Cash flow is the hardest part about maintaining a successful contractor business. Payments come slowly from clients, which challenges meeting payroll, not to mention growth. To combat this problem, there are a number of monetary tools available, including invoice factoring. Factoring may start out a scary endeavor, but is honestly one of the smartest ways to grow a construction business.
What is Construction Factoring?
Construction factoring effectively closes the gap between the due of being paid from a general contractor on commercial jobs or a subcontractor billing a contractors. Factoring is a process in which businesses obtain cash for work already done. When factoring a construction invoice, a construction company assigns its invoice to the factor, and in exchange, the factoring company will wire cash to the construction company.
What Types of Contractors an Factor?
Both general contractors and subcontractors can factor their invoices. The question simply is “who are you billing?” If a GC or SC is billing a government or another business, then their invoices are factorable. So, while the GC who is building homes for private people cannot factor, the SC who is putting in the doors for all of the GC’s building project can factor.
How do you Factor Construction invoices?
First, you need a lender who really understands how construction works, and someone who can match you with them, which is the specialty of Outside the Box Capital. Normally, an invoice is send for work completed, it may take 30-60 days before the invoiced party will pay. Rather than waiting, and since the work was completed, a factor will buy the receivable due to you, and pay out 80-90% of the value of the invoice to you, the subcontractor, immediately, and the bill becomes the factor’s burden to collect. Once the general contractor (or whoever the invoiced client is) pays, the factor will pay the subcontractor that remaining 20-30% minus the factoring company’s fee.
Types of Construction Factoring
Generally all contracts of a specific job will be factored. Through contract factoring, cash will be provided in exchange for each progress payment. Generally, the rate that the factoring company charges will go down when a larger number of invoices are in play, as a volume discount. When utilized for the entire life of the contract, factoring construction invoices can assure steady cash flow for the duration of the job. Every time an invoice for a progress payment goes out, the construction company can get their hands on most of the cash faster. It acts as a very healthy credit facility, a line of credit. In fact, most people treat their credit lines like term loans, instead of paying them down as soon as they are billed, which increases fees. Factoring pays down the credit facility immediately upon payment, which allows for controlled growth of your business.
Why would Construction Companies Factor Their Invoices?
Construction payments come slowly. By factoring invoices, construction companies are able to obtain payment for most of their invoice up to 60 days earlier than they would without factoring, keeping payroll in check. Plus, as long as a subcontractor’s factoring company gets paid in full, the subcontractor will only lose a relatively small percentage of the invoice when it’s all said and done.
Get in a Bind With Payroll & Overhead
We mentioned it above – cash flow can be erratic in construction. Especially in construction, payments come slowly when work is completed. That means it’s often hard to keep cash reserves to pay payroll and overhead. Employees, rent, and other bills can’t be paid at the same irregular schedule that your customers make payments. Thus, by factoring construction invoices, a large portion of the outstanding invoice can be paid up front which might be enough to float payroll and overhead.
Want to Bid on Larger Jobs
Cash comes in at irregular intervals but goes out at a steady pace. However, without a credit facility in place, or cash on hand, it’s impossible to bid for a larger job. In combination with startup capital, a factor has access to all the capital they would need in order to gain new traction, and bid on bigger jobs. Since the margins can be slim in construction, it’s all about larger volume to have more money at the end of the day.
Want to Bid on More Jobs
Much like the above, when a contractor or sub wants to expand their business, that may require bidding on a larger number of jobs. However, bidding on more jobs also means working with companies beyond your normal credit box. By factoring construction invoices, slower payments can be controlled, and your new partners can even provide you with credit information to control which jobs you are willing to sign onto.
Want to Purchase New Equipment
When construction businesses need new equipment, whether it be to grow the business or to replace something broken, it takes cash. By simply selling invoices, versus larger all-encompassing credit facilities, you can purchase equipment with term loans over 60 months to keep cash-flow on reserve for working capital and profit.
Construction Invoice Factoring vs. Bank Loans
Why would a construction business factor invoices instead of going to the bank for a loan? If you’re reading this post, it’s likely that you tried and the bank rejected you, or you have maxed out. Cash flow is erratic, and it’s very common for owners of a construction business to have a sub-perfect credit history, and banks need decent to fantastic credit history. Plus, when dealing with a bank, there’s a lot of paperwork, red tape, and larger collateral needs.
Factors work with one collateral – your invoices. The credit history of the company who’s factoring their invoices is largely irrelevant, it’s the business credit history of the client who’s paying you that matters. As long as that customer isn’t a huge risk, especially if it’s a government invoice, a factor will likely buy from them.
Additionally, please read about Line of Credit vs Term Loan. Term loans are never the way to go when you need larger liquidity.
Can I Factor a Government Contract?
Yes and no. Factoring only is eligible for work that has already been done. However, there are lenders that lender on the simple fact that you have a contract and you need cash-flow to start the project. That’s not called factoring, it’s another mechanism, but it works in tandem with a factor beautifully.
Factoring a construction invoice can be a useful tool for a business in a bind. It might even be a long-term tool for some construction businesses to steady cash flow while growing the operation. This will be highlighted in another article.