Undercapitalized utility construction companies can experience financial problems when they give payment terms to clients. These terms are often non-negotiable and allow clients to pay invoices in 30 to 60 days. This article discusses two solutions: invoice factoring and construction factoring. Both solutions can be used to finance slow-paying invoices and improve cash flow. We cover the following:
- Net-30 terms and cash flow problems
- Offer early payment discounts?
- Financing invoices with factoring
- Are you a subcontractor?
- Advantages of factoring
- How to qualify
1. Net-30 terms and cash flow problems
Utility contracting companies that work directly with utility companies or as subcontractors to general contractors (GC) often give their clients 30 to 60 days to pay an invoice. Working with net-30 accounts is expected in the industry, and companies must offer them to remain competitive. The challenges of offering net-30 terms are usually dismissed as a “cost of doing business.”
However, offering net-30 terms to customers has a direct cost to the contractor. It delays their revenues and affects their cash flow. This won’t create problems for companies that have a cash reserve. Unfortunately, it can create serious financial challenges for companies that don’t have a cash reserve.
Let’s examine this situation from the utility contractor’s point of view. The company has immediate expenses such as payroll and suppliers. However, their revenues are delayed by 30 to 60 days. This delay creates a financial gap between delivering services and getting paid. Companies that face this gap without a cash reserve are forced to delay payments or worse.
These problems can get worse during the low season or if the economy is going through a recession. The best strategy is to prevent this type of cash flow problem in the first place. A simple and often effective way to do this is by offering early payment discounts.
2. Offer early payment discounts
You can improve your cash flow by offering clients a discount in exchange for an early payment. Early payment discounts provide a straightforward solution. You offer a discount of 1% to 2% to select clients who agree to pay your invoices in less than ten days.
Early payment discounts can benefit both parties. Your company gets improved cash flow to pay expenses. Your customers get an opportunity to increase profits with little risk.
Although using early payment discounts works well, they have limitations. Some customers may misuse the discounts to take advantage of your company. Furthermore, the discounts are optional. Your customer decides whether to use it or not. Consequently, early payment discounts can be unreliable.
Utility construction companies with moderate cash flow problems should consider factoring their invoices. Factoring can reliably improve cash flow and financial stability.
3. Financing invoices with factoring
Factoring is one of the most common tools companies use to finance their invoices. The type of factoring you use depends on the type of client you work with and their terms.
Utility contractors that work directly for utility companies commonly use conventional invoice factoring. On the other hand, utility contractors that work for general contractors (or builders) typically use construction factoring.
a) How does factoring work?
Most factoring transactions are not structured as a loan. Instead, your company sells its accounts receivable to a specialty finance company. The factoring company provides an immediate advance, which improves your company’s liquidity.
Transactions have two installments. The first installment covers 70% to 85% of the invoice. The factoring company deposits this advance into your bank account shortly after processing the invoice. Your company gets the second advance, less the finance fees, as soon as your customers pay the invoice in full. You can learn more by reading “How Does Factoring Work?”
4. Are you a subcontractor?
Utility construction companies that operate as subcontractors typically use construction factoring. In this case, your company does not work directly for the utility company or builder. Instead, your company works for another company that is the general contractor.
Construction factoring is a specialized type of financing. It has been adapted to handle the common billing practices of the construction industry. There are four important differences between both financing products. They are as follows:
a) Lower advances
Construction factoring advances are usually lower than invoice factoring advances. This difference is due to the higher risk of these transactions. Advances can range from 70% to 80% and are typically adjusted based on transaction parameters.
b) Progress payments
Construction factoring companies can handle progress payments – which general factoring companies can’t. Progress payments are partial payments based on a percentage (or similar metric) of project completion.
c) Retainage invoices
Some general contractors withhold a percentage of each invoice as retainage. Retainage is usually between 5% and 10% of the project cost. Unfortunately, retainage invoices cannot be factored. This is because they take over 90 days to pay and often have disputes.
d) Pay-when-paid
Some general contractors have a “pay-when-paid” clause in their contracts. This clause allows them to pay their subcontractors only after they get paid by the utility company or builder. Unfortunately, this clause could lead to you not being paid even though your company completed the work.
Construction factoring companies can finance these invoices only if the general contractor waives the clause. In our experience, getting this waiver is not easy. However, you have a better chance of success if your work is essential to the project.
e) Invoice verifications
Every factoring company verifies invoices as part of its funding process. However, construction factoring companies use a more stringent verification process. Invoices for progress payments are verified to ensure that the project segment has been completed. Invoices that are subject to a “pay-when-paid” clause are verified to ensure the clause has been waived.
5. Advantages of using factoring
Factoring plans have several advantages over other solutions, such as bank loans, lines of credit, and merchant cash advances. These are the five most important advantages:
a) Improves cash flow quickly
The main benefit of a factoring plan is that it can improve your cash flow quickly. This benefit is important for utility contractors that have immediate payroll and supplier expenses.
b) Easier to obtain than loans
Most commercial lines of credit and bank loans have complex qualification criteria. They often require assets and a track record of profitability. These requirements make it difficult for new and small subcontractors to qualify.
c) Adapts to your revenues
Factoring lines are flexible and adapt to your changing revenues. The line can increase, often automatically, as long as you invoice creditworthy utility companies, builders, or general contractors.
d) Fewer covenants than a loan
Unlike loans, factoring lines don’t have complex covenants. They are easy to maintain. Your company does not need to provide the lender with ongoing financial ratios and financial information.
e) Does not require long-term commitments
Most factoring plans can be used for a short period of time to handle specific challenges. This period of time varies by factoring company, so you should discuss it with your provider.
6. Qualification criteria
Getting financing can be difficult for utility construction companies and construction companies in general. Most subcontractors can’t meet most lender requirements, especially if their company is small. Factoring has simpler qualification requirements, making it a suitable choice for many contractors. Here are the most important requirements. Your company must:
- Work with commercial clients
- Have clients with good business credit
- Not have liens against its accounts receivable
- Not have serious legal or tax problems
Get more information
We are a leading construction factoring company and can provide you with competitive terms. For more information, get an online quote or call us toll-free at (877) 300 3258.