Construction is arguably the sector of the UK economy most prone to insolvencies and bad debts.
The placing of four Lagan subsidiaries into administration and the collapse of Lakesmere were major shocks, yet have been dwarfed by Carillion’s liquidation in January.
As Construction News highlighted earlier this month, “domino effect” insolvencies are now showing up, with Vaughan Engineering and Sammon Contracting both blaming their own difficulties on bad debts with Carillion.
We’re not going to see an end to trade credit – the construction sector couldn’t function without it – so it will remain a risk for every contractor’s business, one that needs to be properly managed. This risk cannot be fully eliminated and any specialist in credit risk will tell you that it is impossible to guarantee zero bad debts.
Many companies refer to historic performance to decide the level of credit they’re prepared to offer, but this only tells you how something performed in the past. Carlton Ceilings and Partitions had traded for 30 years without major incident before it was hit by an uninsured bad debt with Carillion that caused the firm to go bust.
The best that can be done is to make a detailed assessment of the risk and decide a level of credit you are prepared to offer a contractor.
If credit risk is to be managed ‘in-house’ then provision must be made for potential bad debts – either by way of a reserve fund or by making sure there is headroom in finance facilities to cope with a potential bad debt. In-house provision may restrict a company’s ability to take on larger contracts.
“The availability of cover may become restricted on certain high-profile companies, much as it was for Carillion in its final months”
Trade credit insurance is another option.
In its accounts for 2017, building envelope specialist Prater said it was exposed to Carillion through trade credit owed when the contractor collapsed, but that it expected to recover the full debt through its insurance.
What the future holds
All insurers have unsurprisingly been hit by higher levels of claims recently and expect premiums to increase through 2018 to reflect the higher levels of risk they insure. There is also the likelihood that the availability of cover may become restricted on certain high-profile companies, much as it was for Carillion in its final months.
Insurers may suspend or cease to cover future contracts when a company hits financial problems – if the company recovers, the position will be reviewed, but Carillion never recovered.
In cases where cover is reinstated, it is likely to be allocated first to those companies who already have credit insurance, and with a limited availability for those not currently credit insured.
The current environment makes trade credit riskier than in ordinary times, which is why it’s crucial that firms consider what measures they have in place to manage it.
Tom Rolfe is a construction credit insurance specialist at The Channel Partnership