Managing the cash flow of a directional boring/drilling company can be challenging. Like most companies in construction, they face a typical cash flow dilemma. They have to pay expenses quickly but have to wait up to 60 days to get paid. This situation can leave the company with a cash flow 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:
- Net terms and slow payments
- Solution #1: Build a cash reserve
- Solution #2: Offer early payment discounts
- Solution #3: Finance construction receivables (slow-paying invoices)
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. Getting four to eight weeks to pay an invoice is a good deal for commercial clients. This delay allows them to use your services for up to 60 days before paying for them. However, offering payment terms is not a good deal for your company.
Offering net payment terms hurts your cash flow and can cause problems. Most small drilling and directional boring companies don’t have the resources to wait a month or more for payment. They need funds to pay employees, suppliers, and other expenses. This situation leaves your company in a vulnerable position.
Solution #1: Build a cash reserve
Building a cash reserve is the simplest, yet the most difficult-to-implement, solution. However, it is usually the best solution in the long term. Ideally, your company should build a couple of months’ worth of business expenses as a cash reserve. The reserve allows the business to operate while waiting for client payments. Setting up a cash reserve is a matter of putting away some profits into a savings account.
Building a reserve has an opportunity cost, though. Funds in reserve should not be used for other purposes. Consequently, they just sit in the account. Creating a reserve fund requires a careful balance of the company’s needs and growth plans.
Solution #2: Offer discounts for early payments
You can improve your cash flow by offering early payment discounts to clients. These offerings give 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 they reduce their costs.
While early payment discounts are great for cash flow, they have some disadvantages. The most important issue is that they are not predictable. It’s hard to determine if a client will choose to pay early or not. Additionally, clients are less likely to take advantage of discounts during economic downturns, when you need quick payments the most.
If you are unable to build a cash reserve and early payment discounts are not sufficient, consider financing your invoices from slow-paying clients.
Solution #3: Finance construction receivables
Another way to improve your cash flow is to finance your slow-paying accounts receivable using construction factoring. This solution provides your company with immediate funds to cover operational expenses and grow the business.
Factoring provides many of the advantages of quick payments but does not actually require customers to pay any sooner. Instead, a factoring company provides an advance for your slow-paying receivables. The finance company holds the invoice and waits for payment while you get funds.
a) How does construction factoring work?
The factoring company finances your invoices in two installment payments. The first installment is called the advance. The advance covers about 80% of the gross value of your invoice. It is deposited in your account after the work is completed and the invoice is verified. The second payment covers the remaining 20% (less fees) and is deposited in your account once your client pays the invoice in full.
Note that retainage invoices can’t be factored due to their payment schedules.
To learn more, read “What is Factoring?”
b) Billing by the foot vs. progress payments
Most factoring companies are comfortable financing invoices that bill based on distance, such as by the foot or yard. However, some directional drilling companies use progress payments. These invoices bill for the percentage of the work that has been finished. Financing progress payments is more challenging than financing regular payments. Only a few specialized factoring companies work with progress payment invoices.
Factoring your invoices can have many advantages for your business. It improves your cash flow and puts you in a better position to operate your directional drilling company. It also allows you to offer payment terms to clients without having to worry about slow payments. If you were turning business away, or if offering terms was limiting your growth, using a factoring program can be a game-changer.
The line is flexible and can be used to grow the business. Unlike most conventional loans or lines of credit, the line can grow with your revenues. This flexibility makes construction factoring an ideal option for growing directional drillers with cash flow problems due to slow-paying clients.
Qualifying for construction factoring is easier than obtaining other solutions. The main requirements include:
- Invoice a minimum of $100,000 (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 information, get an online quote or call (877) 300 3258.