As a subcontractor, your business often depends on the contractor whose project you’re working on.  The contractors are paid upfront for their work.  However, it can be days or even months for the contractor to resolve your invoices for services rendered. So how do you keep things running smoothly in the meantime? If you’re comfortable taking on debt over the short term, invoice financing can be an effective way to secure the working capital you need.

What is invoice financing?

Invoice financing, also known as accounts receivable financing or factoring, simply means borrowing money against your business’s unpaid invoices. The amount you’re able to finance can range from 50% to 90% of the balance you’re owed. So if you have an unpaid invoice of $20,000 for electrical work that you did for a home builder, you’d potentially be able to borrow between $10,000 and $18,000, depending on which invoice financing company you choose.

Why invoice financing can be a good fit for subcontractors

There are several ways to obtain working capital during a cash crunch. When strapped for funds, business owners may consider a variety of alternative financing options.  Some of these options include inventory financing, merchant cash advances and short-term loans.  Invoice financing, however, is particularly well-suited for subcontractors for a few reasons:

Financing is fast

When you need to meet payroll or purchase supplies, you can’t afford to wait for a contractor to pay you. With invoice financing, it’s possible to get the money you need in anywhere from two days to two weeks, allowing you to avoid delays in the meantime.

Designed to be repaid quickly

The nature of subcontracting means that in most cases, you can expect payment within 90 days or less of completing a job. Accordingly, lending companies structure this type of financing in a way so that you repay what you borrow once the invoice is paid. Compared to a loan which can take years to pay off, invoice financing is more appealing. Lenders do not lock you into a long-term payment plan.

Collateral and credit guidelines are more relaxed

If you were to go to a bank for a business loan, they’d want to see a strong credit history. They’d also want to see that you had something of value as collateral. If you run a smaller subcontracting operation, your business assets are limited to your equipment, tools or a work vehicle. The upside of invoice financing is that the invoice itself serves as your collateral.  In addition you don’t need perfect credit to qualify. Just keep in mind, lenders may raise an eyebrow if your credit history includes something serious like a foreclosure or bankruptcy.

Calculating the cost

Because invoice financing is an alternative borrowing option, it doesn’t come with the same fees and interest rate structures as traditional loans. Instead of an annual percentage rate (APR), the lender assesses a processing fee. This lending company will charge this fee against your “reserve”.  Reserves are the difference between the value of your invoice and the amount you finance. There’s also a separate factor fee based on the length of your repayment term.

Here’s an example:

A contractor owes a plumber $100,000 for services rendered.  The invoice financing company is willing to front you 85% of that total or $85,000. The lending company will hold $15,000 in reserve.  They will use this money to pay fees (such as processing and factor fees).

The financing company charges a 3% processing fee against the $100,000 invoice, totaling $3,000. Now you’ve got $12,000 in reserve. You’re also responsible for paying a 1.15% factor fee, which comes to $1,500 weekly. It takes the contractor four weeks to pay your invoice. This means the financing company keeps another $6,000 out of the reserve funds. When the lending company receives the money you initially borrowed, they will return the remaining $6,000 to you. Altogether, you’ve paid $9,000 to the finance company.

If you’re thinking that seems steep, you have to ask yourself what’s more important—avoiding a fee or getting the working capital you need. The speed and convenience that invoice financing affords can justify the expense if it allows you to remain competitive in the subcontracting arena. Just be sure to compare terms from different lenders before applying.

Strategic Funding provides needed operating funds to small businesses. Strategic Funding has helped business in hundreds of industries.  Industries served include: restaurants, personal services, construction, medical, manufacturing, agriculture, retail stores, automotive, and food stores.