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Factoring for Businesses in the Construction Industry

February 16, 2021

Finance-Business-Factoring-Construction

Oftentimes, we are placed in situations where we worry about our customers and clients paying us back. We may need to call multiple times, leave countless voicemail messages, or even track customers down in person just to receive payment. This process is stressful, time consuming, and extremely inconvenient. But, there is a solution to this problem: factoring.

 

What is Factoring?

When businesses sell their products to clients they may not always receive payment upfront; some companies offer net terms of 30, 60, and even 90 days. When this occurs, it becomes difficult for business owners to pay for the production of more inventory and pay their workers. Say, for example, a client buys 100 pieces of sheet metal from your company. After the purchase is completed, you have successfully sold 100 pieces, but you may have to wait for your client to pay overtime. You are now out of money and unable to afford more inventory and employee’s salaries.

This is where factoring comes into play. Companies that offer factoring essentially ensure that when businesses sell materials and offer net payments they will get paid the day the sale is made. These companies will also manage invoices, ensuring that clients who choose to pay overtime are meeting their deadlines. For instance, let’s reference our sheet metal example. If your business were to use a factoring company to manage invoices, you would receive a certain percentage of the sheet metal price the day you sell it. This enables you to start adding on more inventory and start paying your employees the day the sale is made. After this, the factoring company will ensure that you are being paid in alignment with invoice deadlines. Even if the client you sell to goes bankrupt, the factoring company will pay you the owed balance.

 

Types of Factoring
  • Recourse Factoring
      1. Recourse factoring is the most common type of factoring. Under this type of factoring, the business selling their invoices to a factor must buy back any invoices that go unpaid. There is also no debt protection under this type of factoring, as factoring companies are not responsible for ensuring that invoices are collected on time.
  • Non-Recourse Factoring
      1. Non-recourse factoring places the responsibility of collecting invoices on the factoring company. The business that sends out the invoice is not responsible for managing or collecting any unpaid invoices.
  • Reverse Factoring
      1. Reverse factoring, also called supply chain finance, works in the opposite direction of invoice factoring. Instead of a buyer factoring customer invoices, it factors supplier invoices. The benefits of reverse factoring are that the buyer has more time to pay while the supplier gets their invoice paid faster. Here’s how the process works:
        1. Buyer places an order with a supplier
        2. Supplier fulfills the order, sends the invoice to buyer
        3. Buyer approves the supplier’s invoice and agrees to pay the factoring company later
        4. Supplier then sells the invoice to the factoring company at a discounted rate
        5. Buyer, at the maturity of the invoice, pays the factoring company
  • Invoice Financing/Invoice Discounting
    1. Invoice financing, also known as invoice discounting, involves the factoring company paying a portion of the supplier’s invoice. Once the supplier’s customer pays the invoice, the invoicing company will pay back the lender/supplier. The supplier company is responsible for collection/non-payment. The supplier is not selling invoices but rather using invoices as collateral for a loan, usually in bulk. The agreement is ordinarily confidential, without the customer knowing. Here’s how the process works:
      1. Supplier submits their invoice to a factoring company
      2. Factor pays the supplier a portion of the invoice- usually 80% to 90%- in the form of a loan or line of credit
      3. Buyer pays the supplier back
      4. Supplier pays the factor back the amount loaned, minus fees and interest. In this scenario, supplier is responsible for collecting outstanding money owed by buyer

 

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What are the Advantages and Disadvantages of Factoring?

Factoring can be an extremely useful tool when it comes to managing business finances and ensuring that invoices are paid. But, it is also important to understand the benefits and risks associated with using factoring.

Advantages:

  • Time-Saving. While a factoring company is managing your invoice collection, you can spend this newly free time working on projects, expanding inventory, and growing your business.
  • Growth. You can use the instant cash that factoring companies gives you to hire an ad specialist, employ a new salesperson, start a new campaign, etc.
  • No Collateral Needed. Unlike bank loans, factoring doesn’t require that you use any of your assets as collateral for payments.

Disadvantages:

  • Less Invoice Control. When you hand your invoices over to a factoring company, you also hand that company the ability to deny doing business with one of your customers on the grounds of poor credit history. You will have less control over who you can do business with.
  • High Rates. Although a good alternative, factoring can be costly. Factoring companies usually keep between 1-4% of receivables and they charge a prime rate plus 2% for all cash advances. This can easily add up to 30% paid in yearly interest.

 

Is Factoring Right for my Business?

Factoring has its advantages and disadvantages. Gauging the financial situation and current state of your business can help you see if factoring would serve you well. If you can muscle the high rates of factoring, it may very well pay off. But, if your business is still pushing to gain that strong financial muscle, factoring may not be the best choice for you. Always remember to weigh the benefits and risks together to see how factoring would affect your own business.

 

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