Beating bad debt in construction

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Debt in construction remains a sad fact of life for many subcontractors. Being able to spot the early signs of difficulties and react quickly are crucial in keeping cash flowing and projects on track

Despite government support measures, analysis by Experian shows the monthly average insolvencies for the first four months of 2022 were 30% higher than the 2019 monthly average.

How do you avoid being hit by one of your customers paying late or, worse, going into administration?

Jump to page 6 to see how you can avoid being one of 75,000 construction firms that could be at risk of collapse.

How did the construction industry reach a debt crisis?

Let’s take a considered look back at how we arrived at this crisis point.

The UK construction industry is without doubt one of the pillars of the economy and the government has made it clear that it will be front and centre of national efforts to “build back better” from Covid-19, level up and make strides towards a net zero future.

The numbers speak for themselves. UK construction is worth £117bn annually and contributes 9% of the country’s GDP. More than 300,000 companies are connected to the sector and the industry employs 2.7m people. Some 99% of these companies are SMEs.

Yet for all the apparent financial power of the sector, many – if not most – construction firms find themselves walking a knife edge when it comes to profitability.

How is the industry tackling the crisis?

A number of factors contribute to this, not least a procurement culture that leads to lowest price tendering – a culture that was roundly criticised by Dame Judith Hackitt’s 2018 Independent Review of Building Regulations and Fire Safety for creating a “race to the bottom” that simply stores up problems for the future.

Thankfully, we are starting to see what is, hopefully, a lasting cultural shift. The Building Safety Act, which received Royal Assent at the end of April 2022, aims to fundamentally change the way buildings are planned, designed and managed. The act will introduce a new Building Safety Regulator to oversee safety in higher-risk buildings and drive improvements in performance standards in all buildings. It will also create an “accountable person” who will be legally responsible for building safety upon occupation and also aims to give residents’ a stronger voice.

This is all aimed at shifting the industry’s focus from lowest cost to best value – across the full lifecycle of the building.

Late payments and debt in construction

While the proposed changes in the Building Safety Act are welcome – and overdue – they will come at a cost. But there is another longstanding cultural problem that impacts profitability and the ability of construction firms to invest in the future: that of late payments and bad debt.

The history of late payments in construction is long and complicated; the roots can be traced back to the 1970s, when companies moved away from employing direct labour and leasing or owning their own plant towards the use of potentially lengthy supply chains of specialists who could provide their services to a main contractor as needed. This increased the number of hands that payments passed through, increasing the potential for delays as companies further down the supply chain waited for the money to trickle down.

Another contentious issue is retentions, which allow clients to withhold money if work has not been carried out on time or to the correct standard. While retentions can provide valuable protection for clients, industry bodies such as the Federation of Master Builders claimed the measures have been unfairly exploited, strangling the cash flow of many smaller firms.

There have been many efforts over the years to tackle late payments. Law firm Charles Russell Speechlys notes that contractual payment provisions were introduced in the Housing Grants, Construction & Regeneration Act 1996, more than 25 years ago.

In 2008, the Prompt Payment Code (PPC) was introduced by the Chartered Institute of Credit Management on behalf of the government, creating a voluntary code for paying suppliers on time, to agreed terms. Thousands of businesses signed up.

However, the January 2018 collapse of Carillion – at the time the UK’s second largest construction firm and a signatory to the PPC – exposed the staggering scale of late payments and the devastating ripple effect they can have when they become bad debts.

Carillion went under owing around £2bn to some 30,000 suppliers, subcontractors and other short-term creditors, according to Charles Russell Speechlys. Furthermore, it emerged that the company had been forcing some smaller firms to accept payment terms of 120 days – double the PPC’s requirement of 60 days and four times the long-term target of 30 days.

Research by accountancy firm Moore Stephens found that the collapse of Carillion fuelled a 20% spike in insolvencies in the first quarter of 2018 compared with the previous three months as thousands of smaller firms lost work or money owed to them, depleting their own cash reserves and ability to pay suppliers, staff and bills.

Lee Causer, partner at Moore Stephens, said: “SMEs and specialist subcontractors have been hit particularly hard by Carillion’s fall, as many of them will have relied on the giant for significant amounts of their work. It is also likely that these subcontractors would have had to write off virtually everything owed to them by Carillion.”

The fallout from Carillion led to reform of the PPC. Since 1 July 2021, the code’s payment times to SMEs have halved from 60 days to 30 days. Organisations that sign up must pay 95% of invoices with businesses employing 50-250 people within 60 days and 95% of invoices from firms with fewer than 50 employees within 30 days.

Furthermore, PPC signatories must issue annual reports on their payment practices and the signatory’s owner, CEO or finance director is now personally liable for poor practices.

The impact of Covid-19 on debt in construction

Nevertheless, late payments and bad debts persist – and the problem has been exacerbated by the economic disorder caused by Covid-19.

Despite government support measures, analysis by Experian shows insolvencies in the construction sector have been rising, along with signs of developing bad debt risk.

Insolvencies rose significantly in 2021, returning to 84% of 2019 pre-pandemic levels.

Furthermore, monthly average insolvencies for the first four months of 2022 were 30% higher than the 2019 monthly average.

More county court judgments are being ordered and the values are rising. Compared to 2019, the average CCJ value in 2021 was 33% higher; the median value was 16% higher at £1,944.

In addition, the number of CCJs incurred in the first months of 2022 exceeded 50% of the total for the whole of 2021.

Experian said there has also been a disproportionate increase to 30-to-90-day delinquent debt, being 24% higher in April 2022 compared with April 2021.

As Carillion illustrated, bad debt can send devastating shockwaves throughout the supply chain, and small firms are particularly vulnerable when cash flow is affected by the collapse of a supplier.

Construction software and the Business Health Dashboard

More than 75,000 construction firms could be at risk of collapse due to a mix of inflation, cash-flow squeezes and shortages of materials, according to Begbies Traynor earlier this year.

How do you avoid being hit by one of your customers paying late or, worse, going into administration?

Visibility is key. Having accurate, accessible data about your projects and costs will help to spot the early warning signs before a potential problem becomes a crisis.

This is where the right software can make a big difference. Technology such as enterprise resource planning (ERP) systems give you that integrated view of day-to-day operations, from accounting and procurement to project management and supply chain operations.

Companies such as The Access Group are exploring new ways to support customers. They’ve partnered with Experian to add the Business Health Dashboard to their software solution.

This dashboard has been developed in partnership with Experian to help construction companies identify credit exposure and debt risk.

It gives an accurate picture of outstanding debt and associated payment risk in a single view, supporting you to make more informed decisions as to the strength, performance and creditworthiness of your new and existing customers and suppliers.

The dashboard gives customers:

  • A single view of the strength, performance and creditworthiness of customers and suppliers.
  • Enables more informed decisions for new and existing customers; to adjust credit terms to reduce financial risk and target sales campaigns to yield the highest return.
  • Segmented data according to your business needs to identify and mitigate risk within your portfolio, proactively.
  • An accurate picture of outstanding debt and associated payment risk.
  • Early visibility of changes to customers/supplier risk profile.
  • Streamlined Credit Control through more effective prioritisation of customer debt.

The Business Health Dashboard from The Access Group provides another layer of information within the single source of truth that underlines a company’s construction management software.

Companies can gain full visibility of all processes, identifying areas where productivity could improve, leading to risks being reduced and margins boosted, helping the entire construction cycle run more efficiently.

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