Guarding against financial failure: some practical guidance

As we continue our mini-series focused on financial issues facing contracting businesses in the UK construction industry, and building on our two articles in this mini-series to date, this week’s article provides some practical guidance aimed at help protect against the risk of financial failure.

Given the fragmented nature of the construction supply chain, this could be quite a broad area, so I have focused the article on main contractors and subcontractors because this tends to be the most critical interface when it comes to financial failure.

I have segmented the article into three areas: one to cover the period leading up to contract agreement; the second to cover post contract award; and the third focused on the importance of communication.

As always, this is contained within a five-minute article, so you get maximum value for your time investment.

Do your due diligence

Before entering into contract with another entity, you should do your due diligence on their business and consider the risks to you:

If this is a resource-hungry supply chain member, do they employ their own labour or outsource?

If the scope will require a significant upfront outlay on materials, do they a sufficient credit rating to make the orders?

If there is a lot of off-site manufacturing, does the business have sufficient short-term assets to cash-flow intense manufacturing periods?

If the technical warranty is important, can you obtain sufficient financial security to underpin the long-term risk?

Think through the risks, what could happen, and what you need to do to protect employer? For me, it’s more than just running a basic credit check.

If you have concerns, then consult with those in your finance team and ask them to perform a review and identify any issues you may have missed. As QS’s we have some knowledge but take advantage of the skills around you to make sure that you identify all the blind spots.

You may still make a recommendation to proceed, despite concerns because the offer presents the best value, or it is the only offer you have. If that is the case, write a disaster recovery plan that describes how you will overcome the risk of financial failure if this occurs during the performance of the subcontract.

On-site problems

You need to have your eye on the tell-tale signs that financial problems might be prevalent. These will initially be shown on site, so stay in touch with what is happening. Better yet, go out there and talk to people rather than waiting for the information to come to you.

What you might observe is a high turnover of labour, materials being delivered piecemeal from multiple suppliers (or not turning up at all), and plant being removed from site without reason. These would all point to credit issues.

What you might see next, to overcome these credit issues, is over-inflated applications to increase the possibility of being paid more. This is a particular concern when you see significant over claims for measured works (i.e. obvious things that can be checked with a physical inspection).

I always recommend preparing robust and substantiated payment notices with supporting records and evidence. However, if you start to see these over claims occur, then double down on that diligence and make sure your payment notices are served on time and to the right person.

The risk is a ‘smash and grab’ adjudication if your payment notice is not compliant, so don’t fall into that trap. And don’t lead yourself to believe that this is only a short-term risk. I experienced an issue in which, many years later, the claim was raised. The valuation in the payment notice was correct, but it was sent late and we had no option but to compromise in reaching an agreement.

Communication

If you are observing these behaviours, then absolutely you need to protect your business and comply with the contract.

However, it is often a good idea to pick up the phone and discuss concerns with the subcontractor. Similarly, if this is happening, subcontractors would benefit from picking up the phone and raising it.

The impact of financial failure on a project can be severe. As a main contractor, you need to find another subcontractor willing and able to complete someone else’s work. In most cases, you will incur a premium and retain risk that you cannot procure (e.g. a warranty for the design).

Through communication, you might get to understand that the issues are not as severe as you expected, and, by making some short-term concessions, you can find a solution that keeps your project moving and gives the subcontractor the breathing space to get their financial affairs in order.

A win/win outcome achieved through sensible discourse: it is possible, I promise.

Final reflections

For me, there is more that can be done to manage the risk of financial failure, and I wonder if we do enough to understand the risks and implement measures to manage these risks.

It has led me to reflect on whether some of the industry’s terrible insolvency statistics could be reduced by taking a more skilled approach to contracting, or do we stick to the unintelligent ‘computer says no’ line when finalising agreements with subcontractors? There is a place for that, don’t get me wrong, and rules are in place for a reason, but as professionals, we need to think more broadly about the risk.

I hope the article gives you some food for thought or maybe even causes you to stop and reflect on a current situation. It certainly has for me, and it is a sobering reminder that this should never be allowed to happen again.

In next week’s article, as we continue our mini series focused on financial issues facing contracting businesses in the UK construction industry, and after covering the macro issues, I will focus on the micro issues that lead to, or cause, financial failure.

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p.s. if anything in this article, or any of our articles, resonates with a challenge you are experiencing, check out our Bringing The science of Quantik® to you initiative where we offer a tailor-made session aimed at helping you tackle your project or business challenge (link below).

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