Why Invoice Finance can be a Crucial Asset in the Construction Industry
We look at how invoice finance can be used to help small construction businesses through gaps in cashflow
With wages to dish out and a long line of materials to pay for, cash is imperative for keeping a construction company going. Whereas other industries are better equipped to hobble along with inefficient cashflow, firms operating within the construction sector rely on an effectual stream of cash. Unfortunately when the economy sinks into decline this cash-reliant industry can be one of the worse affected.
When the economies of the likes of Portugal, Greece and Spain were abruptly tipped into recession in 2008, formerly buoyant construction projects were brought to a staggering halt. Evidence of the industry’s decline can be seen by the many half-built buildings that blot the landscapes of these crisis-ridden nations.
The cogs behind the recovery
While the upturn in the real estate sector has been cited as influencing the construction industry boost, the trade is as reliant on cash as it’s ever been. This is when invoice finance can prove to be an essential tool.
Delays in payments and even cancellations can generate a huge gap in a company’s cycle of cash and for a firm that is struggling to stay afloat, can prove to be the fatal blow. This potentially ruinous situation is not abated at all by the fact many ‘traditional’ lenders can be reluctant to lend to building companies.
Due to the contractual nature of debt and because construction typically operates an “applications for payment” procedure where prepayment levels tend to be lower when compared to other industries, many commercial financiers are unwilling to lend building firms money. In fact so averse have conventional creditors become to lending money to firms operating within the sector that construction has even been cited as being a “four-letter word” to commercial bankers.
How construction companies can use invoice finance
If the traditional financiers aren’t willing to lend then a company sometimes has little choice other than to rely on non-traditional forms of lending. Invoice finance is a type of funding which can assist companies financially when other lenders may be unwilling. Invoice finance essentially involves the financier lending a company cash by using invoices as the principle asset against which the money is raised. By financing up to 90% of the money tied up in invoices, a business can use the crucial cash injection to help their company grow. Instead of having to wait for big incoming payments, which is an unfortunate trait of the construction industry, a factoring company will supply the money – typically within 24 hours. Firms can then pay labourers, buy materials and bid on other jobs.
Compared to a commercial loan, invoice finance can be a less expensive alternative. As the facility is linked to a company’s sales and not its balance sheet, this type of finance can grow with the business. What’s more, invoice finance will typically provide a firm with a larger upfront cash boost than a commercial loan.
There are two types of invoice finance – invoice discounting and factoring. Factoring typically involves the financier managing a firm’s sales ledger and gathering the money owed to them. With invoice discounting the company retains the responsibility of collecting debts from invoices. If a construction company decides that factoring is the most appropriate type of lending for its own circumstances, it will effectively outsource management of its entire sales ledger, thus freeing up precious time to concentrate on other business exploits – like building a house.
For further reading you might like to take a look at our business advice article The Difference between Factoring and Invoice Discounting.