Construction Invoice Factoring: Average Rates, Benefits, and Qualifications
When your payments are delayed, it creates a ripple effect that makes it difficult to pay your own bills and possibly even your employees. What's more, contractors have a variety of significant expenses before they even send their first invoice on a new project. If yours is a new business, the impact of slow payment is even more significant. To improve cash flow, many contractors turn to construction invoice factoring.
What is Construction Invoice Factoring?
Construction invoice factoring is a finance option used by many building contractors who need prompt invoice payment, or those who prefer to not use traditional financing to improve cash flow. These contractors may have credit tied up in purchasing new equipment, a lack of available credit, or may simply prefer to avoid a conventional bank loan.
Factoring is especially popular in the building industry, since so many contractors lack the exemplary credit rating required to receive the best interest rates. Factoring companies aren't worried about your credit-worthiness. Instead, their concern is the credit rating of the entities owing you money, since they rely on these debtors to pay the money they owe you.
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How Does Factoring Work?
Invoice factoring allows you to sell your invoices to the finance company, which then advances payment, typically between 70 and 80 percent of the invoice amount. Then, when payment is received, the factor company pays the remaining amount, minus its fee. You generally receive initial payment within days, a big improvement over waiting weeks or months to receive payment from your general contractors and customers.
The advance amount varies per provider, as does the fee charged.
What Are Construction Factoring Rates?
Factor companies offer three different fee structures.
- Tiered factoring: The most common fee structure, tiered factoring accrues fees based on the length of time the bill remains outstanding. Monthly is the more common rate, though some companies offer daily or weekly structures, as well as 10- and 15-day blocks. The shorter the accrual period, the better for the construction company, since payment on a monthly schedule results in you paying for the entire month, no matter when payment occurs.
- Flat fee: The second most common fee structure, flat fee structures are exactly what they sound like. You pay a flat percentage on every invoice, no matter how long the invoiced party takes to pay its debt.
- Prime plus: You rarely see this fee structure anymore. It uses the prime rate as the basis for your fee, plus another percentage charged by the finance company. The prime rate changes occasionally; as of July 2017, it was 4.25 percent. The finance company's rate varies, but averages between 3 and 4 percent. At the current prime rate, a fee of 3.5 percent brings your total charge to 7.75 percent. That means you pay the factoring company $7.75 for every $100 owed.
The Benefits of Invoice Factoring
Factoring offers a variety of financial benefits. First, of course, it improves your cash flow, as you no longer need to wait months to receive payment on invoices. This improved predictability allows you to invest in and grow your business without taking on new debt.
Another benefit is the fact that your invoice factoring lines increase as you bring on new clients. And, since you're getting paid for invoices within a few days, you have the funds to purchase materials for new jobs, expanding your business more quickly.
The process is also quick and easy, typically taking less than a week to establish a factoring line. Finally, it frees up administrative resources, since your staff no longer needs to hound accounts for payment.
What Are the Qualifications for Construction Factoring?
Factor companies impose certain qualifications. These include:
- Background check: Most factor companies perform background checks to determine criminal history.
- Must operate a formal business: Most factors require a corporate structure, such as a corporation or limited liability company, rather than a sole proprietorship or partnership.
- No liens or encumbrances on invoices: Accounts receivables pledged as collateral do not qualify for factoring. You cannot finance invoices already pledged to another financial institution.
- Open bankruptcy: Factors typically refuse contracts if the contractor has an open Chapter 11 or personal bankruptcy.
- Profit margins: This requirement varies, but in general you need a 10 to 15 percent profit margin.
- Tax liens: If you owe taxes, you must be on a payment plan. Also, the taxing authority (typically the IRS) must be willing to subordinate its position to the factor's.
- You must have commercial or government clients: Factors may not buy invoices from retailers.
- Your client's credit-worthiness: Factors worry more about the credit rating of who owes you than your own credit, since payment depends on your customers paying you.
Prepare for the application process by creating up-to-date financial reports, including profit & loss statements, balance sheet, and A/R and A/P aging reports. If you have any accounts over 60 days, resolve any you can.