Construction Invoice Factoring Guide
How to figure out if construction invoice factoring is a good choice for your business.
Construction Invoice Factoring & Construction Receivables Factoring
Under-estimated projects and over-budget jobs...buying expensive materials weeks before sending an invoice...permitting delays… Sound familiar?
If you work in the construction industry or run a small contracting business, these issues probably come up often.. Regardless of what type of construction you specialize in, whether it is flooring, demolition, electrical, roofing, HVAC, or something else, you know that every type of construction project involves estimating, budgeting, purchasing materials and equipment, and hiring skilled labor.
Especially for larger, more expensive projects, clients may sign an agreement, but won’t expect to pay for the entire job up front. This means you front large amounts of cash for the job costs until the work is completed, which could be months, or even years. If the job lasts multiple weeks, your construction company can sometimes run dangerously low on funds, or even be without operating capital for months, depending on how many concurrent projects and invoices you have.
Of course, no business can stay afloat without cash reserves for long. As a result, many construction companies rely on construction invoice factoring to obtain the cash necessary to perform day-to-day operations.
What is Construction Invoice Factoring?
Invoice factoring is a cash advance for your outstanding receivables. It is not a loan. Once approved for construction invoice factoring, your construction company get access to funds, typically within a few business days, for outstanding invoices.
With invoice factoring, construction companies are able to expedite cash flow, so they can begin the next phase in their projects or start a new project entirely.
Invoice factoring ensures that construction companies will be paid sooner instead of having to wait for customers to pay their invoices after the next milestone, or after project completion.
Who Uses Construction Invoice Factoring?
Invoice factoring is suitable for any type of construction company or independent contractor. Whether your specialty is landscaping, roofing, paving, site clean-up, or utilities, any contracting company that issues invoices with net terms between 15 to 90 days is eligible for invoice factoring.
Construction invoice factoring is also ideal for companies who may not qualify for other types of loans, or companies in need of funds faster than possible with a loan. If your company is faced with immediate expenses to cover and has a lot of high volume incoming invoices, then construction invoice factoring might make sense for you.
Funding Challenges Construction Companies Face
Why would construction companies need cash flow in the first place? Like any other business, construction businesses have operation costs of their own that usually non-negotiable, such as:
Payroll, for hanging on to your employees.
Equipment, tools and supplies, to keep work going in the office and in the field.
Office space, furniture, maintenance and renovations
Business insurance, to protect you in the case of accidents or disputes.
Sales and Marketing, for growing your business and keeping a steady stream of projects in your pipeline.
Legal fees, for assistance with business documents and contracts.
Utilities & rent, to keep your office comfortable and your lights on.
Fees for maintaining locally mandated certifications. For example, in the state of California, all contractors must be licensed by the California Contractors State License Board in order to bid on large projects. Getting certified and keeping your certifications up to date each year can cost hundreds of dollars.
Aside from these day to day concerns, savvy business owners often find that having some extra cash can help them stay ahead of the competition by funding faster business growth. For example, you might use your extra funds for things like:
Hiring new employees to complete jobs faster, or take on more jobs
Purchasing new equipment
Purchasing more vehicles
Expanding to a new location to serve more new clients
Marketing expenses, for attracting new clients
On top of all that, construction businesses also need to have extra capital to be prepared for situations like these:
Threat of getting sued - In the construction field, there is always the possibility of workers or even pedestrians getting hurt or near the construction site. Even if you obey all applicable laws and take all possible safety precautions, you could still become the target of a lawsuit.
Paying overtime hours - When projects grow bigger than their original scope, you’ll need some extra cash to support overtime pay for workers.
No job is guaranteed - The construction is competitive and an industry where clients will potentially jump to another contractor if they provide a better deal.
Unrealistic deadlines - Some clients will ask for highly optimistic deadlines. As a construction business owner, you’re always planning for the possibility of projects that drag on longer than expected and cost more than estimated. Extra cash reduces the pain of these situations by reducing your overall business cash flow volatility.
Economic downturn - If the economy is not doing well, real estate development and investment in construction will most likely follow, translating to less business for you. No construction company is immune to greater economic factors.
Help with clients who won’t pay - Even the nicest clients may turn out to be slow to pay. They might run out of money once a project is underway, or just drag their feet when paying bills. Some clients may want to make changes to like the work and refuse to pay, which could result in a legal battle. If you decide to work with a factoring company experienced in collections, they can help collect what your clients owe you.
Compete for more and larger jobs - By having additional cash flow, you can afford to be more competitive, offer more services, or pay for the up front material costs for new jobs that other companies that cannot.
Handle unexpected losses - Equipment breaks over time. Perhaps your workers organize a strike. Perhaps a storm or natural disaster puts your project on pause. Regardless of what unexpected loss or delay occurs, it’s important to have extra cash flow to face it with confidence.
How Construction Invoice Factoring Works
Invoice factoring is essentially a sale of invoices to a third party company, called a factoring company. The factoring company (also known as a “factor”) then gives you an advance to cover the invoice, minus their fees after your clients have paid back the invoice. It’s important to note that when you sell your invoice to a factor, they take over collections on that invoice, meaning they collect directly from your customer.
Here’s a deeper dive into how invoice factoring works:
Deciding on a factor - If you decide that invoice factoring is for you, first make sure you qualify for invoice factoring by checking to see if you have any outstanding invoices between 30 to 120 days old. If you do, then you can begin researching and looking for a factoring company that best fits your needs. In your research, you should find out what rates they charge, if they are experienced with working with construction companies, and what additional fees they may charge you.
Once you choose a factoring company, you can complete their specific application process. The factoring company may decide to perform a credit check on your clients to determine how likely they are to pay back your invoices.
Once you have completed their application process, if you are approved, the third party will send over a factoring agreement for you to sign. This agreement will outline information about the fees, payment plans, and the initial advancement granted to you. You may wish to review this document with a lawyer experienced in handling factoring agreements if you are new to this and want a second opinion.
After signing the agreement - After you sign the agreement and are happy with the terms, you will be given the advance rate, which is usually 80% - 90% of the invoice value. Because you are essentially transferring the responsibility of the invoices to the factoring company, the factoring company will contact your clients and let them know of your invoice factoring agreement, as well as new instructions for how they can pay back their invoices directly to the factor.
After the client pays the factor - After your client has paid off their invoice, the factoring company will send you any remaining balances, minus their service fee, or rebate, from the remittance. This is known as the “reverse amount”. The rebate is the fee factoring companies charge for factoring your invoices.
How does Construction Receivables Financing Work?
As you are considering construction invoice factoring, you may also come across a similar financing plan called “construction receivables financing.” Construction receivables financing is similar to invoice factoring in that both provide advances based on qualified unpaid invoices and both involve a third party company to coordinate and take responsibility for the financing.
There are, however, a few differences that be significant for your business:
Complete control of collection services - Construction receivables financing does not change the way you collect payment from your clients. With invoice financing, your clients continue to pay you normally, rather than paying a factor. In this case, your clients do not need to aware that you are experiencing low cash flow, something many small business owners prefer.
Full invoice value - Companies using invoice financing can receive 100% of the invoice value beforehand, rather than a portion, as with invoice factoring.
Faster approval time - The application for invoice financing is often shorter than for factoring. It may take only a few hours or days.
All electronic - The process for withdrawing and paying funds can all be done online with invoice financing, which means moving funds around is fast and convenient.
Still wondering whether construction factoring, Fundbox, or another option is the best choice for your business? We’d be happy to help you decide.