How to Determine if Contract Factoring Is Right for Your Business
Once a factoring company purchases your invoice, they’ll pay you 80% to 95% of the invoices upfront. Once they collect payment from your customers, they’ll subtract their fee or factoring rate and give you the remaining amount.
Below we’ll take a closer look at contract factoring, a type of invoice factoring used by many construction companies, so you can determine if it’s right for you.
Contract Factoring Definition
Contract factoring is often used in the construction industry. It’s when you factor in all the invoices for a specific project. Because construction companies face cash flow shortages, they can take on multiple, larger jobs without waiting for customers to pay their invoices.
Suppose you’re like most businesses and bid on multiple construction projects per week or month without knowing which ones you’ll win. In that case, contract factoring can come in handy. It will give you continuous cash flow so that you can take on any project that comes your way without financial concerns.
Contract Factoring vs. Spot Factoring
Contract and spot factoring are the two most common types of construction invoice factoring.
Spot factoring is usually used to get cash for one or several specific invoices. With spot factoring, there’s no obligation for future business, so it’s more of an option than an obligation. On the other hand, contract factoring is a longer-term agreement that may include monthly minimums. It requires you to send the factoring company a percentage of your invoices.
The Pros and Cons of Spot Factoring
Spot factoring might make sense if your construction company maintains a good cash flow but would like to expand beyond your current capacity. If a general contractor won a large project but didn’t have the cash reserves to afford it, spot factoring the initial invoices can give them enough cash flow to avoid payment delays.
While spot factoring has several benefits, it’s more expensive than contract factoring. This is because it’s a one-time service and the factoring company has to cover all of its costs with a single transaction. In addition, spot factoring usually only applies to large invoices.
If your invoice is too small, it may not be worth the factoring company’s time and effort. There’s also a chance that spot factoring causes communication issues with your customers since the factoring company will collect payments from them directly.
The Pros and Cons of Contract Factoring
Since contract factoring involves a large volume of invoices, factoring companies charge lower rates. You might also be able to negotiate and land a discount as factoring companies are interested in developing strong, long-term relationships. Plus, they aren’t regulated like traditional bank loans, so they have the freedom and flexibility to design a contract that works well for both parties.
If you decide to factor all invoices, the factoring company can handle your accounts receivable and free up your resources. This can also lead to clearer communication with your customers and avoid the confusion widely seen with spot factoring.
The most notable drawback of contract factoring is that it requires a long-term contract with a factoring company. It also comes with contract minimums that you must meet to avoid a fine.
What to Look for in a Construction Contract Factoring Company
If you choose to move forward with contract factoring, explore all factoring companies that offer it and compare the following.
- Rates: Contract factoring is less expensive than spot factoring, but it can still cost you a lot. That’s why you should look for factoring companies that offer competitive rates.
- Monthly Minimums: Some factoring companies impose higher monthly minimums than others. Make sure you choose one with a monthly minimum that is realistic for your unique business.
- Minimum Annual Revenue: If you’re a newer construction company, you should look for a factoring company with lower minimum annual revenue requirements. Many cater to startups and newer entities with less revenue.
- Fees: In addition to a factor or interest rate, you may be on the hook for additional fees. These may include origination fees and wire transfer fees.
- Funding Times: If you need fast cash, funding time matters. Some factoring companies will send you the funds the same day you apply, while others will wait 24 hours or even a few business days.
Conclusion: Grow Your Construction Business with Contract Factoring
Construction factoring companies can help you achieve your business goals, especially if traditional financing options are out of reach.
If you go this route, compare various factoring companies and their fees. Also, be sure you can commit to a long-term contract and know how the factoring process works.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.