the business. The council said, "send them this letter, certified mail, that he's in breach of contract if you don't receive payment in 10 days," and we did, and avoided a legal battle. We never went to court over it. But the guy ended up owing us $5,500 that we had to walk away from. But his job isn't finished, either. I hope he used that money to get it done. I don't know the rationale.
Tom: I'm surprised that that happened. We had a lawyer and his whole point was his time was free. We actually had a lawyer chisel us out of about the same amount you talked about.
Let me summarize some of this. I'm going to ask you what advice you would give to a struggling company having problems with cash flow and problems with collecting money. Give some advice as to what they should do.
To summarize — both of you are painfully honest, incidentally, on what you do an how you do it. You are also very fortunate. For our purposes, especially for design/build, we talked about getting an amount down, estimating how much the cost of the project would be based on your experience. Lynne, you get 7 percent of that which includes the design, selection and final budget. Once you get the final budget, you set it up. You get paid for all special orders up front and get your cost. So, you're going to be covered. If for some reason they don't want to complete it, at least you have your cost on custom cabinets and special orders. You take out your 5 percent for the end in the reverse good faith. You divide that up by how ever long it's going to take you per week. You get a payment about every week that is very interesting. It's good to see that you are actually a little flexible. It's not my way or the highway.
Jeff, yours is the modified way of payment, which had four or five, depending on the job. You have a start up payment when you start the job after your retainage for the design, if you do that. If it's not design, you have a start up payment. You do it in stages. It's foundation, completion of foundation and then after drywall. If you could get it before the task starts, at the start of drywall or trim, that's what you try to do, and I believe that's what you added.
Jeff: I didn't fully explain that, but you're right. We have a foundation draw that's pretty clear cut. If it's a drywall draw, it's just the beginning of drywall, not when the beginning or end is.
Tom: We talked about whether you've ever changed structures. Lynne was fortunate enough that she had a very clairvoyant customer at the beginning with a lot of money and helped them set up a way to set up the payment schedule. You had a good foundation when you started out. That's one of the reasons you ended up with the structure that you did. Jeff, your thought is that, thanks to some people you network with, and the education that you've continued to do because of your certifications and things. You used to do it with invoices. Typically with a small remodeler or beginning remodeler, they use the invoice system to itemize. They think it makes them look honest. They add a little markup on it. They show the invoices, and that's the start of disaster. That's what happened to you. They can argue about the line item. You're dealing with a specific amount and you don't deal with the details.
Jeff: Exactly. To add one final note to that, one reason we went to the four and five draw type of system was we ran into many third party lenders that we were having to deal with. That was what they had. "We'll give you five draws, but if you do an extra one it's going to cost someone some money." And, OK we'll do it if five draws. We just had some jobs back to back that worked. We kind of stuck with it. That was the actual genesis of that whole process; a third party financer who didn't allow for more than a set amount of draws.
Tom: On change orders, which we call AWAs, Additional Work Authorizations. Lynne calls them Additional Work Orders and, because Jeff is from Texas, he just calls them Change Orders. There's no question that you've got to be very thorough up front. You want to be specific. Jeff, in your case it was an 11-page contract. You don't like change orders, you tell them it disrupts the schedule. You indicated that inevitably in this business, they happen. In both your cases, the work order is paid in full and signed before the material is ordered and before work is done. On that I applaud both of you. I don't think that's done in mainstream remodeling. We say that we collect it at the next billing. I like your method. I think for our readers and listeners if they could take a small chapter out of your book, it sure would be to be very frank and specific and diligent on being paid before the change order is started.
We did talk about an administration fee that is sometimes charged. We talked about the administration fee and tell the people that we really don't like to use it. As Jeff mentioned, you tell a customer "Unless you become a pain — and then I'm going to charge you 10 percent!"
Jeff: I didn't use pain, it was "unruly."
Tom: Unruly, I can't use it here in Illinois but I will pass it on to our salesmen. Lynne had an administrative change and took it out because it set up a little confrontation. She thought it would be better if she dealt with the big picture as opposed to the little one. I applaud you for that.
On allowances, how do you get paid? In Texas they're brutally honest and say, "It is what it is" on allowances when you go over. You put a markup on every one of them. If it's put in the right way, and don't rub the customer's nose in the fact that you've got a large markup. If you have an allowance, you give them a ballpark, and it falls within that, you don't have any real problems. The key to it is to be very specific on what that allowance is going to be. It is probably easier to get overages on allowances if you're not in a competitive situation. In Lynne's case, what they do is set up allowances but before the final price is completed on the design build, they work those allowances out. Itemizing the specific item, manufacturer and item number, as opposed to just a generality of what the product would be. If the customer delays progress payments — because that happens in this business — Lynne doesn't have a lot of problems with it. They're dated, and it's a specific day of the week, and she's very flexible with the fact that if they have to delay a payment they delay a payment, but it's by mutual consent. With Jeff, the delay of payment, you have a contract that lets you actually walk off the job. If they take anything away from this, I think that's very good. The punch list item on the final payment, you're very specific on getting paid on everything there is, and then we'll do the punch list. We are sometimes drawn into the punch list with the final payment hanging over our heads. If we don't get out there very promptly and get that done, then the five-item punch list that you complete three items on is now a seven item punch list and you complete five items, then it becomes a nine-item list. You're at the mercy of that. Jeff has solved that by before doing the five item punch list I get paid, and that's how we do it. If you want to keep $1,000 or $1,500 back you have some flexibility in that area.
Jeff: We do. And I also explained that we share very much of our reputation in our community and our marketplace. Once we have final payment, it doesn't bother us to come back if they forgot to tell us something about the punch list. We're not going to ignore it. We're young and protective of our reputation. If someone has a problem, I'm going to go and take care of it. But, I'm only going to take care of it if I've gotten final payment.
Tom: People in Illinois have a different attitude than what you're dealing with. They think that you've got to get it 100 percent complete before they give that final payment.
Jeff: Just as you point out, we have a contract starting a kitchen and bath next Monday and the customer is in the commercial end of the business in industrial construction. He's used to retainage and so forth. He said, "Look, can we put something in there for a final, final payment just so I know we put $1,200 in there." I'm not going to walk away from $1,200. We're flexible.
Tom: Lynne has this thing solved. She works off a zero punch list. Two weeks before completion, she just makes everything done and does the punch list before, so that's not even an item. That probably is sound advice.
We talked about the worst situations. I loved it, Lynne, when you said it because we've had only two this year that I know of. We had a substantial upgrade and, in your case, the salesperson, lead carpenter or foreman, whoever it was, who was responsible for getting that change order signed didn't get it signed. What you've found is the same we have found. Anything that was initialed or signed or autographed by the customer was never a problem getting paid. Those that don't get signed cause problems. In Jeff's case, this guy who, I hope I never meet him, couldn't make decisions. You didn't force him to make decisions; he was an attorney anyway. Once it started to go wrong, everything went wrong. From a brick selection, he wanted everything changed and started with the excuses.
In summary, Jeff, and then Lynne, if you were going to give advice to a remodeler, not necessarily a start up remodeler, but someone who is struggling with getting paid that effects the cash flow, what would be your one bit of advice that would be of help?
Jeff: Lynne and I both have different systems and different methods of doing things. There's no right or wrong way to do it. It seems to me that you plug in to your resources: your local NARI or Remodelor's Council and your available education and experts, and Remodelers Advantage or Remodelers 20, and you interface with people and find out what people are doing and ask for help. You lock in and evolve a system and develop something that works for the way you manage your cash and manage your business. Be very procedural about it. Not rigid but something that is accountable and can be predictable and not a different system every time you have a contract. The value is in having a process and evolving that process that probably is always being tweaked. Try different things until you lock in what works and stick with it.
Tom: I like it — sound advice! Lynne, give the remodeling contractors some advice on how to get paid and keep their cash flow going so it doesn't become a burden.
Lynne: First of all, I agree with Jeff. If you're a young remodeler or an experienced remodeler, get involved with a professional organization — some group that you can go to and use as a resource. Ask these questions. People are very willing to share their experience. The first thing is, if you feel like you're an island, find a way not to be an island. The second thing is, as a former teacher, make things as easy for the client as possible — easy and predictable. Make sure that whatever system you use is really clear from the outset. How the payments will be structured and when they are going to be due. The client at the front end can plan how the money is going to be dispersed. You relationship is based on mutual trust. You both must feel comfortable with the other party.
Tom: Sound advice!