Introduction
Why is construction finance important? It is challenging keeping a business afloat inside the construction industry when dealing with delayed payments and bad debts on a regular basis. Most businesses have no choice but to wait as long as four months to receive payment on their finished projects. This naturally creates cash flow problems since employees and material supplies have to be paid for beforehand.
Thus, when payment for completed work gets delayed, a smooth transition to the next project is nearly impossible, causing the firm’s profits to take a hit. Such cases have been flagged numerous times within the construction industry and it seems smaller firms specifically get the shorter end of the stick.
Larger firms have already established a firm footing for themselves. In comparison, smaller firms do not always enjoy the privilege of settling only for the most favourable contracts since they are still trying to build their client base and reputation. However, agreeing to disadvantageous contract terms is what usually puts subcontractors at high risk of cash flow difficulties and in worst cases, business failure.
The next section addresses how construction factoring or factoring applications for payment is there to boost cash flow for small-time construction firms.
How construction finance works
Factoring applications for payments involves a type of factoring tailor-made to streamline cash flow for building firms by providing “construction loans” that are secured against any outstanding billing such as applications for payment. Construction finance allows a firm to be financially ready to fund their next project even while waiting to receive payment for completed work. The cash the firm receives from the lender goes towards purchasing of raw materials and making early payments to suppliers to capitalize on special discounts that are only available with sufficient cash flow.
Basic procedure
The construction finance lender will advance a prepayment once they have gone through the outstanding billing and related paperwork provided by the firm. These can be applications for payments or sales invoices and the prepayment varies but is usually between 40%-60% of the total figure stated in the application of payment. Hence, construction finance enables firms to have better cash flow, so they can take on more significant projects even without getting paid for completed or partially completed work.
Eligibility for construction finance
Construction finance is usually available to main contractors and subcontractors or those responsible for raising certified and uncertified applications for payment and staged invoices for incomplete contracts. Different providers can apply many terms to eligibility, but there is still room for those who may not be eligible to opt for a construction loan they can use to meet working capital requirements.
What can construction finance be used for?
Firms can use construction finance for the following:
- Employee salaries, labour costs and material supplies
- Boost working capital position
- Improve purchasing power
- Avoid raising equity
Certified applications vs Uncertified applications
Although construction finance allows for both certified and uncertified applications, if the application is the latter, then the firm can receive a more substantial prepayment. Firms can receive advances for specific invoices or applications if the need for cash arises since the option of factoring single applications for payment is also available. In such cases, the application must be certified before spot factoring and the advanced funds are usually between 45%-65% of the net value of the application.
Advantages of construction finance
- Saves time and money for firms since lenders can also oversee credit control and collection of payments which are due.
- Business can confidently move forward with their projects.
- When required, it offers confidentiality to ensure clients won’t know the firm is using the fund.
- Increases working capital and lessens administrative costs associated with delayed payments.
- When spot factoring applications, the firm does not have to sign a contract and no minimum fees apply, thus making it a viable and beneficial option.
Disadvantages of construction finance
- The facility needs to have limited use as frequent factoring of applications can incur steep interest rates that will not solve cash flow problems in the long term.
Bad debt protection
This is an effective product that can be added to an invoice finance facility to safeguard firms from non-payment of invoices which usually occurs when a client becomes insolvent.
Construction finance FAQ’s
How long does construction finance provide cover?
It is a very flexible facility in that firms can decide for themselves how long they want the fund. The timeline can be a month or more, depending on the firm’s needs.
How soon can a firm arrange for construction finance?
Once all the necessary paper is in place, prepayment can be received in as little as one week.
What costs are associated with construction finance?
This is, of course, partly contingent on the type of lender you choose but generally, there is a standard factoring fee plus a service charge fee and an annual fee.
Will firms still retain control of their sales ledger?
Firms always have the option to select confidential invoice finance or a more transparent agreement. Thus, a firm can remain in control of their ledgers or allow the factor to take over control, especially if the factor requires control of the ledger as part of the agreement.