How does a line of credit work for an electrical contractor?

Where the cash goes on an electrical job

An electrical contractor's receivables come from two very different kinds of work, and lenders price them differently. Service work — repairs, tenant improvements, maintenance contracts, small time-and-material jobs — is billed when the work is done and paid by building owners and facility managers on ordinary terms. Project work — new construction and major renovations under a general contractor — is billed monthly on a pay application, approved by the general contractor and often the owner's architect, and paid only after the owner pays the general contractor.

The cash leaves in a different order from the way it comes back. Crews are paid every week, and union shops remit fringe benefits to the funds on a fixed schedule whether or not the job has paid. Wire, conduit and fittings are bought on supplier terms. Switchgear, panelboards and transformers often carry long lead times and a deposit at order, so the contractor may pay for the most expensive material on a job months before it is installed or billed.

The result is a working capital hole that grows with the size of the projects. A contractor that moves from tenant improvements to a large ground-up job can double its payroll exposure, add a gear deposit it has never carried, and wait longer for each dollar of billing. How much of that hole a lender will fund depends on which receivables it is willing to count.

How a borrowing base treats an electrical contractor's receivables

A lender that lends against receivables builds a borrowing base: eligible receivables times an advance rate, less reserves. Asset-based lenders typically advance 80% to 90% of eligible receivables. The work is in the word eligible, and contracting receivables fail the test more often than most. The general rules are on eligible versus ineligible receivables; here is how they land on an electrical contractor's aging.

Two further cuts are common. Electrical subcontractors often work for a handful of general contractors, so a concentration limit — commonly 20% to 25% of eligible receivables for any one customer — can remove a large slice of the base. And when the contractor also owes a customer money, for a back-charge or a credit, the lender nets it out as a contra.

Backlog is not collateral. A signed contract tells a lender there will be work; only a billed, approved, unconditional receivable tells it there will be cash.

The WIP schedule: the report lenders read next

Contractors that report on percentage of completion produce a work-in-progress schedule every month or quarter. It lists each open job with its contract value, estimated total cost, cost to date, and billings to date. From those, revenue earned is the contract value times the share of estimated cost spent. The difference between what has been earned and what has been billed is either an overbilling (billed ahead of the work) or an underbilling (work done but not yet billed).

The warehouse job is the one a credit officer circles. It is half complete on cost but billed well behind that, which means one of three things: billing lags the work, the job has had unapproved change orders, or the cost estimate is too low and the job will fade — lose gross profit as it finishes. Every one of those consumes cash that the line has to supply, and none of it shows up as eligible collateral.

Lenders track underbillings across the whole schedule and from one period to the next. Rising underbillings on a contractor whose borrowing base is flat is the most common early sign that a line is being used to finance losses rather than timing.

Sizing the line

The method is the one on sizing a working capital line: find the peak gap between cash out and cash in over the year, not the average. For an electrical contractor the peak usually comes from the calendar of large projects rather than the seasons — two big jobs in rough-in at the same time, or a gear delivery landing just as a third job mobilizes.

A simple test: weekly payroll and burden of 90, material purchases of 60 a week, and project billings that take about eight weeks from the week the work is done to the week the cash arrives. On the project side alone, the contractor carries roughly eight weeks of 150, or 1,200, before the first pay application is paid, plus whatever retainage is building across the schedule. If only half of that sits in eligible receivables, the borrowing base will not cover it, and the rest has to come from the contractor's own working capital.

Some needs are better handled outside the revolver. A large gear order on a single contract can be funded with contract financing or purchase-order financing, or through a negotiated deposit from the general contractor. Service trucks, lifts and trenchers belong on equipment loans. Working capital that the business needs every day of the year — the permanent layer — belongs in term debt or equity, which is the case made on line of credit versus term loan.

The surety and the bank

Any electrical contractor doing public work or larger private jobs needs bonding, and the surety is a second underwriter reading the same balance sheet. Sureties set bonding capacity largely from working capital and net worth, and they want reviewed or audited statements prepared on percentage of completion. The bank line and the bond program have to be built to live together.

• Current liabilities. Draws on a revolver are current liabilities, so borrowing on the line does not add working capital in the surety's eyes. Terming out a permanent portion of the line can.
• Rights to contract proceeds. The indemnity agreement gives the surety a claim to receivables on bonded jobs if the contractor defaults. Banks respond by excluding bonded receivables from the base or by agreeing priorities with the surety.
• Committed versus demand. Sureties prefer to see a committed line with room to spare. A demand line that the bank can pull at will counts for less.

Covenants and reporting

Bank lines to contractors usually carry a short, familiar set of covenants: a minimum working capital or current ratio, a minimum tangible net worth, a maximum leverage ratio, and debt service coverage, where conventional bank lenders commonly look for at least 1.25x. Some smaller lines add an annual clean-up period, which suits service-heavy contractors better than project-heavy ones.

Reporting for a borrowing-base line is heavier: a monthly borrowing base certificate with the AR aging by customer, the AP aging, the WIP schedule each quarter, and annual reviewed or audited statements. Asset-based lenders add periodic field exams, in which an examiner ties invoices to pay applications and lien waivers and tests whether billed work was actually approved.

What trips electrical contractors up

• Funding a losing job with the line. Fade on one large fixed-price job can consume the availability meant for the whole company.
• Material price moves on fixed bids. Copper and gear prices can move between bid and purchase; a contractor that did not lock pricing carries the difference in cash.
• Slow closeout. Retainage and final payments wait on as-builts, O&M manuals and final lien waivers. Paperwork delays become borrowing.
• Payroll taxes. A contractor that falls behind on payroll tax deposits invites a federal tax lien, which can outrank the lender on receivables created after it is filed, and is usually a default that can end a line.
• Stopgap advances. Merchant cash advances taken to make payroll pull cash daily from the same deposits the line depends on; the way out is on refinancing cash advances for contractors.

What goes to lenders

Transparent's line-of-credit checklist is the starting point: the AR aging by customer with days outstanding, the AP aging, the balance sheet, the P&L and a year-to-date P&L, a debt schedule showing existing liens, and optionally bank statements and two to three years of business tax returns. For an electrical contractor, the WIP schedule and a split of revenue between service and project work make the difference between a lender reading the file correctly and guessing.

Of the 1,800+ lenders in Transparent's book, 235 write asset-based loans and lines. Some want service-heavy contractors, some are comfortable with project receivables, and some will not look at a bonded shop. Once the documents are in, Transparent builds the full lender package — financing model, lender presentation, blind teaser and underwriting memo — in a day, so each lender sees the receivables already sorted the way it will sort them. Contractors planning a purchase rather than a line should start with financing an electrical contractor acquisition, and the SBA's lending record for the trade is on SBA loans to electrical contractors.