Construction companies with cash flow challenges often use factoring of their invoices as a viable way to continue funding their day-to-day expenses while waiting on slow-paying clients. While there are many benefits of factoring for construction companies, there are also a few tradeoffs to consider as well. We will discuss both to help you decide if factoring is right for you.
Benefits of Factoring for Construction Companies
1. You Can Get Access to Working Capital Quicker
Speed is usually the #1 reason construction companies partner with factoring companies. Compared to the time it takes to get a bank loan (assuming getting one is even possible), receiving money by factoring can take as little as a few days after your account is created. Quick access to working capital allows you to immediately fund current projects, maintain your workforce, manage your overhead, and continue to scale. When there are gaps in your cash flow, you can’t wait the months of filling out paperwork and decision-makers dragging their feet to find out IF you can even receive payment. Invoice factoring allows you to continue to pay bills without being handcuffed by both the bank and your clients’ slow payments.
2. You Can Keep Your Extended Payment Terms
Another benefit of invoice factoring is it helps construction companies continue to extend 30 to 60-day payment terms to clients. Your factoring company will ensure that you are paid quickly for those invoices, so you don’t have to miss out on deals with companies that need extended payment terms.
As long as you have delivered on the project agreement with your client, you will be able to collect your funds from the invoice company and they will handle receiving full payment from the client.
3. Qualifying for Factoring Can Be Easier
It can be a difficult and lengthy process to qualify for many business financing solutions like lines of credit or loans from banks, but another benefit that invoice factoring provides is it has a relatively simple qualifying process. Most companies are able to contract with a factoring company if their invoices reflect already delivered work with creditable clients.
A Bank’s Typical Required Paperwork:
Part of the complexity of trying to get a bank loan will be paperwork. When you apply for factoring you probably WON’T need to supply these documents:
- A loan application: You will need to complete a loan application form provided by the bank. This form typically includes basic information about your company, the project, and the financing needs.
- The project’s details: The bank may need you to provide detailed information about the project such as plans, blueprints, specifications, and cost estimates. This helps the bank assess the feasibility and value of the project.
- Contractor’s qualifications: You may need to submit documentation that demonstrates your qualifications and past experience in the construction industry. This may include licenses, certifications, references, and a portfolio of past projects.
- Financial statements: You will be required to provide financial statements, including profit and loss statements, balance sheets, and cash flow statements. They want to know this information as insight into your financial stability and the ability to repay the loan.
- A construction contract: Contractors may need to present a construction contract or agreement outlining the scope of work, timeline, and payment terms.
- Insurance documentation: The bank will typically need you to provide proof of insurance coverage, including general liability insurance and workers’ compensation insurance. The bank wants to minimize its liability in case of accidents or damages during construction.
- Personal and business documents: You may be required to submit personal identification documents, such as your/your team’s driver’s licenses or passports, as well as business-related documents like tax returns, bank statements, and business licenses.
Factoring companies will never require this volume of documentation when you apply. However, when they consider you, the only other thing that might stop you from being able to partner with them are certain liens or legal issues with your business. If you are free of those, you should be able to receive invoice factoring services without issue.
4. Your Invoices Are Collateral
Loans and lines of credit often require substantial collateral. Invoice factoring, however, only uses your invoices as collateral. This means you can keep your materials, equipment, and other assets separate.
5. Small Companies or Startups Can Get Invoice Factoring Money
A traditional bank loan can be hard if not impossible to get if you’re not one of the larger, established construction businesses. However, factoring supports these smaller companies in maintaining cash flow, even if they have slow-paying clients. Because factoring relies on your clients’ credit, not yours, factoring gets you cash based on their history. Factoring is a powerful solution for smaller companies looking for solutions to grow their business.
Don’t spend another day hoping your financial situation will change… schedule a call!
Disadvantages of Factoring for Construction Companies
1. Factoring Can Be More Expensive Than Bank Loans
While an advantage of factoring is that it allows you to get your hands on cash fast, the tradeoff is the annual percentage rates (APRs) are typically higher than other forms of traditional financing (however, factoring rates can be much lower than some other available funding options like Merchant Cash Advance loans).
Of course, every factoring company operates differently with different factoring rates (and possibly fees) based on the agreement’s length of time, the amount retained, etc., so it is important to inquire in advance. After all, nobody, including your factoring company, wants surprises. Transparency and communication is the key to benefiting both parties.
2. You’ll Need to Communicate the Factoring Relationship with Your Customer
As with many areas of life, communication is key. When you use a factoring company, you agree that they will be getting payment from your clients, not from you. Letting them know about the new arrangement including the factoring company will save much confusion. When the contract is signed, your client will receive a Notice of Assignment, which will announce your new relationship with the factoring company and the factoring company will be in contact with them.
Notice of Assignment:
A Notice of Assignment (NOA) is a straightforward letter that legally informs your client that a third party, such as a bank, factoring company, or financing company, will now be responsible for managing and collecting their accounts receivable.
If this is something that bothers you, factoring may not be the right solution for you. However, most construction company clients understand this common practice and are rarely troubled by it, especially if they know of the new relationship in advance.
3. The Invoice Payment is Still A Debt
Although very rare, some clients simply do not pay their invoices. This will force the factoring company to pursue payment from your clients. But the factor is not a collection agency. After exhausting other means with the client, in the end, you will be responsible for any bad debt that occurs through unpaid client invoices. However, the factoring company does a lot of due diligence on your client before agreeing to make your agreement official — for both your and their peace of mind and safety.
Is Invoice Factoring Right for Your Company?
With so many pros and cons, factoring can be a great cash-flow-fixing solution for some construction companies… but not all. If you are unsure, let’s talk. We look forward to walking you through the benefits of factoring your invoices and how it might look in your unique situation.
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