Jonathan Hook from PwC explains how construction firms can better manage their financial resources to ride out the difficult period the industry is going through.
Our latest insolvency figures for the construction sector, released last week, showed a further 621 firms placed into administration in the quarter, bringing the total for the past two years to 5,580. That rate is almost twice as high as for 2002-07.
Despite a small reduction in the final quarter of 2012, we are probably not over the worst yet.
The cause of many these insolvencies is companies running out of cash and/or being unable to secure the necessary sources of finance to remain in business. And that cash squeeze feels more acute now than at any point since the downturn began in 2008.
There are a number of reasons:
- Clients have become more wary of advancing cash to contractors ahead of programme;
- There have been significantly fewer PFI-style projects, which have traditionally provided advance cash drawdown;
- As overall output has fallen, the impact of settling supply chain liabilities on completing projects has exceeded cashflow benefits on new projects at lower volumes;
- Work has been tendered in the past two years at very competitive, and often suicidal, margins. The losses and cash outflows from some of these tendering decisions are now coming home to roost.
A cash squeeze at the top of the supply chain will typically lead to contractors looking to manage their own cash more carefully and looking to extend credit periods with the supply chain. The less scrupulous will also find excuses for delaying certification of work, using cashflow as a point of leverage in agreeing final accounts or delaying paying for certified work.
The industry finds itself in a difficult place because the impact of these actions is to place more financial pressure on the supply chain and heighten the risk of a failure, potentially with wider implications for a project. Even if you are paying your subcontractors promptly you don’t know what may be happening on their other jobs.
This cash squeeze is driving an increase in the use of project bank accounts and clients taking a much closer interest in monitoring the financial health of contractors several tiers down the supply chain.
Main contractors need to face up to the reality that the days of healthy advance cash positions on big projects is becoming rarer. They must price accordingly and set a higher margin hurdle to compensate for the adverse impact.
In this environment, beware of the potentially false economy of taking the lowest bids; be careful about advancing cash for offsite materials without understanding legal title considerations; know your company’s exposure to key counterparties and have a contingency plan; assess financial risk further down your own supply chain rather than just focusing on those directly contracted to you.
It’s also prudent to be conscious of the potential damage to your business if bad behaviours towards your supply chain erode confidence and be aware of the impact of market rumour on winning work.
Finally, talk to banks and finance sources early to manage through cash peaks and troughs.
Jonathan Hook is engineering and construction leader at PriceWaterhouseCoopers.