Small and medium sized businesses in all industries struggle for cash flow and liquidity, even when they are undeniably successful. However, construction sector businesses often face even more significant challenges in ensuring cash flow through the business, particularly during the slow period of the year (that’s why you would learn more about construction invoice factoring).
Construction invoice factoring can help you build a successful business, weather those slow spells, and benefit from liquidity at all times. If you’re unsure of what construction invoice factoring is, or how it might be leveraged to foster growth in your business, we’ll discuss the most important considerations below.
What Is Construction Invoice Factoring?
Construction invoice factoring is really no different in practice from any other form of factoring. Basically, the process looks like this:
- You have an invoice due in 30, 60 or 90 days
- You sell that invoice to a factoring company
- The factoring company advances you a portion of the invoice total
- You spend the advance on what you need, including:
- Supplies for new construction jobs
- Materials to finish a current project
- More tools or upgraded equipment to improve quality or performance
- When your client pays the invoice, the factoring company pays you the remaining balance, less a small fee
That’s all there is to it. However, while the overall concept might not be any different in construction invoice factoring, there are considerations to make. For instance, if you run a construction industry business, you’ll definitely want to work with a factoring company that specialises in this area, rather than with a generalist firm. What difference does a specialist firm make? This leads us to our next topic.
Why Specialists Matter in Construction Invoice Factoring
So, why should you make sure that you’re working with a factoring firm that specialises in the construction industry? Wouldn’t just about any factoring company be a worthwhile choice? No, they wouldn’t, and here’s why:
Commercial and residential construction companies face significantly different challenges than businesses in other industries do. You also face seasonal downturns, and other industry-specific issues.
A generalist factoring company will not be familiar with these issues, and will be unlikely to offer a good fit. In fact, many companies may not be willing to work with you at all, simply because they’re not intimately familiar with how the construction industry works, or with your particular niche within the wider construction segment.
Just to illustrate how diverse this area is, some of the specialty areas within the larger construction industry include the following:
- Cell tower construction
- Underground utilities
- Structural steel
- Road construction
- Electrical (high voltage and low voltage)
- Interior finishing
- Directional drilling
In addition to these specialties and niches, there are also other complications, such as the need for subcontractor factoring, or the need for purchase order financing. We’ll discuss those in the next section.
Additional Complications That Necessitate Specialists in Construction Invoice Factoring
As you can see from the information above, the construction industry is incredibly broad, with multiple subdivisions. However, there are even more complications that can make it difficult for a generalist factoring firm to provide you with value and benefits.
For instance, what if you’re a subcontractor, and you’re attempting to sell an invoice owed by the general contractor? Now, the general contractor doesn’t get paid until the actual client signs off on the job. In some instances, this might be a very long time down the road, and it’s not unheard of for clients to not pay at all if something was not completed to their satisfaction.
That’s a great deal of risk for a factoring company to take on, and you’ll find that most generalist firms will balk at the idea. Specialist construction invoice factoring companies are familiar with how the industry works, and realise that this is little more than “business as usual”.
Still not convinced that invoice factoring can help you build a successful business? Let’s explore the reasons why this is such an important financial tool for your company.
Why Consider Construction Invoice Factoring?
Construction companies like yours require a constant stream of cash flow through the business. It’s necessary in order to keep taking on new clients. Once you complete a job, you’ll need to be paid so you can purchase the supplies and material, and pay for the manpower, needed for the next job. If all of your capital is tied up in unpaid invoices, that leaves you no way to move forward. In short, you’re sitting still and your company is stagnating.
With construction invoice factoring, you’re able to sell an unpaid invoice, receive an advance on the amount your client owes you, and use that money to purchase supplies, and materials, as well as to pay for labor on new jobs. In short, you’re able to grow your business without having to wait 30, 60 or 90 days for your client to pay you.
If the ability to leverage capital locked up in unpaid invoices for immediate use in your business sounds appealing, you’ll need to know more about how the overall process works. We’ll explore that topic now.
How Does Construction Invoice Factoring Work?
While we’ve covered a little of how the invoice factoring process works, we need to take a look at several important areas in order to ensure that you fully understand what’s going on.
One of the first things we need to look at is the advance. This is the amount of capital that you’ll receive from the factoring company when you sell the invoice. The total advance amount will be based on the value of the invoice. Most companies offer advances of anywhere from 70% to 90% of the invoice total.
That money is available to you immediately (within 24 to 48 hours of the sale), and can be used for anything you need. After all, it’s your money, and there are no limitations on what you can use your own money for.
The factoring company will take over billing and collections on your client. In point of fact, they will inform your client that payment will need to be remitted to them, rather than your construction company. However, don’t let the fact that the company notifies your clients dissuade you. Factoring has become recognised as not only a legitimate means of financing, but a vital tool for many smaller firms, so there’s little to no chance that your clients will take it as a sign that there’s something amiss.
Once your client pays the factoring company, you’ll receive the balance of the invoice total, less the factoring fee and any other charges. Note that some companies do assess other fees, and some have hidden charges tucked away in the fine print of the contract you’ll need to sign. Because of that, it’s crucial that you thoroughly read the contract before signing. Otherwise, you could end up with less money than you expected.
After you’ve been paid the balance on the invoice, the transaction is done. However, your relationship with the factoring company might not be over. Some construction invoice factoring firms do offer spot factoring, which is really just the ability to sell invoices on a one-off basis. However, others require that you sign a long-term contract and factor all the invoices from a particular client through them moving forward.
That’s not as prominent in construction invoice factoring as it is in other types of invoice factoring, though, as there’s a good chance that you may never work with that particular client again. More construction factors offer spot factoring because of that.
However, while factoring does provide some significant advantages, it might not be the best fit for all needs. This bring us to our next topic, which will help you determine if you’re a good fit for construction invoice factoring.
Is It Better to Wait Until Your Client Pays?
In most situations, you’ll find that construction invoice factoring is an excellent option, as it allows you to move forward and grow your business, even if your clients aren’t going to pay their invoices for another 90 days or so. However, there are a few instances where it might make more sense to wait for your customers to pay, rather than factoring the invoice. These situations include the following:
- You need 100% of the invoice amount to turn a profit (with factoring, you never receive 100% of the invoice total due to the factoring fee)
- Your terms are net 90 and you cannot afford to pay the monthly fee three times (factoring fees are usually calculated monthly, so a 90-day invoice would incur three charges)
- You have sufficient operating capital flowing from other invoices while you wait
As you can see, for most companies, factoring is the better decision, as opposed to waiting for a slow-paying client. Waiting even a few days could mean the difference between paying workers and not, buying new equipment and missing out on a deal, or paying utilities.
What about conventional loans, though? Is factoring the same thing? If not, would it be better to work with a bank? We’ll explore that below.
What’s the Difference between Construction Invoice Factoring and a Bank Loan?
You would be forgiven for thinking that invoice factoring was somehow akin to conventional lending. After all, both are viable financial tools for businesses. However, they’re not even remotely the same.
First and foremost, construction invoice factoring does not involve debt on your part in any way. That means you’re not taking on additional liability, and there is no loan to repay. It also means that you don’t need to worry that you won’t be approved because your business credit isn’t perfect.
In fact, your credit has nothing to do with it – it’s all about your customer’s credit, instead. Of course, this means that if your client isn’t a good risk, then you might be better off not factoring the invoice (or you might find that the factoring company won’t buy the invoice).
Another way that factoring differs from conventional lending is in terms of speed. With a bank loan, you might wait up to 60 days to get your money. There’s little difference between that and just waiting for your client to pay the invoice in the first place.
With factoring, you should have your money in a few days. If you’re new to a relationship with the factoring company, they may have a three to five day waiting period, but any advances on invoices after that point should be made within 24 to 48 hours.
Now, a great deal of your success in factoring depends on the company that you work with. Your choice of factoring company is crucial.
Choosing a Factoring Company
From the information above, one thing should be clear – you have to work with a construction invoice factoring company. Obviously, not all companies are the same. In addition to the generalist and specialist discussion we covered previously, there are other issues. Some companies tack on additional fees and charges that can eat into your money in the end, while others might practice predatory collections techniques that can damage your reputation with past clients.
It’s very important that you choose your factoring partner with care. Start with research on the various companies available to you in Canada (there are quite a few out there) and narrow down your choices by determining if they’re a good match for your needs. For instance, look for companies that offer spot factoring, that have a “no hidden fees” policy, and that offer flexible terms on factoring.
Once you’ve narrowed down your choices to a few options, you will need to interview them and study the contracts for additional charges, as well as for any potential problems (such as being required to work with the factoring company for an extended period of time).
Next, you’ll need to learn more about their customer service, as well as how they treat your clients during the billing and collections process.
Find out if any of the companies you’re considering offer additional services, like back-office solutions, or value added perks. It is also good if you’re able to speak with references (past and present clients of the factoring company) to learn about their experience.
Conducting research and comparing different companies can be quite difficult. After all, you have a business to run. There is help available.
When You Need Help
We understand that there’s a great deal of legwork involved in vetting construction invoice factoring companies. You need the ability to focus on running and growing your business, and investing a lot of time in comparing factors will definitely cut into that ability. We specialise in helping clients connect with the ideal factoring company for their specific needs. We invite you to take advantage of a free consultation with one of our factoring specialists and learn for yourself how simple it can be to obtain the financing you need for growth.