Navigating Construction Invoice Factoring

What is construction invoice factoring?

Construction factoring is a type of financing that allows construction companies to use their customers’ pending purchases (i.e. accounts receivables) as collateral for getting cash upfront. A small business might choose this type of financing for the common following reasons:

• To buy machinery, materials, or other services needed to fulfill a construction project
• To get working capital for immediate costs like maintenance, emergencies, or even payroll.
• To access capital when banks and other financial institutions will not lend to you.

How construction invoice factoring works.

Here’s a simple step-by-step journey through the construction invoice factoring process:

1. Start a job – You commence work on a construction project, carrying out tasks as per your client’s requirements.
2. Invoice your customer – Upon completion of a phase or the entire project, you send an invoice to your customer detailing the work done and the amount due.
3. Sell the invoice – Instead of waiting for the customer to pay, you sell the invoice to a factoring company.
4. Get advance payment – The factoring company then provides you with an immediate advance, usually around 80% to 90% of the invoice value.
5. Factoring company collects payment – The factoring company takes on the responsibility of collecting the payment from your customer.
6. Receive remainder minus fees – Once the customer pays the invoice, the factoring company will pay you the remaining balance, minus their fees.

This process allows your construction business to maintain a steady cash flow, even when customers take their time to pay. With construction invoice factoring, you can keep your projects on track and your business thriving.

Example

Let’s take the example of Buildit Construction, a small construction firm. They’ve just completed a major phase of a residential complex project and have invoiced the client, a property development company, for $100,000. However, the terms of payment are 90 days, and Buildit Construction needs the money now to fund their next project phase.

Using construction invoice factoring, Buildit Constructions sells the invoice to Fast Funds factoring company. Fast Funds provides them with an immediate advance of 85% of the invoice value, which is $85,000. Fast Funds then takes over the task of collecting the payment from the property development company. Once the payment is received, Fast Funds will send the remaining $15,000 to Buildit Constructions, subtracting their factoring fees. This way, Buildit Constructions can continue their operations without having to wait for the property development company’s payment, streamlining their cash flow and keeping the project moving forward.

Benefits of construction invoice factoring.

Let’s break down the advantages of using construction factoring:

• Improved cash flow – By selling your invoices, you receive immediate funds to cover expenses and invest in growth opportunities for your business.
• No debt incurred – Unlike traditional loans, invoice factoring does not create any debt on your balance sheet.
• Quick access to capital – Traditional financing can take weeks or even months, but factoring allows you to receive funding within 24 hours.
• No impact on credit score – Since factoring is not a loan, it doesn’t affect your credit score.
• Flexibility – Factoring companies are often more willing to work with growing construction businesses and offer flexible terms to meet their unique needs.

Requirements for construction invoice factoring.

To qualify for construction invoice factoring, there are a few key requirements your business must meet.

• Legitimate invoices – First and foremost, you need legitimate invoices for completed work. The invoices should be free of any liens or encumbrances and tied to creditworthy commercial or government customers.
• Good standing – Your business should be in good standing, with no legal issues or tax problems that could impact the factoring agreement.
• Customer’s creditworthiness – Unlike traditional lending, factoring companies focus more on your customer’s creditworthiness rather than yours. If your customers have a solid payment history, you’re more likely to get approved for factoring.
• No outstanding loans or liens on invoices – If your business has any outstanding loans or liens on your receivables, it may complicate the factoring process. It’s essential to disclose this information up front.
• Professionalism – You should have a history of conducting your business professionally, as this reflects positively on your relationship with your customers and the factoring company.

Remember, requirements can vary from one factoring company to another. It’s wise to discuss your specific situation with potential factoring companies to understand if this solution fits your business needs.

Construction factoring rates and fees.

Since invoice factoring is not a loan, you will be charged a fee instead of an interest rate. The factoring fee is typically a percentage of the total value of the invoices ranging from 1% to 8%. Some factoring companies may charge a smaller fee for the first 30 days and then slowly increase the fee if the invoice remains unpaid.

Some additional fees you may be charged include:

Lockbox fee: This fee is charged by the factoring company for receiving and processing payments from your customers.

Monthly access fee: Some factoring companies may charge a monthly access fee for using their services. This fee can vary depending on the company and the services they offer.

It’s important to carefully review all potential fees and rates before choosing a factoring company. Each company may have different terms and conditions.

The difference between invoice factoring and invoice financing.

Often, the terms ‘invoice factoring‘ and ‘invoice financing‘ are used interchangeably, but it’s worth noting that there are subtle differences between the two.

The main difference boils down to who manages the customer payment. In invoice factoring, the factoring company takes on the collection responsibility, while in invoice financing, you’re still in charge of your accounts receivable. Both offer similar benefits in terms of improving your cash flow, but the best choice for your construction business will depend on factors like your business size, customer payment history, and your capacity to handle collections.

Before deciding on construction invoice factoring, carefully weigh the benefits against any potential drawbacks and consider consulting with a financial advisor to determine the best course of action for your business. By making informed decisions, you can keep your cash flow steady and ensure that your construction projects continue to soar. Keep building, both literally and financially.

Visit this page to learn more about other construction business loan options.