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The worst is yet to come…

Despite reports of increased turnover, profits and record order books we are not through the downturn yet. By Jonathan Hook

A look at the results announced by many of the leading contractors in the last few months could lead you to think that things are going pretty well with increased turnover and profits, strong cash generation and record order books.

So what are people concerned about and where do the risks lie?

Many contractors lag behind the economic cycle because of the impact of having a great deal of work through existing order books.

But there is a real dip in current opportunities for contractors to bid for and that will feed through into turnover and profits in 2010 and beyond.

And the shortfall in opportunities means that the reduced amount of work that is out there is being bid for at more competitive rates.

This is likely to put pressure on margins and may lead to some companies taking jobs outside their core competencies and this will inevitably heighten the risk of making a loss.

The impact though is not just on margins, the more significant effect could well be felt with regards to cash.

A well run contractor has traditionally operated with negative working capital at around 10 per cent of turnover.

As volume unwinds and jobs aren’t replaced with new work, cash will inevitably end up flowing out of the door.

Further to this there are operational and commercial challenges too.

It can be a lot harder to reach completion on site when teams don’t have new projects to go to and therefore managing utilization becomes more difficult.

It is also likely that there will be more disputes between contractors and both clients and the supply chain as jobs are closed out and there isn’t the same incentive to get issues resolved and move on to the next challenge.

A somewhat overlooked issue, but nonetheless very important, is the risk of financial failure in the supply chain.

As contractors seek to reduce cost there is a temptation to go for the lowest cost alternatives. 

The challenge is to ensure construction firms understand the financial robustness of their suppliers, and know who they are exposed to across their entire business.

Contractors may also find they suffer losses because of problems coming from sub-contractors, unrelated to the projects they are working on together.

This could be due to the sub-contractor experiencing difficulties elsewhere in their business.

Furthermore, over the next couple of years, it is highly likely that there will be a lot more scrutiny over the robustness of reported order books.

This will be both in their phrasing and what organisations choose to count within the overall numbers.

But as with any situation, while there are plenty of causes for concern, the strong and wary will be able to take advantage of others difficulties in order to gain market position.

Jonathan Hook is global leader in engineering and construction at PricewaterhouseCoopers

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