Invoice factoring is a type of construction financing where a merchant sells goods on credit yet receives cash on the spot.
Instead of racking up construction receivables with no cash coming in, the business owner will seek a factoring company to buy the invoices. That way, you have ready money to run the business as the factoring company awaits the customer payment.
Therefore, construction factoring entails borrowing cash from a construction factoring company in exchange for your client’s invoice.
You should consider construction factoring services if you:
- Have clients with good credit histories
- Are facing cash flow problems
- Face problems acquiring a line of credit from traditional lenders
- Are free of lien and litigation
- Operate a business or carry out larger jobs that require huge outlay, so it is difficult for most clients to pay upfront
Construction invoice factoring covers all sub-trades of companies in the construction industry, including general contractors and construction subcontractors. To mention a few, companies that offer roofing, landscaping, wiring, HVAC, and other construction-related services can apply for invoice factoring.
There are several types of invoice factoring. What you choose will depend on the nature of the factoring agreement, the factoring rates, and the number of invoices you are selling. The five main types of construction invoice factoring include:
- Full recourse factoring: you agree to buy unpaid invoices from the factoring company if the customer does not pay within the specified period.
- Non-recourse factoring: in this case, the factoring company agrees to take full responsibility for invoices that remain unpaid.
- Spot factoring: also referred to as single invoice factoring, you sell a single invoice in a one-off deal. It is more expensive than long-term factoring.
- Long-term factoring: also known as whole-turnover invoice factoring, you sell all your invoices over a specified period. It establishes a long-term financial relationship between you and the factoring company, perfect for negotiating favorable factoring rates.
- Selective factoring: This type of factoring allows you to choose the invoices you want to sell over some time. It is safer as it will enable you to select invoices from reliable clients and thus protect you from extra costs that are the hallmarks of unreliable customers.
So let’s say you are handling a new project in the construction industry. Since it’s one of your larger jobs, it won’t make sense to invoice at the project’s end as it would probably run for a year.
The best way to handle it would be progress billing, where you bill an invoice upon milestone completion. That ensures you have working capital as the project progresses.
Like every other business transaction, you need to understand how invoice financing works to make informed decisions. If the terms aren’t as appealing, you may want to consider other financing options, such as a bank loan.
Here’s how a typical factoring application process would pan out:
i) Before factoring your invoices
- Identify all 30-120 days old outstanding invoices and calculate the total invoice value. Naturally, a considerable total invoice value will boost your chances of qualifying for invoice factoring.
- Send your application to the best construction factoring companies in the industry. They have agreeable advance rates and considerate payment terms.
- Apply for the Account Receivable product. The invoice factoring company will likely verify the customers’ credit history.
- If considered, scrutinize the agreement and pay close attention to the payment plan, cash advance amount, and service fee. Negotiate where necessary.
- Sign the agreement if satisfied with the payment terms.
ii) After signing the agreement
- Excellent construction invoice factoring companies like Resolve will give you up to 90% of the invoice value in advance payment to boost your cash reserves.
- Take the initiative to inform your client about the factoring company that will handle the invoice payments.
- The lender will notify your client of the factoring agreement and the new payment instructions.
iii) During the construction factoring period
- Follow the instructions in the factoring agreement.
- If there are future invoices, the factor will verify the validity of the invoices, set payment terms, and collect the clients’ payments.
iv) Finalizing payments
Once the client makes the final payment, the factoring company will account for the invoice. The most crucial part of invoice factoring is verifying the viability of each customer. According to PWC, businesses lost more than $42 billion to customer fraud, asset misappropriation, and cybercrime.
That’s why factoring companies conduct customer credit checks before extending credit terms. One such lender is Resolve, which offers net term solutions and free credit checks.
After approving the customer’s net terms, which could be 30, 60, or 90 days, Resolve will advance the cash and follow up the payments. In short, this is what you should expect from Resolve:
- A cash advance of up to 90% of the invoice’s value.
- Explicitly stated factoring fees (primarily the interest of the total amount) and no hidden costs.
- After the customer pays, Resolve will send you the balance after total deductions.
If your construction company has outstanding invoices that affect its cash flow, it is high time you consider construction invoice factoring. The benefits of applying for construction invoice factoring include:
a) Predictable revenue
Rather than waiting for payments, invoice factors pay invoices instantaneously. Instant payments improve your cash flow, making for smooth business operations.
b) Better alternative to bank loans
The factoring fees for construction invoices are often more affordable than the accumulated interest rates you’ll pay for bank loans. It is also easier to obtain invoice factoring on short-term notices and removes your company’s debt management burden.
c) Protects your business from bad debts
Accumulated invoices leave you with unpaid bills and uncovered operational costs, which may compel you to take desperate measures. Selling your company’s invoices protects you from bad debts.
d) Reduces the stress of following up delayed payments
You transfer the burden of chasing after delayed payments to the factoring company. In return, you will get more time to focus on your projects and other tasks to spur business growth.
e) Increases the chances of your business’ survival
Most small businesses are in a vicious cycle where customers pay more than a month later. The construction industry is particularly notorious for this, with payments as slow as 50-75 days.
That means you can’t get more stock while the poor revenue collection stagnates construction projects and the growth of your business. Remaining liquid is key to covering operational costs, key for your business’s survival.
f) Boosts your business growth rate
Invoice factoring companies provide funds to purchase or rent construction equipment, start new jobs, and hire more staff. That is vital for fueling business expansion as factoring gives ready funding to explore the new opportunities.
The construction industry is notorious for late payments, with average payments often 50-75 days after a job. If you are to survive in these murky waters, you need to find ways to get your payments faster.
The golden egg might be construction invoice factoring. It is a form of invoice financing where invoice factoring companies will advance the invoice amount on the spot, even though the client will pay later.
That ensures you always have liquid cash to stock up and settle operational costs. The best lenders will provide competitive factoring rates and charge reasonable factoring fees, so it’s a win-win.