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Reconstructing the Relationship Between Contractors and Factors
It has been about 25 years since factoring was introduced to the construction industry, mainly as a finance and working capital mechanism to enable subcontractors to increase cash flow and perform for their general contractors.
Factoring is the process of purchasing commercial accounts receivable from a business at a discount. A financial intermediary, known as a factor, may take on responsibility for managing a firm’s receivables.
Several problems existed pursuant to factoring’s introduction to construction. Factoring was considered a magnet for questionable business conduct, and fraud and theft were always major concerns. Subcontractors using factors carried a stigma because if everything was on the up-and-up, they would be financed by a traditional bank.
While factoring may cost more than working with a traditional bank, a contractor or subcontractor must take into account the added value factors can bring to a transaction.
How Factors Work
Factoring has broken away from its past and earned greater acceptance in the construction industry. More effective, efficient checks and balances are somewhat driven by industry-specific software and Internet data technology, which enables the parties involved in the process to monitor the work performed and the funds being spent.
In construction, it is not uncommon for subcontractors to use monies received from contractors on one project to help finance another project.
For example, most subcontractors and even some general contractors do not have an in-house financial administration. So, the factor that offers financial controls can save the subcontractor money on overhead while creating a point of credibility in the eyes of the contractor, developer or project principal.
Construction factors usually establish a line of credit for a subcontractor based on its cash needs for six, eight or 12 weeks. (The factor needs to validate that the owners, principals and contractors behind a project have the capacity to pay their bills.)
In response to what has become a bonded environment, today’s management techniques and accounting tools ensure a factor or funding source only disburses funds in support of a specific project.
Disbursement programs run by factors make advance payments to all subcontractors, suppliers, employees and parties that have lien rights on the project in question. The factor’s funds control administrator, usually an experienced numbers technician, is in charge of writing checks for payroll, benefits, taxes and deductions (941, Social Security, FICA, workers’ compensation).
Whether it is overhead for trailer rental, portable bathrooms, security personnel, fuel, rubber, steel, concrete or roofing, the factor and its funds control administrator analyze all cost details and make disbursements.
The funds control administrator also can use the new working capital strength provided by the factor to obtain discounts for prompt payment or to check on delivery of materials and supplies. In an inflationary marketplace, quoted prices are usually only good for one or two months, and credit rates for materials and supplies are high. The factor can deliver advantageous economies to benefit the subcontractor.
Factors for Public Projects
The public works sector generally poses the least amount of risk and offers the greatest safety net for banks or factors. All public works projects require surety bonding, and factors should not have any issue with a surety being in the first position on receivables because the factor already will have paid the parties that have the right to file a claim against the bond for the project. Thus, the factor perfects the payment side of the bond, working hand-in-hand with the surety.
This control protocol benefits all parties while giving a level of comfort to owners and general contractors. Factoring represents an alternative financial solution for the 50 percent of contractors and subcontractors estimated to be distressed with their banks. During this unstable economic climate, contractors, their subcontractors and factors must have respect for each party’s role in the process and work together.
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Friday, September 3, 2010