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Invoice discounting: An alternative tool for growth

The 950,000 SMEs that operate in construction have probably felt the impact of the access to lending crisis more than anyone else.

Even with signs of recovery and new contracts under their belts, successful businesses still face severely restricted options when it comes to funding new growth opportunities.

However, over the past couple of years alternative forms of finance have emerged to meet this latent demand.

While crowdfunding attracts significant media attention, it is a new variant on the proven model of invoice discounting that is establishing itself as an important tool for SMEs in construction.

Building value 

Pre-downturn, invoice discounting was a mainstream form of finance used by contractors to boost cashflow and generate working capital.

By releasing the value tied up in invoices, businesses are able to bridge the gap between the outlay on materials, labour and equipment required to fulfil a contract and payment by the customer.

“The funding gap in the construction sector is rapidly being filled by a number of independent providers of selective invoice finance”

For many, the liquidity boost provided is a crucial element in funding large contracts, smoothing cashflow during fluctuations in demand, supporting capital expenditure and coping with issues such as late payment.

However, the retrenchment of high street lenders has seen availability constrained and the structure of agreements has become increasingly out of step with SME contractors’ need for flexibility and value.  

Many traditional providers will only lend against the entire sales ledger, which can prove an expensive way to fund a construction business with volatile monthly cashflow.

The contractual obligations around facilities can also be ill-suited to the current climate, with many providers being criticised for high minimum fees, lengthy lock-ins and unnecessary administration costs.

Rise of the alternative

The funding gap in the construction sector is rapidly being filled by a number of independent providers of selective invoice finance – also known as single invoice discounting or spot factoring.

This flexible new approach enables businesses to choose which specific invoice or set of invoices to borrow against, rather than entering into a contract to fund their whole sales ledger.

“Recent research showed 40 per cent of recent loan applications made by FMB members were rejected by traditional funders”

Giving a contractor the ability to tailor facilities like this means it can be extremely responsive to specific requirements, generating a short-term funding boost capable of easing cashflow pressures or funding larger jobs.

As the SME is essentially selling an invoice rather than borrowing, facilities can be agreed quickly and the transparency around total cost of funding allows for better financial planning and forecasting.

With the funding decision based on the strength of the debtor, rather than the company itself, smaller contractors can benefit from working with customers with stronger credit ratings.

This can be particularly useful for firms who have been previously declined because of their own rating issues or simply because they operate in construction.

Recent research from the Federation of Small Businesses showed 40 per cent of recent loan applications made by its members were rejected by traditional funders.

It’s therefore vital to the entire economy that construction SMEs are aware the alternative sources of funding can provide access to the financial tools required to fund growth.

Dai Rees is director of Creative Capital

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