Contract factoring, or factoring financing, is a type of financing often used in the construction industry. When a factoring company purchases your invoices, they will advance 80% to 95% of the value. Once your client pays the invoice, the factoring company will pay the remaining 5% to 20%- minus their fees.
In this blog, we’ll explain more about contract financing and how it can help your construction business.
Defining Contract Factoring
Factoring financing is often used in the construction industry and involves factoring all of the invoices for a particular project. This type of financing allows these companies to continue working on, as well as submitting bids for, multiple projects without having to wait for their customers to pay their invoices. It gives you the cash flow you need to take on any project that you have without worrying about finances.
Contract Factoring versus Spot Factoring
You should be aware of two types of factoring financing: contract factoring and spot factoring.
Spot factoring allows a company to get cash for a single invoice or several invoices as needed. There is no obligation for future business but remains open on an as-needed basis.
On the other hand, contract factoring is a long-term agreement between the business and the factoring company. It often includes monthly minimums and requires the company to submit a certain percentage of its invoices.
Below, we’ll explore the advantages and disadvantages of each type of factoring financing.
Advantages and Disadvantages of Spot Factoring
Spot factoring is ideal for construction companies that have good cash flow but want to expand. For example, if you submit a bid and win a particular construction project, but don’t have the cash reserves to get started, spot factoring can help.
However, while there are benefits associated with spot factoring, it’s important to note that it is more expensive than contract factoring. Since it’s a one-time transaction, the factoring company must cover the cost at one time. Additionally, spot factoring is typically only applicable to large invoices. If the invoice is too small, the factoring company may not feel that it is worth their time and effort. Finally, since the factoring company will collect payment from your customers directly, there may be communication issues between you and your client.
Advantages and Disadvantages of Contract Factoring
Contract factoring involves a large volume of invoices, which means the factoring company can charge less. In addition, since factoring financing isn’t regulated like traditional bank funding, you can work with the factoring company to negotiate a mutually beneficial contract.
You can choose to factor in all of your invoices, which allows the factoring company to handle your accounts receivable, freeing up your resources. This also creates clear communication between you and your customers, avoiding the confusion that comes with spot factoring.
The biggest disadvantage is that it requires a long-term contract with minimums that must be met.
How to Choose a Factoring Company
If you decide that factoring financing is a viable option for your business, make sure to do your research by comparing the following:
- Competitive Rates: while contract factoring is not as expensive as spot factoring, it can still cost a lot. Therefore, look for a company that offers competitive rates.
- Monthly Minimums: contract factoring usually requires that certain minimums be met each month. Find a company with a monthly minimum that makes sense for your business volume.
- Minimum Annual Revenue: many companies also require a certain minimum annual revenue. If you’re just getting started, choose a company with a lower minimum annual revenue requirement.
- Fees: pay attention to the various fees that are charged, including the factoring fee/interest rate, origination, and transfer fees.
- Funding Time: when you need quick cash, funding time is critical. Some companies can send the funds on the same day as your request. Others require a wait time of 24 hours or more.
Is Contract Factoring Right for Your Construction Business?
If you believe that factoring financing is right for your construction business, contact Scarlan Capital Group to get started. We can help you understand your options and choose the one that best fits your business. Then, we can help you apply and get funding fast.