Most construction subcontractors experience financial problems at one time or another. The industry is known for working with tight cash flows. This situation can create serious challenges for business owners and affect their ability to run and grow their companies. In this article, we discuss alternatives to solve this problem once and for all. We cover:
- Slow-paying clients create cash flow problems
- How to improve cash flow without financing
- How to finance progress payments and invoices
- “Pay-when-paid” clauses
- Qualification requirements
- Bonded projects
- Advantages and disadvantages
1. Slow-paying clients and cash flow problems
Construction subcontractors who work with general contractors (GCs) and commercial clients usually have to wait 30 to 60 days to get paid. This situation can be challenging because subcontractors are often responsible for a number of expenses that must be paid beforehand. This situation is a common source of financial problems for construction companies.
Companies often respond to this situation by juggling supplier payments and hoping for the best. This strategy can work sometimes, but it often leads to problems with suppliers. Furthermore, some expenses can’t be “juggled,” such as payroll, insurance, or taxes.
2. Improve cash flow without financing
Your first step should be to determine if you can fix your cash flow by improving operations. You should consider financing only if improving operations won’t fix your problem.
a) Improve invoicing and collections
Many small businesses encounter cash flow problems simply because their invoicing and collections are not well organized. Fortunately, this problem is easy to fix and can improve your cash flow quickly. Here are some suggestions:
b) Offer early payment discounts
If your invoicing is working well, but you still have cash flow problems, consider offering discounts for early payments. These discounts are easy to implement. Simply provide the client a small discount if they pay within ten days. Here are some common ways to offer them:
The “1%/10” in the first example states that the client gets a 1% discount if they pay in 10 days. The “Net 30” means that if the client does not take the incentive discount, they can pay the total amount in 30 days. Keep in mind that these discounts are optional, and your clients decide whether to take them or not.
3. Finance progress payments and invoices
If your invoicing and collections are not working well and early payment discounts are not helping, consider financing your invoices using construction factoring. These plans provide immediate cash flow, which you can use to cover the costs of operations.
Factoring plans finance your invoices in two installments. The first installment is deposited to your bank account shortly after you submit the the invoice and the factoring company approves it. This installment covers up to 80% of the value of the invoice.
The second installment, less the factoring cost, is deposited to your bank account once your end customer pays the invoice in full. This payment settles the transaction. Construction subcontractors can use factoring as needed. To learn more about factoring, read “How Does Invoice Factoring Work?“
While the process is simple, financing construction receivables can be challenging. This is because most construction companies invoice for progress payments that are also subject to a “paid when paid” clause. These invoices have a higher risk of being disputed and only some factoring companies are comfortable financing them.
4. “Pay when paid” clauses
Invoices that have “pay-when-paid” clauses are riskier to finance than conventional invoices. These clauses allow general contractors (GCs) to delay paying subcontractors until they receive payment from the project owner. Furthermore, a GCs payment may depend on work performed by several subcontractors. Consequently, your company could experience payment delays unrelated to its own work.
Some construction factoring companies avoid financing invoices with these clauses because of the additional risk. However, specialized construction factoring companies can finance them without requiring the GC to waive the provision.
In our experience, many invoices subject to “pay-when-paid” clauses can be financed if the GC is creditworthy and your company has a solid track record. We evaluate these transactions on a case-by-case basis rather than automatically rejecting them. This approach allows us to finance qualifying invoices that other factoring companies may decline.
5. Qualification criteria
To qualify for a factoring plan, companies must meet these criteria:
You can find additional information here.
6. Why can’t my company be bonded?
Unfortunately, we cannot work with subcontractors who have a direct performance bond (a surety bond) for the project they wish to finance. The bonding company usually has a lien on the receivables, and factoring companies cannot purchase receivables encumbered by liens. However, we can work with subcontractors working for general contractors who have their own performance bond.
7. Advantages and disadvantages
Factoring lines have a number of advantages and few disadvantages. Advantages include:
However, the solution has a couple of disadvantages that business owners should keep in mind. Factoring is more expensive than conventional financing. Consequently, your profit margins must be high enough to support the cost of financing.
Factoring is a solution that is designed to solve one problem: cash flow issues from slow-paying customers. It’s great at solving this specific issue but won’t be of much help if your problems are not due to slow-paying invoices.
Get more information
We are a leading construction factoring company and can provide you with competitive terms. For information, get an online quote or call (877) 300 3258.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.