The construction industry is currently bearing the brunt of tough economic conditions. PwC's recent analysis of 2010's insolvency figures reports that 15,894 companies went insolvent in 2010, a fall from 19,512 in 2009, suggesting a return to 2008 levels. However, they report that in the construction industry the number of companies going under remains 15% above 2008's levels with the industry remaining one of the worst affected.
Construction is seen as the benchmark of an economy. At the moment that benchmark is not looking particularly healthy. Until recently, public building projects helped the sector through difficult economic times with construction activity in 2010 being 8% up on that in 2009, which was largely credited to the government's investment in public non-residential and social housing projects. However, the impact of the coalition's spending cuts will have a serious impact on this and, many fear, are likely to result in an increase in insolvencies in the industry this year.
Lending and overdraft facilities are fundamental to construction contractors to cover their costs before projects are completed and the end client pays. Any rise in interest rates will increase the costs of borrowing, which will impact on the bottom line for the construction sector. Coupled with hard fought tender competition and the increasing price of raw materials any interest rate will have a dramatic effect on the sector.
Expert predictions suggest that interest rates will rise at least once, if not twice, during 2011 as the Bank of England struggles to reduce consumer rates of inflation (currently at 4%) to 2% or less. Some claim that the current level of inflation is a result of factors outside of the bank's control, such as foreign influences and the recent increase in VAT to 20% (some speculate that this alone accounts for a significant level of the current rate of inflation). Despite this there is general consensus that the bank is more likely than not to increase rates within the next 12 months.
There is currently a split in opinion between those who think we will see a double dip back into recession and those who think economic growth will flat line. With the construction industry accounting for a significant proportion of the UK's economy, in turn accounting for a significant proportion of spending, the effect of any rise in interest rates (coupled with the cut in public spending in that area) is, in my view, more likely than not to tip the economy into double dip recession. However this may not be a bad thing, as (we hope) recovery will follow; whereas a flat line in growth is more likely to result in us all feeling the pinch for a significantly longer period of time.
In any event economic indicators suggest that this year will be a tough year in the construction industry with a significant number of more construction companies going to the wall. So, what can you do to secure your position? Practically I would suggest you do as follows:
- Review your current funding options and facilities as well as your project costs (both for existing and future projects) in order to ensure that your cash flow will survive any increases in the cost and borrowing.
- Carry out due diligence on both new and existing clients to ensure that they will be able to pay you as and when payment is due. Include financial comfort and reporting provisions in your agreement to enable the stability of clients and contractors to be monitored as the project unfolds.
- Consider your quotes carefully, ask whether you will make money out of the project and cover your base costs. Ensure any tender allows for any increases in raw materials (particularly bearing in mind the current situation in the Middle East and the effect it is already having on oil prices).
- Review your contract terms with your contractors and suppliers. Make sure there are suitable exit provisions if they fall into insolvency or fail to honour their terms of the agreement. Consider whether it is wise to enter into exclusive supply contracts or better to spread your risk in the current market.
- Make sure that you have agreements in place with all of your contractors (it never ceases to surprise me how many projects are undertaken or contracts are started without contracts having been formally signed).
- Audit your current agreements with contractors and suppliers. Make sure that you are getting competitive terms and, more importantly, that you are only being charged for what you are obliged to pay. Likewise, make sure that you are charging your client and obtaining all of the payments that you are entitled to in your agreement with them.
- Take professional advice as soon as you suspect you may be in / likely to hit cash flow problems. There are a number of restructuring options you can consider to help you through, but the later you leave it the more difficult they can be to secure. The key is to act sooner rather than later.
The contents of this brochure are intended as guidelines for clients and other readers. It is not a substitute for considered advice on specific issues. Consequently, we cannot accept any responsibility for this information or for any errors or omissions.
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