Managing the cash flow of a directional boring/directional drilling company can be challenging. Like most companies in construction, they face a common cash flow dilemma. The company has to pay expenses quickly but must also wait up to 60 days to get paid by clients. This situation can leave directional boring companies with a cash shortfall – unable to meet obligations or take on new clients. Fortunately, there are a few ways to solve this problem. In this article, we discuss some solutions:
- Net terms and slow payments
- How to avoid cash flow problems
- Financing slow-paying invoices
- How does factoring work?
- Construction factoring differences
1. Offering net-30 terms hurts cash flow
Most utility, commercial, and construction projects have contract clauses that allow clients to pay invoices in 30, 45, or 60 days. Having customers as net-30 accounts is a standard commercial practice that benefits your clients. The delay allows your clients to use your services for up to 60 days before paying for them. However, there is another side to this transaction.
Offering payment terms can create problems for your business. Many small drilling and directional boring companies don’t have the financial resources to wait a month or more for payment. They need immediate funds to pay suppliers, payroll, and other expenses. This situation leaves your company in a vulnerable financial position.
2. How to avoid cash flow problems
The best strategy to avoid cash flow problems is to take steps ahead of time to ensure your company is well-prepared. The best option is to build a well-funded cash reserve. A reserve allows you to weather financial problems while you operate the company normally. An alternative is to offer early payment discounts to clients. Early payments are useful if your company has minor cash flow problems.
a) Build a cash reserve
An emergency cash reserve puts your company in a strong position and helps minimize the need for future financing. A well-funded reserve allows the drilling company to operate while waiting for client payments. The size of the reserve is a matter of opinion and preference. Ideally, it should cover a couple of months’ worth of expenses.
Setting up a cash reserve involves putting away some company profits into a savings account. You can build it slowly as long as you are disciplined and consistent.
b) Offer discounts for early payments
A second strategy to avoid cash flow problems is offering clients early payment discounts. The strategy is simple and effective. Your directional drilling company gives clients a 1% to 2% discount if they pay their invoices within ten days. Otherwise, the client pays the total amount on their usual terms. Clients like these discounts because the discounts reduce their costs.
If you cannot build a cash reserve and early payment discounts are not sufficient to solve your problems, you should consider getting financing. One alternative source is to use factoring to finance your slow-paying invoices.
3. Use factoring to finance slow-paying invoices
Companies with cash flow problems can use invoice factoring to finance their slow-paying invoices. Factoring improves your cash flow and provides funds to cover ongoing expenses. More importantly, it can be used as a financial platform to grow the business.
Directional drilling contractors can use two types of factoring programs. The factoring program your company uses depends on who your clients are and how they pay you.
a) Conventional factoring
Companies that bill by the foot (or similar) and don’t have any of the billing issues commonly associated with construction should use invoice factoring. Most factoring companies offer this solution, and it is the most flexible.
b) Construction factoring
Directional drilling companies that work with general contractors (GCs) or certain commercial clients commonly use construction factoring. This factoring solution has been tailored to the specific needs of subcontractors. It can be used by companies that have the typical challenges associated with construction invoices:
- GCs with “paid-when-paid” clauses
- Retainage invoices
- Percentage-based progress payments
4. How does factoring work?
Invoice factoring and construction factoring work very similarly. The factoring company buys your accounts receivable in exchange for an immediate payment. The purchase is made in two installments.
The first installment is deposited into your bank account once you submit the invoice to the factor. The first installment covers 70% to 85% of the invoice, depending on the type of factoring you use.
The second installment covers the remaining 15% to 30%. The factoring fees are deducted from this installment. Learn more by reading “How Does Invoice Factoring Work?”
5. Construction factoring differences
Construction factoring is similar to invoice factoring but has some important differences to adapt to construction industry practices:
a) Lower advances
The first installment in a factoring transaction is commonly called the advance. The average advance is 75% but varies based on transaction details. Construction factoring programs often have lower advances due to the risk and billing practices.
b) Progress payments
Construction factoring programs can handle conventional progress payments. A progress payment allows you to invoice once a specific project stage has been reached, such as percentage completion. Factors use special verification techniques to manage these invoices.
c) Pay-when-paid clauses
Some general contractors have a so-called “pay-when-paid” clause in their contracts. These clauses allow the GC to pay you only when they receive a payment. Consequently, you could fulfill your contractual requirements and have your payment delayed because of issues unrelated to your company.
Construction factoring programs can finance these invoices if your GC agrees to waive the “pay-when paid” clause. In our experience, getting a GC to waive this clause is difficult. You have a greater chance of getting the waiver if your work is essential to the project.
Some general contractors and commercial clients hold off a portion of your payments until the project ends. This holdback is known as retainage. Retainage invoices can cover 5% to 10% of the project value. Unfortunately, retainage invoices cannot be financed due to their risk.
e) Invoice verifications
Factoring companies verify invoices before funding them. This step helps ensure that the invoice is accurate and work has been completed. Construction factoring verifications are usually more stringent than conventional invoice factoring verifications. For example, invoices for progress payments are verified to ensure the work segment has been completed. Invoices subject to “pay-when-paid” clauses are verified to ensure the clause has been waived.
Factoring lines have several advantages over other solutions. These include:
- Effective: The line can solve cash flow problems effectively
- Speed: The line can be deployed in days
- Flexibility: The line adapts to growing businesses
- Ease: The line has simple qualification requirements
7. Qualification requirements
Qualifying for construction factoring is easier than obtaining other solutions. The main requirements for construction factoring include the following:
- Invoice a minimum of $100,000 per month (if using progress payments)
- Have clients with good commercial credit
- Invoices must be free of liens/encumbrances
- Payroll taxes must be up to date (or have a payment plan)
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.