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How “Factoring” Provides Contractors Access to Working Capital

Being a contractor in today’s environment is extremely difficult. Banks are not lending and contractors are reliant on their customers to pay their invoices in a timely manner — and all the while you’re expected to make payroll, pay vendors and try to grow your business. This is impossible without access to working capital and if a bank won’t lend you the money you have got to either:

  • Turn down jobs
  • Find jobs where GC’s/owners pay promptly, which aren’t abundant because most contracts are “paid-when-paid”
  • Find an alternative solution to improve their cash flow

Subcontractors bear most of this burden because they are furthest from the cash flow. On top of the slow payment terms, most general contractors or owners hold a 10% retainage from each pay application, further crippling their cash flow.

One increasingly used solution is called factoring. Factoring provides contractors access to immediate working capital without any additional burden on the GC or owner to pay quicker than they normally would. It allows contractors to consistently meet their payroll, pay vendors timely and bid on more jobs they otherwise couldn’t. Here is how factoring works:

  • A contractor sends the factoring company an invoice for work they’ve completed.
  • The factoring company wires up to 80% of its value into the contractor’s bank account that day, holding 20% in escrow.
  • The contractor’s customer sends the factoring company the payment when the invoice is due.
  • The factoring company remits the balance of the escrow less a fee to the contractor.

Where banks will consider whether your company is financially sound when deciding to approve a loan, factoring companies don’t look at the size of your business or your creditworthiness. In fact factoring companies look at the creditworthiness of your customers. So just about any contractor that has a creditworthy commercial customer base with invoices for services rendered can benefit from factoring.

Once the contractor submits an invoice to their factoring company, the factor will pay the vendors right away. The quick payment to the vendors often allows the contractor to receive early payment discounts that they otherwise would not receive.

Understating the lien laws can often be challenging for contractors. Often times factoring companies who specialize in construction understand the lien process and can help with a basic understanding of lien laws in each state as well as get the lien releases for you. Additionally, they often subscribe to a service that gives updates on the latest changes to the lien laws by state to help you stay current with the laws for your area.

Small and growing contractors don’t always have the staff to operate as an accounts receivable department like larger companies might have. The factoring company can step in and provide some of these services including paying subs and suppliers to helping manage the financial aspects of the project and additional back office services such as making sure contracts are bonded and you have the key contacts for the job.

Factoring may not be the right fit for everyone, but with factoring volume at over $2.1 billion in 2016 (according to the 2016 highlights of the Commercial Finance Association’s Annual Asset-Based Lending and Factoring Survey) many companies see it as their key to cash flow security and growth.