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When you're running a construction business, cash flow is extremely important. You can't start any jobs without enough cash to purchase your materials. Furthermore, you probably have employees to pay, and other overhead expenses. You probably even have vehicles or trucks to pay for, and getting financing for trucks isn't easy either. That's not even counting yourself. I'm sure you'd like to stock up your refrigerator at the end of the week, right?

As time goes on, it only seems to become more difficult to get a business loan, especially when you are in the construction industry. In fact, almost half of small businesses are denied financing. And a quarter of those don't even know why they were turned down.

Fortunately, there are products like accounts receivable factoring that allow business owners to finance unpaid construction receivables.

Accounts receivable factoring is a financial product for businesses that allows them to get near instant funding for their invoices, rather than waiting 30 or even 60 days to get paid. Because it does not need to be paid back, it is not quite a loan. The way it works is simple.

  1. A contractor that is in need of some cash decides to factor some of their receivables.
  2. The factoring company will determine the creditworthiness of your customers. They will also ensure that the invoice is valid, the work was actually completed, and there are no disputes over the invoice amount.
  3. Assuming everything checks out, the factor will advance your business a percentage of the invoice amount (usually within 24 hours). This working capital allows you to purchase materials and pay your workers.
  4. When the customer pays the invoice, they will remit directly to the factoring company. When this occurs, your factor will send you the remaining balance minus their factoring fee.
What Does it Cost?

Now, factoring is a bit more expensive than getting a loan. But that is because of the convenience it offers, and because most small construction businesses can't get a loan to begin with. On average, factoring fees are around 3%. This means that on a $25,000 invoice, you would be paying $750 in interest to have your money 30 days sooner. And if payment terms are extended beyond thirty days, more fees can start to accumulate.

So What are the Benefits?

While the fees are high, construction invoice factoring has many benefits if used appropriately. First, it provides a cashflow injection when you many need it most; Whether its seasonality or even if your business is growing faster than cash is coming in.

Additionally, factoring companies will not scrutinize your business financials and credit when applying to factor your invoices. It is in fact your customer (the invoicee) that will be scrutinized to ensure that they will pay the invoice. Now, that being said, most factoring companies will still require your business to be somewhat financially sound, and not involved in any litigation or tax issues. But this isn't an issue for most.

When Should it Be Used?

Because of the high fees associated with construction factoring, it should only be used when absolutely necessary. Business owners that rely on it to sustain their business long term may have some underlying business problems that need to be resolved. It is simply leaving massive amounts of cash on the table when used for long periods of time.

A great example of an appropriate time to factoring your construction invoices may be when you are experiencing a period of rapid growth. Maybe you have taken on a surprise job that is your biggest ever, and you need to purchase materials to begin work. Because the job is so big, you may not be able to afford to cover the costs. This is when factoring is a good idea. The high fees will be negligible because it allows you to do a job that you normally wouldn't be able to. This allows you to scale your company extremely fast.

What Else Should You Know?

Factoring may not be right in all situations, and it can be easy to get stuck in the trap of using it for longer than necessary. Furthermore, it is a very competitive industry which means that every factoring company wants your business. Because of this, it is important to do some research prior to making a commitment. If used correctly, invoice factoring may allow your contracting or subcontracting business to reach new heights.
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