Managing the finances of a new firm can be difficult, especially when you have invoices with net 30, or net 60 days (or more). How are you supposed to keep up with payroll or start a new project if you haven’t been paid for the last one? This is how the big companies stay big, they have the capital reserves to bite the bullet and keep going perpetually. This challenge for small construction businesses can be mitigated with the use of Receivables Financing.
Imagine, you are a small electrical contractor. You are great at what you do and clients have noticed it as evidenced by your growth. You have just completed a job and are waiting on payment when another once-in-a-lifetime project comes along. That job would really open the door to much future work. However, because you have not yet received payment for the original job, you can’t buy the raw materials needed for the new project and pay the crew. So you sadly turned down the once-in-a-lifetime project.
This example happens every day. Companies like this electrical contractor are just too new to have established credit for other financing options like bank loans. This is exactly when Receivables Financing can be a game changer. Using Receivables Financing can supplement the cash gap between job completion and payment allowing them to take on those once-in-a-lifetime projects (and everyday projects too).
What Is Receivables Financing?
(Accounts) Receivables Financing, or “receivables factoring” as it is sometimes called, is a quick, simple process. First, you sell your products or supply your service to your customer as you normally would, and are issued an invoice for payment by that firm. You then sell that invoice to a third-party Receivables Financing company (like CapitalPlus). In exchange, you will receive an advance payment, often 70-80%. After your customer pays the invoice, a fee is taken out and the rest of your money is returned to you. This simple process can be a great temporary option or repeated over and over as a strategic tactic.
What Companies Are a Good Fit for Receivables Financing?
(Accounts) Receivables Financing can benefit many industries. From construction and trucking to healthcare and staffing, AR financing can likely help any industry where there is that lag time between completing a job and getting paid by the client.
Helpful Tip: look for a Receivables Financing company that specializes in your particular industry or trade. They not only understand the nuance of your business works but might also offer industry-specific benefits and support.
What are the Benefits of Receivables Financing?
Receive Payment Immediately
- Because the Receivables Financing company pays you right away, you do not have to wait 30, 60 days, or more. You are no longer stagnant – free to complete the job, pay past bills, fund the next job… whatever is needed. You are paid in advance on future payments.
Heavily Dependent on Your Customer’s Credit Rating
- It can be hard to get traditional financing from a bank or other source if your company is young and doesn’t have established credit. Receivables Financing takes your debtor’s credit and trustworthiness into account much more than that of your company.
No Collateral Required
- With most loans, having some sort of collateral is required. However, with Receivables Financing, the purchased invoice acts as the collateral.
Easier Qualification Compared to Traditional Loans
- Everyone knows that getting a loan from a bank can be a slow, difficult process. This is especially true if your business is in an industry that banks dislike financing like construction or trucking. Receivables Financing, being a much simpler process, has fewer requirements for approval. You might be asked for basic documents like proof of insurance, a business license, copies of the invoices you want payment for, and possibly a few others. The banks will need much more information to even consider you.
A More Flexible Alternative
- Unlike a bank or other source of financing, there is no long-term contract or obligation involved. Some companies don’t even require you to finance all your invoices from the same debtor, only the ones that you need (see Spot Factoring).
What are the Drawbacks of Receivables Financing?
Not the Cheapest Option
- Because of faster turnaround and fewer requirements, receivables financing tends to be more expensive than traditional financing options like bank loans or lines of credit. It is, however, cheaper than, other forms of funding like Merchant Cash Advances.
Perceived Trust Issues with Receivables Financing
- When talking to your client, they may not understand why you chose to finance your receivables. This can make things a little awkward especially if they learn it from the factoring company before communicating with you.
You Are Ultimately Liable for Repayment
- If on the slim chance that your client cannot pay their invoice, the Receivables Financing company will exhaust all avenues to collect from them. However, you are next in line. So when applying for receivables financing, it’s best to choose the invoices of clients who are the safest bets. The Receivables Financing company will help you choose by running their credit beforehand.
Alternatives to Receivables Financing
There are many options available to the small business to find support money. Here are three of the most popular.
>> Related Reading: Top 19 Construction Financing Options
As discussed before bank loans can have lower fees than receivables financing. And traditional loans will help your business’s credit score. However, bank loans have a lengthy, arduous application process requiring collateral and good credit. Receivables financing focuses on the creditworthiness of the business’s customers and with fewer requirements, can happen much quicker. The trade-off is that factoring is typically more expensive than bank loans.
Merchant Cash Advances:
A Merchant Cash Advance (MCA) is a funding option with a similar (quick) funding timeframe as Receivables Financing. It provides a lump sum loan payment based on a percentage of the business’s past credit card sales. They are repaid by pulling a percentage of weekly or daily sales directly from your bank account. This can be difficult if you have limited or erratic cash flow.
Plus an MCA’s interest rates are often much higher than most funding options including Receivables Financing.
Backed by the Small Business Administration SBA construction loans are designed to support most small businesses. Depending on the option you choose, they offer long terms and low fees. However, the application process is slow with many requirements. They also require collateral and personal guarantees.
No, receivables financing is not the “silver bullet” solution for every construction company. But for many, it’s a lifesaver. If you would like to discuss exactly how it looks for your business, schedule a meeting or call us at 865-670-2345. We would love to discuss your options.
Curt Powell — VP of Sales
Joining the team in 2006, Curt serves as the Vice President of Sales at CapitalPlus Financial Services, a direct lender based in Knoxville, Tennessee focusing exclusively on the construction industry. His primary expertise has been in the factoring and material finance space. Since its establishment in 1998, CapitalPlus has provided over $1 billion in funding empowering thousands of construction companies all over the US.
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