Many underground utility locating companies find it challenging to wait 30 to 90 days to get paid by commercial clients. Offering payment terms is a standard business practice. However, it can create cash flow problems for companies that aren’t well-capitalized. This article explains how to improve cash flow by financing invoices using factoring. The article covers the following:
- Slow cash flow challenge
- Can early payment discounts help?
- Factoring your invoices
- Are you a subcontractor?
- Advantages of factoring invoices
1. Slow cash flow challenge
One of the biggest challenges for small underground utility locating contractors is waiting for their commercial clients to pay their invoices. Most utility companies, builders, and general contractors expect to get net-30 to net-60 day payment terms. This is a common business practice that companies have to follow if they want to remain competitive. However, this practice can also create financial problems for some utility locating companies.
Let’s review an example. Many underground utility locating companies handle “dig safe” calls (e.g., dialing 811 in most states) for local utilities. These contracts provide regular work and can make the majority of the revenue for some utility locating companies. However, the utilities (or the master contractor) pay their invoices in 45 days.
Now, let’s examine this transaction from the underground utility locating company’s point of view. Payroll is usually their largest expense, and it is paid every week or two. However, there is a time lag between when you must pay employees and when clients pay their invoices. This time lag is the source of the problem.
Companies with a cash reserve can cover this time lag while waiting for invoice payment. Unfortunately, companies without a reserve run the risk of financial problems. These financial problems can grow unless they are fixed quickly. The simplest way to solve this problem is to use early payment discounts. We cover this strategy in the next section.
2. Can early payment discounts help?
Using early payment discounts is an effective strategy to improve your cash flow. Companies typically offer a 1% – 2% discount to select clients that agree to pay their invoice in less than ten days. This strategy works well for companies that have minor cash flow problems. They also benefit your clients because the savings increase their profit margins.
However, early payment discounts have some limitations. They are optional, which means you never know if a client will take advantage of them. They can also be abused, so they have to be offered selectively. Lastly, your clients may avoid taking advantage of them during recessions when you most need quick payments.
Companies that cannot improve their cash flow with early payment discounts should consider using invoice factoring. We will discuss this strategy in the next section.
3. Factoring your invoices
Underground utility locating companies that work with commercial clients can improve their cash flow by factoring their invoices. This solution lets you finance your accounts receivable and provides immediate funds to cover company expenses.
Invoices are financed in two installments. You get the first payment shortly after sending the invoice to the factoring company. The second installment is paid once your customer pays the invoice in full. Note that the factoring fees are subtracted for the second installment. To learn more, read “What is factoring?” and “What is a factoring company?”
4. Are you a construction subcontractor?
Companies that work as subcontractors to a general contractor, master contractor, or builder may need construction factoring instead of conventional factoring. Construction factoring is a specialized form of financing designed to help subcontractors. This solution has the capability to handle progress payments and “paid when paid” clauses, which are common in construction.
a) Progress payments
Most subcontractors get paid through progress payments, though they are less common for underground utility detection companies. Progress invoices cover a portion of a project rather than the whole project. These invoices require a more comprehensive verification process which construction factoring companies are equipped to do.
b) Pay-when-paid clauses
Many underground utility locating companies work through master contractors (or general contractors) rather than directly for utility companies. Some master contractors use “paid when paid” clauses in their contracts. These clauses enable the master contractor to pay you only when and if they get paid. These clauses are considered to have a high risk of non-payment. Construction factoring companies can finance these invoices only if the master contractor waives this clause.
Some general contractors or master contracts withhold a portion of each payment until the end of the project. The retainage portion usually goes from 5% to 10%. Unfortunately, retainage invoices cannot be factored because they are usually open for more than 90 days and can be subject to disputes.
5. Advantages of factoring
Factoring lines have several advantages over other solutions. These are the four most important benefits of the solutions.
a) Improves cash flow
The most important advantage is that factoring can improve your cash flow. This improvement can become noticeable shortly after deploying the factoring line. Furthermore, the solution enables you to offer clients net-30-day terms (or longer) while minimizing the financial risks of doing so.
b) Can be obtained quickly
Factoring lines can usually be deployed in 2 to 5 days, though this depends on the details of your transaction. This is considerably faster than loans and lines of credit. Consequently, it can be a viable solution for companies that need immediate funding.
The line’s credit limit is flexible and linked to your revenues. Consequently, the line can adapt as your company and revenues grow. Qualifying for increases is usually simple and can be done as quickly as one day.
d) Simple qualification requirements
Factoring lines have simpler qualification requirements than loans and lines of credit. In general, underground utility detection contractors must:
- Invoice on net-30 to net-80 terms
- Work with creditworthy commercial clients
- Not have serious tax or legal issues
- Not have their A/R encumbered by liens
6. Is factoring right for you?
Factoring lines are specifically designed to solve a single problem. They will help you only if your cash flow problems are due to slow-paying invoices. It will not help you if your financial problems are related to other issues, such as profitability. In general, factoring can help companies that have:
- Cash flow issues due to slow-paying invoices
- Creditworthy clients
- Profit margins higher than 20%
- An experienced management team
- No serious legal or tax problems
Note: Consult a CPA or similar professional if you are unsure if factoring is right for you.
Get more information
We are a leading construction factoring company and can provide your utility locating company with competitive terms. For information, get an online quote or call (877) 300 3258.