When cash flow becomes a problem, you need options to help get cash coming in. It doesn’t matter how much you invoice, it’s the lack of payments that’s the issue! Bank loans, lines of credit, and credit cards are some options you can consider. But they can take a long time to process, require a credit check, and often require collateral. Construction invoice factoring might be the solution you’re looking for. We’ll look at what factoring is, why you might use it, and weigh the advantages and disadvantages — the pros & cons of construction factoring.
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Factoring turns construction invoices into cash
Construction invoice factoring involves a company purchasing your unpaid invoices in exchange for immediate cash. You sign an agreement to sell your invoices to the factoring company, and they give you 75-90% of the money upfront as an advance. Your customer then pays the factoring company, who sends you the remaining balance, less the factoring company’s fees. Fees for this service, called the factoring rate, are approximately 1-3% of the amount of invoices sold.
Why use invoice factoring?
You need money quicker than your customers typically pay you.
In construction, you may have to wait 45-60 days or more for payment (the average time in construction is 83 days!). It can be difficult to wait that long, especially when you need to buy materials, meet payroll, and pay your suppliers. If you find that you are always having to wait to pay your bills, factoring could be a good choice for you. You can receive most of your money in just a few days from the factoring company, and you’ll get the balance when your customer pays (less the factoring company’s fees).
You have no credit (or you have credit issues).
Factoring companies aren’t interested in your credit history or how quickly you pay bills. After all, your customers are the ones who will be paying them. The company will check the credit of your customers and will use this information to decide which of your invoices to purchase. The only credit that matters with factoring is your customers’.
You don’t have collateral to get a loan.
Banks usually require collateral in order to secure a loan (house, car, equipment). When you put something up as collateral, the bank has the right to take it away from you if you default on the loan. Invoice factoring is not a loan, so there is no collateral. The factoring company buys the rights to the payment of your invoices so no collateral is needed.
You don’t want to use other financing options, such as bank loans or credit cards.
There are several negatives about getting a loan or applying for credit cards:
- Your credit will be checked when you apply for a bank loan or a credit card.
- You are developing a long-term financial relationship with the bank or credit card company. You will be paying them for years!
- It can take weeks or months to process a loan or get a card.
There is no credit check when you factor invoices, Also, depending on the contract, you can have an on-going relationship or a short-term arrangement, depending on your needs. When you don’t need to use factoring anymore, you can simply terminate the agreement and return to business as usual. And, you can receive most of your money within a few days of signing an agreement.
Video: The pros and cons of construction factoring
The Pros: Benefits of construction factoring
Using factoring, can get cash faster and more easily than with other types of financing. When you factor, you can get 75-90% of the invoices you sell paid for in days, not weeks or months.
Factoring is typically cheaper than credit cards. The typical fee for factoring is 1-3% per month. Credit cards often charge much higher rates, with the average APR close to 20%.
No credit check
The factoring company shouldn’t need to check your credit. If you have issues in your past, or no credit history at all, you can still factor invoices. To assess payment risk, factoring companies look at the value of the invoice and the creditworthiness of your customer.
Invoice factoring can take the worry of chasing down customer payments off your plate. You don’t have to worry about exactly when customers pay their invoices. You get most of your cash up front as soon as you invoice, and the burden of collection passes to the factoring company.
No collateral required
Factoring doesn’t require you to provide collateral. The factoring company buys the collection rights to your invoices, so you don’t need to put up any collateral. In effect, the invoice itself serves as its own collateral.
The factoring company will research the credit of your customers, letting you know if there are any issues. The burden of checking your customer’s credit history passes to the factoring company. They’ll let you know if anyone has an issue. Of course, you may want to take additional steps to check the GC’s credit before a project begins.
Generally, factoring can improve the relationship between you and your customers. When you don’t have to continue to bug them about payment, you both can concentrate on the project. Factoring – especially contract factoring – can take the payment stress off of your plate.
You can use factoring to improve cash flow on an on-going basis. Factoring companies offer long-term contracts that can last for months, so you don’t have to keep reapplying every time you want to factor. A long-term factoring contract will help take away your accounts receivables worries, and you’ll get your money promptly each month.
Available to everyone
Factoring is available to all companies of all sizes. There are no requirements for the size of the company. Small companies and large companies can use factoring to help with their cash flow. Keep in mind, however, that while they may not consider the size of your company, they will consider the size of the invoice.
No cash outlay
With invoice factoring, you never actually “pay” anyone anything. The fees for the service are taken out of the payment the factoring company sends you when they collect from your customers. You shouldn’t have to write a check for the service.
The Cons: Drawbacks of construction factoring
Not exactly upfront
You can only collect money after the work is complete and you have billed for it. Factoring only pays on invoices you’ve sent to your customers, which usually means that the work is complete. If you need cash up front before a project starts, factoring isn’t going to be much help.
Good customers only
Your customers need to have good credit and pay their bills on time. If you have slow paying customers or invoices that are past due, factoring won’t help. The factoring company may refuse to buy invoices from slow paying customers. Once invoices are past due, the factoring company won’t be interested, so you will have to file a lien or send them to a collections agency.
Do you work with slow-paying or fast-paying contractors? Look up their Contractor Profile to see payment practices and read vendor reviews.
Lower communication stress
Factoring changes your relationship with your customers and GCs. You will have to instruct your customers to make payments direct to the factoring company. This may be an unusual practice, and they might be uncomfortable doing so. Open communication about what you’re doing will help put their minds at ease.
I know what you’re thinking…”didn’t you just say cost was an advantage?” Yes, but it’s all relative. Factoring is more expensive than a line of credit or bank loan. With the factoring fees, administrative expenses, and wiring fees, factoring can end up being more expensive than getting a bank loan or line of credit. Rates will depend on the credit worthiness of your customers, and there isn’t much you can do to change that.
Before you start, read more about the costs involved in construction factoring.
Factoring companies will generally only buy your invoice for a maximum of 90 days. After that, most factoring agreements require you to buy it back. Factoring companies aren’t the same as collection agencies. Unless you have a non-recourse agreement, collecting bad debt is still your problem. The factoring company isn’t going to go after your customers if they refuse to pay.
It’s important to protect your lien rights on every job – whether you’re factoring the invoices or not.
You will have to give some of your financial information to the factoring company. They will need access to your invoices, customer information, bank account, and potential other financial information. Not everyone is comfortable with sharing this information.
Commercial invoices only
Factoring is not available if you sell directly to consumers. You can only factor invoices sent to companies or governments. They are a better credit risk in the factoring company’s eyes. Personal consumer purchases cannot be sold in this way.
To factor or not to factor?
Factoring is one of many options to improve a contractor’s cash flow situation. Each option has their own pros & cons! Only you can decide if invoice factoring is the right choice for your company. Do your homework, research companies carefully, and ask questions.