There are various cash flow problems faced by construction firms. This is because the firm will have already completed the work while payments will only come after several weeks. In this period, the firm will have to keep making payments to the workers, suppliers, and other running costs. This is where invoice financing can be applied. Invoice financing involves the provision of funding based on unpaid invoices in the company. The firm does not have to wait for the customer to pay for the invoice but access a percentage of it. Invoice financing is not for all companies and therefore it is important to understand the benefits it has on construction companies.
What Is Invoice Finance?
Invoice finance is a type of business financing based on outstanding invoices. The finance company may provide funds for an agreed proportion of an eligible invoice before the invoice is paid by the debtor. The rest of the invoice amount will usually be made available once the invoice has been paid, after deduction of the fees. Invoice finance exists in different varieties. Some common examples include invoice factoring and invoice discounting. The structures and roles vary and so businesses should be aware of them before entering the contract. The main idea is very clear—invoice finance enables converting invoices into available cash.
Why Construction Firms Might Struggle With Cash Flow
A construction firm often has expenses before getting paid by its customers. A contractor can incur expenses for the purchase of materials even before finishing the job. Other parties, such as subcontractors, could also be incurring costs in accordance with the agreement. Expenses, including wages, cost of equipment, insurance, among others, will be incurred whether or not there are any payments pending on the invoice. Think of a construction firm that has successfully completed a £50,000 job. However, the firm has raised an invoice, which should be settled in 60 days by the client. The firm still incurs costs in those 60 days. If many jobs are at that stage simultaneously, the gap between the work done and payment is likely to widen.
The Main Advantages of Invoice Financing for Building Companies
1. Improved Cash Flow
The most significant possible advantage is improved cash flow. Since there is no need to wait for payments from clients, eligible firms will be able to get financing based on invoices that are outstanding. Construction companies will have more freedom in dealing with everyday finances. Better cash flow can also help to alleviate any stress from the fact that several large invoices fall due at different periods of time. Nevertheless, businesses should remember that invoice financing does not bring extra profits. It brings cash flow at a different time.
2. Better Control of Working Capital
Working capital is crucial for construction companies. Although the company can generate good sales, it may face cash flow problems if its customers take too long to pay. Invoice financing can allow for accessing cash based on invoices that are unpaid. This may make it easier to deal with working capital. Short-term working capital needs of a company can be satisfied in this way. But good bookkeeping practices are needed. Anyhow, the owner will know which invoices were generated and which are unpaid.
3. Increased Financial Flexibility
There will never be an absolutely regular flow of business activities in construction. One month there can be many big contracts and the next one – fewer of them. The cost of material and the need for labor are not constant too. Access to the working capital allows organizations to be more flexible in such cases. For instance, the contractor may have enough work to do but a little money for materials. An earlier access to the invoice finance can solve this problem somehow. Still, the organization has to evaluate its costs first.
4. Financing during Business Growth
Growing the business can cause some unexpected difficulties. There may be a case when a construction company wins a bigger contract and expects additional revenues. However, the more projects it takes, the more money it needs to spend before the payments are made. This becomes a problem since the organization needs even more working capital while growing. Invoice financing can help such organizations overcome this timing problem. It can be a way to grow without spending all the existing money.
5. Reduced Dependence on Timing of Customer Payments
Late payments can cause problems for construction businesses. A firm may be able to complete their work perfectly according to the contract requirements, generate a correct invoice but still be waiting for payment. Invoice financing may lessen some of the strain caused during this period. Nonetheless, firms must not rely on financing to replace good credit control practices. Good financial procedures will go hand in hand with any finance scheme.
6. Improved Budgeting of Recurring Costs
There are certain recurring expenses that construction firms incur. These include such things as salaries, supplier bills, payments to sub-contractors and other genuine business costs. Firms having more clarity on their anticipated inflow of money will make financial planning easier. Management accounting will assist the owner of the business to know about revenues, costs, profit margins and the entire financial position of the business.
Invoice Financing Cannot Eliminate Financial Risk
One prevalent misunderstanding about invoice financing is that it eliminates all cash flow problems. It doesn’t. Financial institutions may also have criteria for eligibility and funding, as well as fees and terms and conditions for financing. In certain cases, there might be extra obligations relating to collecting payments from customers. Construction firms should therefore analyze the costs of financing against the benefits of early payment. Customer contracts must also be carefully considered since certain issues like retention, disputed invoices and staged payments may render particular invoices ineligible for financing.
The Role of Bookkeeping in Invoice Finance
It is even more important to have precise bookkeeping when using invoice finance.
A company requires precise accounts for:
- Outstanding invoices
- Date of payments
- Balance of customers
- Credit notes
- VAT
- Expenses of business
- Accounts payable to suppliers
- Payroll
- Payments received
Bad record keeping may complicate the understanding of cash flow and the identification of outstanding invoices. This is the reason why construction firms require up-to-date bookkeeping and not the one that will be done at the end of the year. Contemporary cloud accounting systems can also facilitate access to financial data. City Gate Accountants offer bookkeeping and accounting services tailored to each business individually.
Considerations for VAT and Invoice Finance for Businesses
It is possible that VAT will create yet another complication in terms of construction cash flow. Invoices have to be kept well sorted and up to date to fulfill the businesses’ obligations in relation to VAT. Any issues regarding VAT may turn out to be costly and take quite some time to sort out. It is important that the business does not view the availability of finance as profits. With the help of a qualified accountant, businesses can get all their accounting records sorted along with a better idea about their overall tax and VAT position.
Some Typical Accounting Errors Construction Businesses Should Avoid
Thinking of Sales as Available Funds
A big sale doesn’t mean that there are funds available. It’s important to distinguish between sales, invoicing, collections, and available cash.
Not Accounting for Payment Problems
When there are frequent problems with payments, this should be taken into consideration in the budgeting process. Waiting until there’s too little cash in the bank can leave too few options.
Failure to Maintain Proper Invoicing
Failure to have all relevant invoices in place may lead to unnecessary problems. It’s important to make sure the correct details are included on invoices.
Confusing Business and Personal Expenses
Keeping business expenses separate will simplify the process of accounting. Also, this will help to understand the real financial position of the construction business.
Invoicing without Analyzing Costs
Early access to funds comes at a cost. Construction companies need to take into account the associated costs of using invoice financing.
A Practical Example
Let’s consider a construction firm that has £100,000 in eligible unpaid invoices. Typically, its clients take from 30 to 60 days to pay their bills. In the meantime, the company requires money to cover salaries, raw materials, and subcontractors. Rather than having to wait until all £100,000 is paid, the firm could be able to benefit from an invoice financing scheme, thus receiving an agreed percentage of this sum. However, the firm should weigh the pros and cons of such an approach.
How City Gate Accountants Could Play a Role
Invoice finance is not a substitute for good accounting. Construction companies will always require correct bookkeeping, tax planning, financial documentation, and informed business decision-making. This is where an expert accountancy firm can step in to help. City Gate Accountants provides accounting, bookkeeping, VAT, payroll, tax planning and business advice for businesses. The company’s website focuses on qualified experts, bespoke service and solutions tailored to individual needs of each business. For a construction business thinking about invoice finance, having proper accounting data would help to address the following issues.
- Does the business make money?
- How much money is trapped in unpaid invoices?
- Do clients pay on time?
- What are the usual outgoings of the company?
- Would better cash flow enable sustainable growth?
These are the questions that should be answered before seeking additional finance. City Gate Accountants also places emphasis on clear prices and bespoke accounting support, thus providing companies with the knowledge of their financial situation, and not only with transaction details.
Is Invoice Finance Suitable for All Construction Businesses?
No.
Invoice finance might work for companies that have steady invoices and customers who always pay on time. On the other hand, it might not work well when invoices get challenged too often or when financing is more costly than cash flows.
Some considerations include:
- Customer payment habits
- Invoice amounts
- Cost of financing
- Contract conditions
- Margins
- Borrowing
- Cash flows
- Plans to grow the business
It may be worth thinking about whether improvements in credit control and accounting can help.
Conclusion
The advantages of invoice financing for construction businesses lie largely in the cash flow and working capital aspects. Construction companies are able to undertake valuable projects even when the payment is due after weeks. Invoice financing could possibly be helpful in this regard but should not automatically be considered as such. Based on the cost of financing, payment habits of customers, quality of invoices and overall financial performance of the business, construction companies must make their decision. Keeping good accounting records and management information is equally essential. Construction companies, by maintaining good accounting records, will be better able to take decisions regarding financing, taxation, VAT and overall growth of the business. Businesses requiring any assistance with bookkeeping, accountancy, VAT, tax planning and business advice are catered to by City Gate Accountants.
FAQs
Why is invoice financing good for construction businesses?
The advantages that invoice financing offers to construction businesses can be seen in the better cash flow and easier working capital management.
What are the advantages of invoice financing in construction cash flow?
The process of invoice financing could result in quicker availability of money from unpaid invoices. It could be useful for construction businesses in handling wage payments and other costs while awaiting the payment of customer invoices.
Is invoice financing applicable to small construction firms?
Yes, it is applicable to small construction businesses provided that they have on-going invoicing and reliable paying customers.
Is there an impact on VAT accounting for invoice financing?
There is no effect on VAT accounting with invoice financing as it does not take away the company’s regular VAT duties.
What is the difference between invoice factoring and invoice discounting?
Both are ways to finance using eligible invoices, but they have different structures. Factoring will involve the finance company taking care of customer collections, while invoice discounting usually leaves collections with the business.
How can invoice financing help in the development of construction companies?
Invoice financing could possibly help in growth by enabling easier access to funds when payments from customers are delayed. This will be helpful when dealing with higher amounts of work.
Is it advisable to consult an accountant prior to taking invoice finance?
Consulting an accountant will be beneficial when assessing your cash flow, profit, bookkeeping, tax liability, and the total cost of financing.