Progress payments are common in the construction industry. They are also one of the reasons why many factoring companies cannot work with subcontractors in the construction industry. This article discusses how progress payments work, why they are a problem for some factoring companies, and how construction factoring overcomes those issues. We cover:
- What is a progress payment?
- Why are progress payments difficult to finance?
- Financing progress payments using construction factoring
- Advantages and disadvantages
- Qualification criteria
- Is factoring right for you?
1. What is a progress payment?
In construction, a progress payment is a partial payment that covers the amount of work that has been completed up to the point of invoicing. There are several ways to structure these types of payments. The most common ways of progress billing are:
- Invoicing by the percentage of completion
- Billing by project stage
A subcontractor using the percentage-of-completion method sends an invoice when specific percentages (e.g., 30%, 60%, and 100%) of the project are completed. On the other hand, a subcontractor who invoices by stage sends their invoices when specific project stages (e.g., all drywall installed) are completed.
Financing invoices by project stage is easier than financing invoices based on a percentage of completion. This is because it is easier to determine if a stage has been completed than a percentage of a project.
2. Why are progress payments difficult to finance?
Progress payments in the construction industry are difficult to finance. These invoices are often disputed, especially at delivery. Furthermore, these invoices often have a “pay-when-paid” clause, which complicates the transaction. These issues increase the workload and the risk for the finance company. Consequently, most finance companies avoid these transactions.
Invoice disputes are common in the construction industry. Subcontractors and general contractors often disagree about the amount and quality of work that has been completed. These disagreements delay invoices, take time to resolve, and often leave all parties with less than they expected.
b) Issues with the final deliverable
One of the main challenges of progressive billing is that the end customer pays a substantial amount of money before seeing the finished product. It’s not unusual to see a commercial client or general contractor (GC) who accepted all partial deliveries only to reject the final product because of quality or other concerns. This is also why retainage invoices cannot be financed.
In our experience, these disputes are notoriously difficult to solve and can leave all parties disappointed. Furthermore, a short payment or non-payment on a final invoice that has been factored can have financial consequences for the subcontractors.
Many construction projects that use a GC have “pay-when-paid” clauses in their contracts. These clauses allow the GC to pay subcontractors after the end client pays them.
This clause can be the source of many problems when progress payments involve work done by many subcontractors. The GC’s payment could be delayed due to issues with another company’s work. Unfortunately, there is little a subcontractor can do in these situations. Additionally, there are also situations where GCs can delay (or withhold) a subcontractor’s payment even though the end customer has already paid. GCs can do this as a negotiation tactic or if they have cash flow problems.
3. Financing progress payments with construction factoring
One way to finance progress payments is to use construction factoring. It’s an industry-specific factoring program designed to work with construction subcontractors. Construction factoring programs can finance progress payment invoices due to be paid in 30 to 60 days. It provides the subcontractor with immediate funds to pay suppliers and employees and to run their business.
a) How does factoring work?
Invoices for progress payments are financed in two installments. The first installment is called the advance and covers 70% to 80% of the invoice. This installment is deposited to your bank account once your commercial client or GC has confirmed that the invoice is approved. The second installment is deposited to your bank account, less the cost of service, once your client pays the invoice in full. For more information, read “How Does Factoring Work?”
b) How are progress payments handled?
Most construction factoring companies handle progress payments through a modified invoice verification process. Factoring companies always verify invoices to ensure the work has been completed and is due to be paid.
In the case of progress payments, the factoring company usually asks that your customer sign a verification and acceptance document. The document states that the percentage (or stage) has been completed to their satisfaction. It also confirms they will pay the invoice in 30 to 60 days.
c) How are “pay-when-paid” clauses handled?
Factoring can work with invoices with a “pay-when-paid” clause only if the GC is willing to waive it. The factoring company requires your GC to sign an acceptance document where they agree:
- To waive the “pay-when-paid” clause
- That the work/stage has been completed to their satisfaction
- That the invoice will be paid in 30 to 60 days.
Consider discussing this topic with your general contractors early on in the process. Their agreement and cooperation with the process are essential to finance these invoices.
4. Advantages and disadvantages
Factoring programs have several benefits and a few disadvantages. Advantages of factoring programs include:
- Improves your cash flow
- Available to small and growing companies
- Easier to get than conventional financing
- Grows with your sales
However, construction factoring does have some disadvantages as a solution. These must be taken into consideration so you can have a balanced view:
- More expensive than conventional financing
- Requires the GC to sign an approval letter
- Only solves cash flow problems due to slow invoice payments
5. Who can use construction factoring?
Qualifying for factoring is simpler than obtaining other financing solutions. Some of the qualification criteria include:
1. You must work with reputable commercial customers or GCs
2. The GC or commercial client must have good business credit
3. Your profit margins must be over 20% (higher is better)
4. Your invoices should not be pledged as collateral to other lenders
5. Your company should not have an open bankruptcy
6. Your company must not have serious tax issues
This solution is available to subcontractors in most specialties, including:
- Directional boring
- Utility construction
- Drywall companies
- Construction clean up
- Most subcontractors…
If you are looking for a finance company, read “How to Choose a Factoring Company” for more detailed information.
6. Is factoring right for you?
Construction factoring is a solution designed to solve one specific problem. It can help companies only if they have cash flow issues related to slow-paying customers. Factoring works best if your profits are higher than 20%. Lastly, your GCs and commercial clients must agree with the verification/payment process.
Get more information
Are you looking for a factoring quote? We provide construction factoring at affordable terms. For more information, get an online quote or call us toll-free at (877) 300 3258.