The construction sector – booming but where does all the cash go?
Financial cracks are starting to appear in the finances of the construction industry’s biggest contractors. The problem is that the growth in the economy has represented a double edged sword for the sector and challenged existing business operating models and with the global economy facing difficult times may lie ahead. The UK’s largest construction giants are wrestling with loss-making contracts which in turn is squeezing their cash just as demand for both commercial and residential properties increases. But can contractors keep pace with the demand or are they at risk of out stripping their abilities to service their contracts? How can smart firms capitalise on this uncertainty?
Between a rock and a hard place
Main contractors find themselves in a tight spot. On the one hand many have won projects by putting in rock- bottom bids. Or they have taken on over-optimistic projects. On the other hand, their reducing margins have been transferred down the supply chain resulting in sub-contractors being less inclined to tender which has the reciprocal effect of reducing competition and so forcing up the price of both labour and materials for the main contractor.
The dual pressure of maintaining profitability and managing ever tighter working capital requirements means that the main contractors are having to get ever more creative. This generally results in the main contractor placing downward pressure on their supply chain. If managed well with robust sub- contractors this policy can pay dividends. However, it can also spell financial disaster for both parties. By passing their working capital and margin strain on to a more vulnerable third party they are exposing themselves to factors outside their control.
The supply chain is delicate and is often being broken by the reliance on major suppliers who are often less able to withstand the working capital pressures which are loaded onto them by the main contractors further up the supply chain. Delays and penalties for delays under the contracts result in the application of liquidated damages clauses by employers and turn contracts into loss making projects, to the detriment of all businesses in the chain.
Don’t expect things to get better any time soon
Greater problems are on the horizon as the problems in the industry are actually structural rather than cyclical. Over the last few years the man contractors have been quietly losing money and the upturn has exposed the fact that they now have low cash reserves and little ability to ride out the awkward and unprofitable jobs they find themselves saddled with.
Big contractors can no longer operate on 2% margins by front loading payments from their clients then hanging on to the money as long as possible before paying it out to their subcontractors. There’s a dawning realisation that a new business model is required – one that works around more sustainable margins of 4% or 5% and where the profit doesn’t come from delaying payments.
Late payments have long been a contentious issue for the construction industry. The National Specialist Contractors Council, the main trade body representing the UK’s subcontractors, has been lobbying long and hard, through its Fair Payment Campaign, to put pressure on main contractors to speed up the process. But these efforts have stubbornly been resisted by the main contractors and their own trade body who represent their interests – the UK Contractors Group – who are equally committed to protect their own cash-flow.
Even the recent merger between both groups doesn’t necessarily mean an imminent change to things. Previous efforts by the two organisations at joining together and speaking with a single voice for the whole industry and presenting a united front to the government have always foundered on the divisive issue of payment – meaning a satisfactory resolution may still be a way off.
What’s a smart sub-contractor to do then?
What does this mean for sub-contractors? Well, things could get become increasingly difficult. In the short term the current wave of projects need to run their course to completion and there’s every likelihood that the main contractors will do their utmost to pass their pain on to the first tier companies. However, the frequency of early payment requests or part payments to the procurement managers of the large main contractors is increasing with decisions who gets paid and who doesn’t being based on the financial strength of the sub-contractor and how vital the project is. In short – assumption and selfish need, which is a dangerous mix and we may see a string of big corporate failures on the back of this approach which will obviously send shockwaves through the industry.
But it also presents an opportunity to switched on sub-contractors. It is a good time to put measures in place to head off potential cash-flow shortages which will give those prepared sub-contractors the ability to service a growth in projects, react quickly to new opportunities all the while absorbing the payment terms of the main contractor which will undoubtedly heighten their reputation and cement relationships.
After all, who will get the new opportunities moving forward; the firm who is always asking for payment early and struggles to deliver. Or the firm who doesn’t create any waves, delivers without issue and is always able to take the work given to them.
Construction Finance: Managing growth safely and securely
It has become ever more important for all contractors in the chain to manage their cash-flow or to look for working capital support. However traditionally the sector has been seen as high risk for bank lending with fully secured overdrafts the preferred mechanism to fund working capital. However, these are usually insufficient in size and jeopardise the directors, shareholders and potentially their families by extension due to the tangible security taken typically being the residential home.
A more efficient way to fund growth is to make the business work for itself and unlock the value of the work already done ahead of payments being made. Applications whether uncertified or certified have a value and the value of this can be unlocked to fund against. It is a specialised type of lending and there is only a handful of lenders who would consider such facilities but where a firm qualifies the benefits are potentially significantly more cash being made available when compared to overdrafts with significantly less security having to be offered by the owner of the business.
Background checks and protection
Equally important however is the need to undertake a full due diligence on both suppliers but also debtors with consideration given to whether specialist credit insurance policies that also covers retentions and has 6 months bound contract cover (which is key for any sub-contractor) is required to protect against their debtor failure as the knock on affect down the supply chain of a debtor failure can result in a domino effect of insolvencies.
The smart firm knows this. By securing their funding base, tightening checks on suppliers and debtors and insuring the money owed to them growth, however rapid, can be managed safely and with confidence.
For more information on the financing options available within the construction sector go to our construction finance page: https://www.oakmeadfinance.com/construction-finance/
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