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Your guide to construction invoice factoring

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Managing cash flow is a critical challenge for construction businesses, which are often impacted by payment delays that are all too common in the industry. These delays can have significant consequences—delaying project delivery timelines being just one problem. This is where construction invoice factoring can be a help.

Invoice factoring converts receivables into immediate cash, providing a lifeline to businesses grappling with delayed payments.

In this blog, we’ll get into the ins and outs of invoice factoring for construction companies, the steps involved, why construction companies choose the option (and how they benefit), what you can use this financing for, and the difference between invoice factoring and receivables financing.

What is construction invoice factoring?

Construction invoice factoring offers a cash advance for unpaid invoices. It’s not a loan, but an advance against your open invoices. You get funds in a few business days, expediting your cash flow so you can start new projects quickly and ensure faster payment over traditional invoicing.

When you take this route, you receive up to 80% of the invoice value in cash. After your client pays, you get the balance, minus fees and interest. As a result, it’s used to bridge the gap between job completion and invoice payment. This helps you manage multiple projects while covering ongoing expenses.

The steps in factoring construction invoices:

Invoice factoring in construction follows a straightforward process:

  1. Service Completion: The process begins when you complete your services and generate an invoice for the client.
  2. Invoice Submission: This invoice is then sent to the factoring company, initiating the factoring process.
  3. Invoice Approval: The factoring company reviews the invoice. Upon approval, it agrees to buy the invoice.
  4. Cash Advance: Based on an agreed-upon advance rate, the factoring company sends a cash advance to the construction company minus the cost of capital (or the discount rate). This rate typically covers a major portion of the invoice value.
  5. Reserve Account: The remaining balance of the invoice value, not covered by the cash advance, is held in a reserve account by the factoring company.
  6. Client Payment: The client then pays the invoice amount directly to the factoring company, not the construction company.
  7. Reserve Release: Once the client pays the invoice, the factoring company releases the remaining balance in the reserve account to the construction company, minus any fees or interest.

 

An example of the numbers behind invoice factoring for construction

Let’s say Smith Construction has an outstanding invoice worth $150,000. Their factoring company offers a rate of 80%.

Based on this rate, Smith Construction receives a cash advance of $120,000 (80% of $150,000).

The factoring company applies a discount rate of 3%.

Applying the discount rate to the invoice value, the purchase price becomes $145,500 ($150,000 – 3% of $150,000, which is $4,500).

The difference between the invoice value and the cash advance, which is $30,000 ($150,000 – $120,000), is held in a reserve account.

The factoring company waits for the client to pay the full invoice amount.

Once the client pays the invoice, the factoring company releases the balance from the reserve account to Smith Construction. This amount would be the reserve minus any additional fees or the remaining purchase price after the discount. If there are no additional fees, Smith Construction would receive the balance of $25,500 ($145,500 – $120,000).

Why construction companies choose invoice factoring

Invoice factoring provides a host of advantages for construction companies, particularly in addressing the industry’s slow payment cycles.

One of the primary benefits is how fast invoices can be processed, often within days, eliminating the lengthy wait times that can span months. This quick turnaround is facilitated by high advance rates, with companies able to receive a large portion of their invoice value ASAP.

You can also rely on a reduced administrative burden. Factoring lessens the workload involved in invoice collection, freeing up resources and time for other critical business operations.

Moreover, invoice factoring is suitable for various construction specialties—it serves as an ideal alternative for companies that may not qualify for traditional loans. Construction invoice factoring is also especially beneficial in situations involving a high volume of invoices. (You likewise get an effective way to cover immediate expenses and support business expansion.)

 

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What can I use invoice factoring for in my construction business?

Firstly, it plays a pivotal role in payroll management. The construction industry often faces the challenge of ensuring timely payments to employees, especially when revenue is tied up in unpaid invoices.

Secondly, it enables you to expand your business. With the immediate cash available through factoring, construction businesses can confidently take on new projects without the typical delays caused by waiting for payments. This capability is crucial for maintaining competitive momentum and capitalizing on market opportunities as they arise.

Lastly, factoring helps in managing operating expenses, which can be significant. The cost of maintaining equipment, as well as transportation expenses, are ongoing challenges.

 

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What about construction receivables financing?

Construction invoice factoring and construction receivables financing (otherwise known as invoice financing) are two distinct financial services used to manage cash flow, but they differ in several key ways.

One primary difference lies in the control of collections. In construction invoice factoring, the factoring company takes over the collection of payments from clients. In contrast, with receivables financing, the construction company retains control over client payment collections.

This can impact client relationships and the business’s autonomy in managing its receivables.

Another difference is in the advance rate. Construction invoice factoring typically provides an advance of up to 80% of the invoice value, with the remainder paid out (minus fees) once the client settles the invoice. On the other hand, receivables financing often offers an advance of 100% of the invoice value, providing more immediate cash flow to the business.

Lastly, receivables financing is often more technology-friendly, offering electronic processing and online fund management. This digital approach can streamline operations and provide more flexibility in managing finances, a significant advantage in today’s fast-paced business environment.

Not sure if you need construction invoice factoring or another form of financing? We can help you understand the differences and find the best fit for your business.

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Our commitment is to understand your business’s potential beyond just the numbers. We’re here to offer insights and guidance—not just financing.
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