In this article we focus on financial risk to building businesses.
FOUR AREAS OF RISK
Unfortunately, it is a fact that over half of all New Zealand construction businesses will have failed after just four years*. The Mainzeal collapse in 2013 served to highlight the risk that many sub-contractors face when working for a principal contractor; the danger of not getting paid for work done and/or losing retention money that has been withheld. More than 1,000 sub-contractors and other unsecured creditors have made claims in excess of $150m and two years on are still waiting to hear if they will receive any of their money.
Alongside the risk of a big collapse are the smaller bad debts that can seriously affect the viability of small building companies. Margins are tight in construction and many times we have heard that a builder has gone bust because just one customer failed to pay, leading to a cascade of cashflow issues, inability to pay creditors on time and ultimately liquidation.
However, there are a number of ways building companies can reduce their risk of financial failure:
The agreement you have up front will set out how you are to be paid and when. Getting this right is crucial. Trade associations have comprehensive contracts that include protections for the builder.
Don’t wait until the end of the month to do your invoicing. Where possible they should be issued immediately upon completion of the work or when achieving the relevant milestone. Modern accounting systems will allow you to do this quickly and easily. Talk to your accountant about this. You can even email invoices and take card payments using your smartphone these days, so you get paid straight away. Talk to your bank about this.
Additionally, the Construction Contracts Act includes provisions to enforce your rights to be paid for the work you have done in a timely manner. Make sure your payment claims comply with the requirements of the Act and you’ll be in a much stronger position to get paid if there is a problem. Trade associations and some merchants offer templates or pads of these.
Your accounting system should alert you immediately if a payment you’re owed has not been made by the due date. Having a robust system for chasing these to ensure prompt payment is another key tool to manage cashflow and avoid bad debts building up. Once again, modern accounting systems will do this for you.
Knowing in advance when you’ll need to make payments and when money will come in is critical to being able to plan for any “pinch points”. A rolling 6 month forecast will give you a good idea of what the future financial health of the business is, and what actions you’ll need to take to correct any issues, before they become a problem. Your accountant can help you with this.
Regular Financial Reviews
Ideally, every business should have a monthly review of its financial health. How profitable is it, what is your return on capital, what is your working capital situation? Back costing jobs will also mean you’re learning from past projects and ensuring future ones are profitable. With a good accountant and a modern accounting system this is doable even for the smallest building business.
Payment Guarantee Insurance
Sometimes, as in the case of Mainzeal and the others that have gone before and since, an event out of your control will put severe financial strain on your business, and often as a result your family, employees and suppliers. Insurance is available to cover the risk of a main contractor going bust and leaving their subbies unpaid. Called a trade or sub-contractors payment guarantee, it pays 75% of the money owed, up to a chosen limit. For more information on this visit: www.builtin.co.nz/SCPG.
The government have announced plans that will require all retention money to be held “in trust” by the main contractor. This means they can’t use it for their own day to day operation and must keep it separately. However, your money is still tied up in their bank account instead of in yours. Rather than allow retention money to be withheld from your payments, you could supply a retention bond. This is a promise to the main contractor that you will fulfil the contract and it is backed up by a bank or insurance company. Instead of having your cash locked up in retentions by your main contractor you simply pay a non-refundable premium to the bond provider and they make the promise for you, thus freeing up your cash to be put to better use. For more information on this visit:www.builtin.co.nz/retentionbonds.
Even though the industry is a tough one, with good financial systems, procedures and forecasts, as well as the right contract terms and insurance in place, withstanding unforeseen financial shocks is possible for any business.
*Table 11, New Zealand Business Demography Statistics: At February 2012, Statistics New Zealand
The final article in this series will focus on how insurance can help manage the risk of personal injury or illness and its effects on your ability to continue working and provide for your family.