Trade contractors carry a lot of financial risk.
Coming onboard to a large construction project means working with businesses that are much larger than your own. These companies typically have a greater ability to absorb impacts or wait out construction project delays. At the same time, suppliers will expect you to pay them long before you have been paid yourself.
This is why financing is a fact of life for most trade specialists.
Below, we will explore how financing works, what options are available to subcontractors, and what advance work trade contractors need to do to access financing.
Why Is Financing Useful?
As a trade contractor, you are expected to pay your employees, your suppliers and often your taxes before you get paid for the work you do.
“Construction subcontractors who work with general contractors (GCs) and commercial clients usually have to wait 30 to 60 days to get paid,” the team at Commercial Capital LLC writes. “This situation can be challenging because subcontractors are often responsible for a number of expenses that must be paid beforehand. This situation is a common source of financial problems for construction companies.
“Companies often respond to this situation by juggling supplier payments and hoping for the best. This strategy can work sometimes, but it often leads to problems with suppliers. Furthermore, some expenses can’t be ‘juggled,’ such as payroll, insurance, or taxes.”
So, cash flow becomes an immediate concern for trade specialists. Knowing how much cash you owe, how much cash is coming in and how much cash you have on hand to pay your liabilities is a core capability in any business. When you have more cash going out than you have on hand — or than you can afford to pay without putting your business at risk — then you will need to find that cash somewhere else.
Further, having access to that kind of cash is important in growing a business. “Larger projects come with bigger rewards, of course, but they also come with more risk — namely, your ability to successfully complete that project and turn a profit on it,” the Billd team writes at For Construction Pros.
“If your company doesn’t have the bandwidth, employees or equipment to take the project from bid to completion, you can jeopardize both your reputation and your ability to win future projects. Financing can help minimize that risk by enabling you to invest in the resources you need to complete those projects.”
What Financing Options Do Trade Contractors Have?
All financing options come with some kind of cost. That’s the price you pay for borrowing money.
So, if you do have cash on hand to pay expenses, that should be your first option for payment. “Establishing a sizeable cash reserve is still the wisest approach and can protect your company’s profitability in the longer run,” writes Patrick Hogan, CEO of Handle.com, which helps contractors and material suppliers with construction lien and financial management and payment compliance.
However, it’s rare for small and medium-sized construction businesses to have the kind of cash on hand needed to cover a construction project’s material costs, labor costs and overhead. These are the sources of funding available to these businesses:
Company credit cards can be useful for covering small expenses, but the limits will be too low to cover most purchases. Furthermore, you cannot pay salaries or taxes with a credit card.
Lines of Credit
The bank you use for your business will probably offer a line of credit to finance large purchases. However, as with credit cards, you will probably hit your spending limit quickly.
“Often, banks will offer limited lines of credit, and if a subcontractor puts even a single material purchase on it, it eats into a majority of that line,” Robbie Reynolds at Billd writes. “Smaller regional or local banks may have better odds of helping you get a line of credit, especially if you’re a midsize sub.”
Billd’s team covers the financial side of subcontracting so thoroughly because the company acts as an alternative source of financing for so many such companies. Billd’s material financing service will pay a subcontractor’s supplier upfront in cash, and then the subcontractor pays Billd back on looser terms, usually 120 days or whenever the sub gets paid.
There are several options here, depending on how much money you need. GUD Capital has a nice breakdown of all the types of loans available to subcontractors.
There are also financial companies willing to lend you money against the value of your invoices. These companies understand that trade contractors have to wait 30, 60, and sometimes 90-plus days to get paid, so they offer loans to cover expenses until those outstanding invoices are paid.
Invoice factoring works like invoice financing, but with a key difference: You aren’t borrowing money against outstanding invoices; you’re selling those invoices to a factoring company. Olivia Chen at NerdWallet does a great job of breaking down the difference.
The important thing to understand is invoice financing means paying a fee for borrowing money. Invoice factoring means selling your invoice at a discount in exchange for cash on hand.
Supplier Payment Terms
Supplier payment terms aren’t methods of financing, exactly, but they are useful options for protecting your cash flow all the same.
Supplier payment terms are agreements you make with your supplier to delay payment. This buys you extra time to pay your other costs with available cash and lessen the amount of money you have to borrow.
Which Type of Financing Is Right for Your Business?
When you are considering your financing options, some key things to think about are:
- How much money do you need?
- What payment terms, interest rates and premiums can you afford to pay?
- Do you have the documentation to support your case when you ask for financing?
Let’s start with the first two questions.
Your budget and estimates will give you a good idea of how much money you will need to cover costs. “Consider all the costs involved, including materials, labor, permits, and any unexpected expenses that may arise,” the team at Boom & Bucket writes.
Then, consider how expensive it would be to borrow that money from financing sources available to you. A bank might charge 5 percent interest for a $50,000 line of credit whereas a material financing company would charge 3 percent. All other terms being equal, that’s a difference of $1,000.
Each financing option might come with its own specific terms and additional fees, too, so check those thoroughly.
Once you’ve made your choice, it’s time to apply for financing from the lender. As NerdWallet’s Chen writes in another piece, lenders will need to see proof that you will pay them back. This might come in the form of proof that you’ve been awarded a contract, or details of your business history that indicate your business is thriving and solvent.
How Construction Management Software Can Help
Applying for financing means digging into your construction project documentation and your financial statements.
That work is much more efficient when your project documents are complete, accessible, organized and easily searchable in a cloud-based storage system.
To learn how eSUB Cloud can help you get your construction project documents organized and in lock-step with your financials, schedule a demo today.
Images used under license from Shutterstock.com.