The construction industry can be lucrative, but it comes with its own share of risks that businesses need to manage if they want to succeed. The amount of time that passes between breaking ground on a home or building, and collecting revenues from the sale of that home are often very long. Meanwhile workers and subcontractors need to be paid, and those subcontractors need to make their own purchases in order for projects to progress. The resulting financial pressures can make it difficult for both large builders, and their smaller subcontractors to operate efficiently.
Supply chain finance and invoice finance are critical tools that allow the construction industry to cope with these issues, providing the funds and the time they need to relieve the pressure. This allows them to regulate their cash flow, and to operate much more securely and effectively.
Large builders are at the mercy of the real estate market
Big property developers operate with long cash conversion cycles. They need to purchase properties, hire subcontractors, wait for construction to finish, and then sell the real estate they’ve built. This process can take a long time, with larger projects dragging out over many months. If property values decline, or the homes can’t be sold due to an economic downturn, the company can lose some or all of its investment, potentially rendering it unable to pay its subcontractors, or making it more difficult to launch new projects.
In more minor cases, where profits are simply reduced, subcontractor payments might be delayed. Cash flow delays, however, can be a major problem because they can result in operational delays on the part of the subcontractor. That means projects are finished even later, which might exacerbate the larger cash flow problem even more.
Subcontractors need reliable payment
Typically, smaller construction companies subcontract jobs from larger builders. They purchase their own building supplies, and need ready working capital in order to take on new jobs. This means that if a payment is late, the subcontractor may not be able to take on a new contract until it arrives.
Cash flow interruptions during a longer-term project can also leave subcontractors unable to purchase supplies, resulting in operational delays that leave workers furloughed. Both subcontractors and large builders need financial tools that help them to protect their working capital, and to limit the impact of cash flow interruptions. Supply chain finance and invoice finance do this by both providing capital when it’s needed most, and by helping subcontractors to close the gap between the time at which they need to make purchases, and when they’re paid.
Supply chain finance keeps big builders on schedule
Supply chain finance allows property developers to pay their subcontractors out of a separate credit fund, rather than directly out of their own pocket. This means that payments will always be on time, regardless how much cash the business has on hand at that time. The credit fund can then be paid off later, with payments deferred by up to 90 days. This gives builders the crucial time they need to manage shortfalls, so subcontractors can keep working. By making sure subcontractors are paid, they can better guarantee the timely completion of current and future projects, so that those projects won’t cause their own cash flow delays.
Invoice finance helps subcontractors to fully finance their operations
Smaller construction firms constantly need to purchase supplies, and pay workers. Like any other business, they can’t afford to keep large quantities of excess working capital lying around. Supply chain finance allows these businesses to launch new projects without being forced to invest funds out of their own pockets. Instead, they can simply pay suppliers using their credit fund, and then pay off the fund when payments come in, up to 90 days later.
Of course, there is a catch. The time of invoicing, combined with potentially long payment terms and, according to Illion’s most recent 2019 report, an average 10.5 days late payment in the construction industry, can easily exceed 90 days. This is where invoice financing comes in.
Invoice financing allows subcontractors to collect payments when an invoice is issued, instead of when the payment is actually due. Instead of waiting for the property developer to pay an invoice, the subcontractor simply takes the invoice to their financial institution, who issues most of the payment immediately, before collecting the payment on their behalf. Once that’s done, the remaining funds are issued.
This means that, as long as subcontractors can issue invoices within 90 days of paying their own suppliers, they don’t actually need to invest any of their own working capital. Financing tools like these insulate large builders from the immediate impacts of market forces, and allow smaller construction companies to fully finance their operations, while also making revenues more reliable.