Material Financing vs. Factoring: Big Differences You Need To Know About
Construction payments can take a long time; it’s not a big secret. Keeping a construction business running while waiting for a backlog of unpaid invoices requires strong resolve and creativity. Some contractors rightfully turn to a variety of financing options to help them bridge the gap between incurring costs and receiving payments.
Two options that subcontractors turn to for financing include invoice factoring and material financing. However, this is where the similarities end. We can’t stress this enough: They’re extremely different financing options, used under entirely different circumstances. Factoring, on the one hand, carries a negative stigma. Material financing, by contrast, has no such stigma, because it can (and should) be used even when your construction business is thriving. While factoring can signify financial hardship (though it doesn’t always), material financing signifies a shrewd, financially healthy business with strong cash flow.
Before we dive into what makes these two forms of financing so different, we’ll explore a brief overview of each one and how it works.
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What Is Material Financing?
With material financing, your material finance partner will pay your supplier upfront for materials, and then extend you the ability to pay when paid, or up to 120-day credit terms. The key with material financing is that the financing takes place before the project begins and prior to work starting, meaning you don’t have to lay out any cash ahead of time to get started. And payment is made directly to your supplier. Contractors who are interested can review our criteria on whether material financing is the right choice for them.
What Is Invoice Factoring?
Invoice factoring for subcontractors involves selling your receivables to a company in exchange for a cash advance. You typically receive 70-90% of the invoice amount upfront, then when the invoice is paid by your customer to the factoring company, the factoring company sends you the remaining money, after taking their fee. Note that factoring is only available for currently outstanding invoices, after work has already been performed and an invoice has been submitted. Work has to be complete and ready to bill before you can get a cash advance through invoice factoring.
Why Material Financing Is the Better Choice for Contractors
When it comes to choosing between material financing and factoring for contractors, there’s a clear winner…
1. Material Financing provides you with financial support before the project, not after
Rather than waiting until you are ready to invoice your GC, which means you’ve already purchased materials and likely had to pay your crew, you’ll receive cash flow benefits before work even begins. This allows you to complete projects more comfortably, and on-time, even when inevitable payment delays occur or change orders arise. Thanks to your material financing partner paying your supplier upfront, you won’t have to dip into your cash flow or put large material expenses on your line of credit, which can jeopardize your ability to obtain additional financing elsewhere. With materials covered until you receive payment, you can use your existing cash flow to expand your business and take on more, or larger projects.
With invoice factoring, you have no cash flow support at the onset of a project. Financing here only becomes an option after all the work is said and done. As a result, you must rely on existing options to pay for materials, labor and equipment, which is likely supplier terms that tend to not be long enough, cash, credit cards, or a line of credit. When payment gets delayed, you’re likely moving money from one project to another, halting any opportunity to take on new projects to grow your business.
2. Material Financing prevents third parties from interfering in your relationship with your client
With material financing, you maintain ownership of your receivables. There’s no third-party involved with your invoices, and you control communication with your client regarding the invoice.
When contractors use invoice factoring, they can’t hide it; their clients will inevitably find out, which is partly what drives the perception of financial problems. With factoring, your client sends their payment to the factoring company, not you, because the factoring company owns the invoice. This can lead to awkward situations when the factoring company inevitably reaches out to your client for payment, as they’re primarily incentivized by getting paid, not maintaining strong relationships for you and your client.
3. Material Financing enhances, rather than hurts, your business reputation
Material financing falls under the umbrella of everyday business financing. Strong businesses use financing for one reason or another, whether it’s to purchase equipment, scale into larger or more complex projects, or to expand operations. No one will question the strength of your business when you use financing. In fact, there are ample reasons why GCs outright prefer subs who use material financing, because it positively impacts the entire project. Material financing is perceived as a tool used by smart contractors to help them manage their cash flow.
Invoice factoring, as discussed, has been associated with negative connotations in the business world, meaning your reputation could suffer. When your customer hears you’re using invoice factoring, it may bring into question your ability to manage your business and cash flow, and thus they may question your ability to successfully complete projects.
4. Material Financing improves your margins and strengthens your cash flow
Material financing puts you in position to take advantage of cash pricing from suppliers. Because your financing partner pays your supplier upfront, they’re likely to offer discounts of anywhere from 2-5%. When materials can cost up to 40% or more of your entire project, those discounts become meaningful to your project profitability.
With invoice factoring, there is no such opportunity for you to take advantage of. And with the high costs of factoring, your overall project profitability will be minimized.
Ready to Experience the Benefits of Material Financing for Your Business?
Material financing offers a variety of advantages over invoice factoring that contractors can’t ignore. But more importantly, you’ll need to be aware that the two are very different, and should never be confused with one another. It’s a mistake to discount material financing by treating it the same way you would invoice factoring.
If you’re ready to leverage the benefits material financing has to offer, Billd is ready to provide material financing for your next project. We provide same-day approvals and up to 120-day payment terms.
Enroll now to get started.