Many underground-utility-locating companies find it challenging to wait 30 to 90 days to get paid by commercial clients. Offering payment terms is a standard business practice. However, it can create cash flow problems for companies that aren’t well-capitalized. This article explains how to improve cash flow by financing invoices using factoring. The article covers the following:
- Slow cash flow challenge
- Can early payment discounts help?
- Factoring your invoices
- Are you a subcontractor?
- Advantages of factoring invoices
- Is factoring right for you?
1. Slow cash flow challenge
One of the greatest challenges for small underground-utility-locating contractors is waiting for their commercial clients to pay their invoices. Most utility companies, builders, and general contractors expect to get net-30- to net-60-day payment terms. Companies have to follow this common business practice if they want to remain competitive. However, this practice can also create financial problems for some utility-locating companies.
Let’s review an example. Many underground-utility-locating companies handle “dig safe” calls (i.e., dialing 811 in most states) for local utilities. These contracts provide regular work and can generate most of the revenue for some utility-locating companies. However, the utilities (or the master contractor) pay their invoices in 45 days.
Now, let’s examine this transaction from the underground-utility-locating company’s point of view. Payroll is usually their largest expense, and it is paid every week or two. However, there is a time lag between when you must pay employees and when clients pay their invoices. This time lag is the source of the problem.
Companies with a cash reserve can cover this time lag while waiting for invoice payment. Unfortunately, companies without a reserve can risk financial problems. These financial problems can grow unless they are fixed quickly. The simplest way to solve this problem is to use early payment discounts. We cover this strategy in the next section.
2. Can early payment discounts help?
Using early payment discounts is an effective strategy to improve your cash flow. Companies typically offer a 1% to 2% discount to select clients who agree to pay their invoice in less than ten days. This strategy works well for companies that have minor cash flow problems. It also benefits your clients because the savings increase their profit margins.
However, early payment discounts have some limitations. They are optional, which means you never know if a client will take advantage of them. They can also be abused, so they have to be offered selectively. Lastly, your clients may avoid taking advantage of them during recessions, when you most need quick payments.
Companies that cannot improve their cash flow with early payment discounts should consider using invoice factoring. We discuss this strategy in the next section.
3. Factoring your invoices
Underground-utility-locating companies that work with commercial clients can improve their cash flow by factoring their invoices. This solution lets you finance your accounts receivable and provides immediate funds to cover company expenses.
Invoices are financed in two installments. You get the first payment shortly after sending the invoice to the factoring company. The second installment is paid once your customer pays the invoice in full. Note that the factoring fees are deducted from the second installment. To learn more, read “What is Factoring?” and “What is a Factoring Company?”
4. Are you a construction subcontractor?
Companies that work as subcontractors to a general contractor, master contractor, or builder may need construction factoring instead of conventional factoring. Construction factoring is a specialized form of financing designed to help subcontractors. This solution can handle progress payments and “pay-when-paid” clauses, which are common in construction.
a) Progress payments
Most subcontractors get paid through progress payments, though they are less common for underground-utility-detection companies. Progress invoices cover a portion of a project rather than the whole project. These invoices require a more comprehensive verification process, which construction factoring companies are equipped to do.
b) Pay-when-paid clauses
Many underground-utility-locating companies work through master contractors (or general contractors) rather than directly for utility companies. Some master contractors use “pay-when-paid” clauses in their contracts. These clauses enable the master contractor to pay you only when and if they get paid. These clauses are considered to have a high risk of non-payment. Construction factoring companies can finance these invoices only if the master contractor waives this clause.
c) Retainage
Some general contractors or master contractors withhold a portion of each payment until the end of the project. The retainage portion usually ranges from 5% to 10%. Unfortunately, retainage invoices cannot be factored because they are usually open for more than 90 days and can be subject to disputes.
5. Advantages of factoring invoices
Factoring lines have several advantages over other solutions. These are the four most important benefits of factoring:
a) Improves cash flow
The most important advantage is that factoring can improve your cash flow. This improvement can become noticeable shortly after deploying the factoring line. Furthermore, the solution enables you to offer clients net-30-day terms (or longer) while minimizing the financial risks of doing so.
b) Can be obtained quickly
Factoring lines can usually be deployed in 2 to 5 days, though this timing depends on the details of your transaction. This deployment is considerably faster than that of loans and lines of credit. Consequently, factoring can be a viable solution for companies that need immediate funding.
c) Flexible
The line’s credit limit is flexible and is linked to your revenues. Consequently, the line can adapt as your company and revenues grow. Qualifying for increases is usually simple and can be done as quickly as one day.
d) Simple qualification requirements
Factoring lines have simpler qualification requirements than loans and lines of credit. In general, underground-utility-detection contractors must:
- Invoice on net-30 to net-80 terms
- Work with creditworthy commercial clients
- Not have serious tax or legal issues
- Not have their A/R encumbered by liens
6. Is factoring right for you?
Factoring lines are specifically designed to solve a single problem. They help you only if your cash flow problems are caused by slow-paying invoices. Factoring lines do not help you if your financial problems are related to other issues, such as profitability. In general, factoring can help companies that have:
- Cash flow issues due to slow-paying invoices
- Creditworthy clients
- Profit margins higher than 20%
- An experienced management team
- No serious legal or tax problems
Note: Consult a CPA or similar professional if you are unsure if factoring is right for you.
Get more information
We are a leading construction factoring company and can provide your underground-utility-locating company with competitive terms. For more information, get an online quote or call us toll-free at (877) 300 3258.