What Is Construction Invoice Factoring?

By Nadya JosifovLast Updated Jun 24, 2020 7:19:39 PM ET
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If you want to start a business in the construction industry, then you need to learn all the special terminology related to this field. Financing is a major factor in construction, and construction factoring is one funding solution contractors and subcontractors can use to obtain cash advances on unpaid invoices. Also known as invoice factoring, this practice helps businesses maintain cash flow to pay their suppliers and employees before they have collected on unpaid invoices due to them from others.

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In many cases, cash flow is one of the biggest obstacles for businesses, and that is particularly true for construction companies that often aren’t paid in full until work is completed but have to pay their own suppliers along the way. If they couldn’t pay for materials, it would create substantial construction delays. Construction factoring offers a quick, stress-free solution to temporary cash flow problems. Here’s what you need to know about the various types and benefits of construction invoice factoring.

Argument for Construction Invoice Factoring

Unlike many businesses that take in cash daily, construction businesses often receive a small amount at the beginning of a project and then have to wait until the end to receive the remaining — usually much larger — balance. This makes it difficult for them to effectively manage their cash flow to pay all their employees and suppliers on time, especially if their suppliers have 30-day payment terms.

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You could struggle to establish your construction business under these circumstances, but if you had access to 95% of the value of unpaid invoices owed to you, it would give you the necessary capital you need to operate your business and finish the job at hand. Additionally, having an invoice finance facility in place allows you to confidently focus on completing high-quality work instead of worrying about ways to cut corners to save available cash. Eliminating cash flow issues will help your company thrive.

Basics of Construction Invoice Factoring

When the primary contractors on a job set up lengthy or delayed payment terms, it could trigger cash flow problems for the subcontractors they hire to do some or all of the work for them. To counteract this problem, companies draft and submit their unpaid construction invoices to a finance provider. These invoices generally include the unpaid portion of the total fees due to them for completing the work as well as other incidentals that other parties may owe them as they complete the job.

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After reviewing your invoices, a bank or finance company may agree to pay your business a percentage of the total invoice value up front, minus any agreed-upon fees. The finance provider then confidentially collects any payments made by the client on your behalf. After your client’s balance is paid in full to the company providing the financing, the remaining percentage of the balance is released to you.

Different Types of Construction Invoice Factoring

Finance companies use two types of construction invoice factoring: spot factoring and invoice discounting. Spot factoring or single invoice factoring refers to the method where your business completely hands over credit control responsibilities to the third party (the factor), and they do the work to collect payments. This form of accounts receivable finance is ideal for small and medium-sized businesses with an established customer base and a low level of invoice disputes. Spot factoring doesn't include long contracts.

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Invoice discounting is a larger-scale agreement with a finance company. When your company invoices your clients for payment, the factoring company sends you the agreed-upon percentage of the money so you don't have to wait for the invoice to be paid. However, you still maintain control of your invoices and the payments that come in from clients. This type of contract can be granted for longer terms to ensure steady cash flow for the duration of the job. Additionally, larger numbers of invoices owed to you usually lowers the rate the finance company charges.

Benefits of Construction Invoice Factoring

Construction factoring is a worthwhile financing option for different construction businesses for several reasons. First, it offers fast funding with some companies completing their contracts and receiving their cash in less than a day. Depending on your preferences, credit management can be externally managed or confidentially kept in-house. Additionally, you can decide to add Bad Debt Protection (BDP) to the terms to protect against non-payments.

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Contractors and subcontractors can also receive funds if they want to bid for additional jobs. This helps them expand their businesses, and some slow-payment risk can be mitigated by factoring construction invoices. This type of financing would also allow you to stay on top of payroll and overhead, as employees, rent and other expenses can't be paid on schedule if your income is based on the irregular payment schedules of clients.