One of the challenges of providing lumber to general contractors and builders is that you often need to provide them with 30 to 60 days to pay their invoices. Offering payment terms can strain your cash flow and affect your ability to pay your expenses. This article discusses how lumber distributors can use factoring to finance their invoices and improve cash flow. We cover the following:
- Net payment terms and cash flow
- Can early payment discounts help?
- What is factoring?
- Advantages of factoring
- Can factoring help you?
1. Net payment terms and cash flow
Lumber distributors work with a variety of retail and commercial clients. Their retail clients are usually individual homeowners and handymen who buy the lumber and pay immediately. However, commercial clients are different. Industrial clients (e.g., pallet manufacturers), home builders, and general contractors (GCs) typically ask for payment terms, also known as a net-30 account.
Offering payment terms to commercial clients gives them 30 to 60 days (negotiable) to pay their invoices. This practice is a standard in business, and most home builders, construction companies, and GCs operate this way. Not providing payment terms to commercial clients who have good business credit is seldom an option. They can always take their business elsewhere.
Getting 30 to 60 days to pay an invoice benefits your clients. They get to use your lumber and work on their construction projects for a month or two before they pay you. Lumber yards with a solid cash reserve should be able to offer these terms without a problem. However, lumber distributors that don’t have a good cash reserve can easily encounter cash flow problems.
a) Let’s examine this in more detail
The lumber distributor gets their lumber from a mill or larger wholesaler. They buy the lumber, and then it goes to the warehouse as inventory or on the sales floor to be sold. The distributor may or may not get terms from their supplier.
This business model creates the possibility of a financial gap for the lumber distribution company. They may need to pay their suppliers before they get paid by their commercial clients. Consequently, these payments need to come out of the cash reserve. If the cash reserve is low or non-existent, the company is in trouble.
Lumber distributors with minor cash flow problems may be able to solve them using early payment discounts. Distributors that cannot solve their problems with early payment discounts should consider financing options such as invoice factoring.
2. Can early payment discounts help?
A simple solution for your cash flow problem is to ask builders, construction companies, and GCs to pay their invoices quickly. A common way to accomplish this is to offer a discount if they pay early.
Early payment discounts are negotiable and range from 1% to 2%. Offer them to select clients who agree to pay their invoices in less than ten days. Clients with good cash flow will likely take your offer since the discounts increase their profits.
Early payment discounts have some limitations. They are optional, so you are never sure whether the client will pay early (and take the discount). Furthermore, most clients scale back early payments during a recession. This practice impacts your company because the early payments are most needed during recessions, when other clients are paying slowly.
Lumber distribution companies that need more reliable cash flow solutions should consider factoring. We discuss this tool in the next section.
3. What is invoice factoring?
Invoice factoring is a financial tool that allows companies to finance their accounts receivable. Factoring improves their working capital and provides funds to pay suppliers, employees, and other expenses. This solution is commonly used by companies that have cash flow problems but don’t qualify for a line of credit.
Transactions are usually divided into two installments. The first installment is called the advance. It provides an upfront percentage of the invoice, generally between 70% and 85%. Your company gets the advance once the invoices are received and verified.
The second installment is paid once your commercial client pays their invoice. The fees are deducted from this payment. This payment settles the invoice purchase. To learn more, read “How Does Factoring Work?”
a) Issues related to construction
Most factoring companies can’t handle invoices with progress billing or “pay-when-paid” clauses. In our experience, most lumber distributors don’t have these payment clauses and can use conventional factoring. However, if your contracts have these clauses, you need to use construction factoring instead. Construction factoring is a specialized form of factoring that some companies offer.
Progress payments are commonly used in some projects. These payments usually apply to subcontractors and allow them to invoice after only certain milestones are met. Construction factoring companies can finance these invoices as long as they have adequate documentation to show the milestone was met.
Invoices subject to a “pay-when-paid” clause can’t be financed unless the payer waives the clause for your contract. This is due to the increased risk associated with invoices subject to this clause. Getting a waiver is not easy and depends on your relationship with your client.
4. Advantages of factoring
A factoring line can offer several advantages to lumber distributors that need to improve their working capital. Here are the four most important benefits:
a) Improves cash flow quickly
A factoring line can improve your cash flow quickly. This is the main reason that companies get factoring financing. Lines can usually be deployed in 2 to 5 days, though this timing varies by transaction.
b) Allows you to offer net-30 terms
Most companies use factoring to offer net-30 terms to clients. This strategy allows them to minimize the risks to their cash flow. A properly used line can remove a lot of the financial stress of offering terms to clients.
c) Easier to get than bank financing
Qualifying for invoice factoring is easier than qualifying for bank financing of comparable size and flexibility. The main requirements to qualify to include having:
- Creditworthy commercial clients
- Net-30 to net-60 invoices
- Minimal tax or legal problems
- No liens against your A/R
d) Adapts to your company’s growth
The line is linked to your revenues. It can grow as you invoice more clients and your company grows. Qualifying for line increases is usually simple and can be done in a day or so.
5. Can factoring help you?
Whether factoring can help you depends on your lumber distribution company’s circumstances and available opportunities. Factoring improves cash flow if your main problem is that clients pay in 30 to 60 days. It won’t help much if your problems are due to other issues (e.g., profitability). If you are unsure, consult an expert such as a CPA.
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.