Managing the cash flow of an oil and gas pipeline construction and maintenance company is challenging. Managers at the company often face complex operations and demanding cash flows. Consequently, the company risks financial problems if its finances are not managed correctly.
This article discusses companies’ most common cash flow problems and provides two possible solutions. We cover:
- Fast growth and cash flow problems
- Early payment discounts
- Finance your invoices
- Is it right for your company?
1. Fast growth and cash flow problems
The oil and gas industry is dynamic and unpredictable, often going through periods of quick expansion and pauses. Managing the cash flow needs of oilfield construction and maintenance companies is challenging. It requires careful balance and financial discipline.
On one hand, you have expenses that need to be paid quickly. Expenses include payroll, supplier invoices, etc. On the other hand, your clients pay your invoices in 30 to 60 days. You often have to pay expenses out of your cash reserve and then settle once invoices are paid.
Having net-30 accounts is a common practice in the oil and gas industry and is not a problem for companies with adequate reserves. However, it could be a problem if your company is expanding and you are taking on new projects. This challenge often affects small and growing companies.
This problem can become severe if it’s not managed correctly. There are two options for solving this problem. The first option is to ask clients to pay sooner. If that solution does not work, consider using financing to enhance your cash position.
2. Early payment discounts
Pipeline maintenance and construction companies whose financial problems are not severe should first consider offering early payment discounts. It’s a common solution to this problem and can work well.
Early payment discounts work by offering customers a discount if they pay their invoice in less than ten days. The usual discount averages 2%, though it is negotiable. Your customers can pay early and get the discount or pay the invoice amount on their usual terms without the discount. The customer chooses which option suits them best.
Companies can make the mistake of offering early payment discounts to customers with bad payment track records. They hope that the discount will motivate them to pay sooner. This strategy seldom works and usually backfires. A better strategy is to offer these discounts only to your best customers. These customers have the best chance of using the discount.
Early payment discounts have some disadvantages as well. Your customers get to choose if or when they use it. Consequently, you are never certain if the customer will pay early. Keep in mind that companies tend to avoid taking advantage of early payment discounts during times of economic uncertainty.
3. Finance your invoices
Pipeline construction and maintenance companies that need a reliable option to improve cash flow should consider financing their invoices. This option is known as invoice factoring. Factoring companies buy your invoices at a discount and provide immediate funds to cover payroll and other business expenses. To learn more, read “What is Invoice Factoring?”
Factoring transactions buy your company’s accounts receivable in two instalments. The first instalment covers between 75% and 85% of the invoice and is deposited into your bank account shortly after you submit the invoice. The remaining 15% to 25% is deposited into your bank account once your end customer pays the invoice on their usual terms. The factoring fee is subtracted from the second instalment. To learn more, read “How Does Factoring Work?”
There are two types of factoring that could help your company. The specific factoring program you select depends on the type of work, customers, and payment terms from your customers.
a) Construction factoring
Companies who use progress billing and are involved in the actual construction of the pipeline need to use construction factoring. Progress billing includes billing based on completed percentages or stages.
Construction factoring is a specialized product that handles only transactions for construction projects. These specialist companies have the infrastructure to handle the complex contractual and financial relationships between subcontractors and general contractors.
The main differences between conventional and construction factoring include a different advance and cost structure and a customized verification process.
b) Conventional factoring
Companies that invoice for completed work should use conventional invoice factoring instead. This type of factoring applies to most companies that handle pipeline maintenance and oilfield services. Depending on their billing practices, it may also apply to some subcontractors of a new facility or pipeline infrastructure.
This type of factoring is the most common and is offered by almost every factoring company. It is more flexible and does not require the comprehensive verifications associated with progress billing.
Using accounts receivable factoring to improve cash flow has several benefits over other solutions. The benefits include the following:
a) Improves cash flow quickly
The most important advantage of implementing a factoring solution is that it improves your cash flow quickly. It also allows you to offer net-30 terms to clients, which minimizes the associated cash flow issues of waiting for payment.
b) Available to small companies
Conventional factoring lines are available to small companies. Finance companies can work with new businesses that have just started billing clients. Construction factoring companies in Canada often have minimums, though. Consequently, your company needs to meet those minimums to qualify.
c) Adapts to growth
The line is adaptive and can grow as your company grows. This benefit is important because your line won’t need to go through the full underwriting process or a credit committee before the increase. The process is usually automatic, though some finance companies may need to briefly review your account before the line increase.
d) Easy qualification
Qualifying for a factoring line is comparatively simple. Lines don’t have the comprehensive and demanding requirements often associated with loans and lines of credit.
Using factoring can improve your cash flow. However, the solution also has some limitations that companies should examine. The three main limitations are as follows:
a) Solves a single problem
The most crucial limitation of factoring is that it solves a single problem. Factoring is designed to improve cash flow if the problems are due to slow-paying customers. The solution won’t help – and could actually hurt – if your cash flow problems are due to low profitability or declining sales.
b) Comparatively expensive
Factoring programs are more expensive than lines of credit or loans of comparable size. They work best for companies whose customers pay in less than 70 days and whose profit margins exceed 20%.
c) Customer involvement
Your customer will be aware that you are using a factoring line. Companies that use construction factoring may need to get additional signatures from their general contractors. This customer involvement is not necessarily a problem, but it is something you should be aware of.
6. Is factoring right for your company?
The best way to determine if factoring is the right option for your company is to review your situation with your finance team. In general, this solution will help you if the following are true:
a) Your profit margins exceed 20%
As mentioned earlier, factoring can be an expensive type of financing. However, companies with a profit margin that exceeds 20% should have a sufficient cushion to allow them to maintain reasonable profitability.
b) Your clients pay in less than 70 days
The cost of factoring is tied to the length of time it takes your clients to pay their invoices. As with all revolving lines of financing, the financing cost increases as time goes by. Factoring works best in transactions where invoices are paid in less than 60 to 70 days.
c) Your cash flow problems are due to slow-paying invoices
Managers should always match the type of financing they use to the problem they are trying to solve. A factoring line helps you only if your main cash flow problem stems from slow-paying invoices.
Get more information
We are a leading provider of factoring financing to companies in the oilfield services industry. For more information, get an online factoring quote or call us toll-free at (877) 300 3258.