The rise of bad debt in construction

Carol Massay, head of construction at the Access Construction group, advises practical measures that can be taken to avoid bad debt in construction

As one of the most important sectors of the economy, 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.

But there’s a worrying trend: despite government support measures through Covid-19, analysis by Experian shows the monthly average insolvencies for the first four months of 2022 were 30% higher than in 2019. Some 99% of these companies are SMEs, and many – if not most – construction firms find themselves walking a knife edge when it comes to profitability and, more importantly, cash flow.

So how do you avoid being one of 75,000 firms estimated to be at risk of collapse? Read on to learn about the industry outlook and some practical measures you can take to avoid bad debt in construction.

What was the cause of bad debt in construction?

Several factors have combined to contribute to a sector that can be financially challenged, not least of which is a procurement culture that leads to lowest price tendering 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, and will hopefully also help change the lack of profitability.

But it would be the height of folly to think that suddenly every contract is going to be wonderfully profitable. The wider economic news isn’t altogether rosy either, with increases in gas prices, higher food prices and higher interest rates denting household incomes and putting pressure on consumer and business spending.

With the UK now being forecast to enter recession, it is more important than ever for businesses to make sure that they have got the foundations right. Part of those foundations is to have a healthy supply of cash because, in a very real sense, cash means strategic options, and in a time of difficult economic conditions, having strategic and tactical flexibility can be vital.

Dealing with retentions

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.

Long retention times can take a lot of management, especially when subcontractors are working with a large number of clients, each with several contracts a year. Unfortunately, there have been allegations of larger firms relying upon smaller businesses ‘forgetting’ to collect these debts as an added source of income.

Late payments and bad debt in construction

While the proposed changes in the Building Safety Act are welcome – and overdue – there is another longstanding cultural problem that impacts profitability and the ability of construction firms to invest in the future: 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 towards the use of potentially lengthy supply chains of specialists who could provide their services to the main contractor as needed. This increased the number of hands that payments passed through and expanded the potential for delays as companies further down the supply chain waited for the cash to trickle down.

The lingering effects of Covid-19

As if the inherent bad debt problem wasn’t bad enough, along came 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. Experian said there has also been a disproportionate increase in 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.

What can construction companies do to protect themselves and secure their future?

Alongside industry best practice techniques such as making sure you have clear and lawful contracts, setting up a credit control policy and being prepared to say goodbye to bad customers, visibility is key to keeping control.

While the construction industry tends to be later than others to adopt new technology, this doesn’t mean that cutting-edge technology isn’t available. In fact, adopting new solutions such as the Access Business Health Dashboard is a great way to give you an edge over your competitors and solidify your finances.

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. The Access Business Health Dashboard 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 boosting, helping the entire construction cycle run more efficiently. It gives you a single view of the strength, performance and creditworthiness of customers and suppliers, with rich data incorporated directly from Experian, meaning you have the visibility you need to make the right decisions for your business.

If you would like to learn more about how you can help beat bad debt or about the Access Business Health Dashboard, please download our free eBook using the QR code below.