Avoiding financial failure: the existential threat of one problem project

As we continue our mini-series focused on financial issues facing contracting businesses in the UK construction industry, the purpose of this article is to cover the micro issues relevant to construction industry insolvency (in contrast to our 05 June 2024 article focused on the macro issues).

The idea is to cover this by looking at how a construction business might only be one bad contract away from financial failure and look at those things, from a quantity surveying perspective, which can positively or negatively impact the liquidity of a construction business.

The article covers tendering, negotiating contracts, administering contracts, and financial control, and provides some ideas that may help you reflect on, and refine, your approach to these issues.

As always, I will attempt to cover this in a five-minute article (albeit I think this one stretches to six minutes).

It only takes one bad contract

A construction business can spend years building a strong reputation and a healthy balance sheet.

Then you take your eye off the ball, maybe complacency creeps in, maybe you have grown too fast and your controls are no longer effective, but you sign a contract riddled with risks you cannot control, scope you didn’t fully understand, in a duration that is impossible to achieve, at a price that is not sustainable.

Or you get into bed with a client who cannot pay or has no intention to pay.

You try to deliver the project and fulfil your obligations, but it drains your money and decimates your balance sheet as you try to negotiate your way out. You might have 25-30 good projects delivering profitably across your portfolio, but this one undoes everything because the loss on this one project is more than all those projects combined.

These projects do not go bad overnight. The warning signs are there from the start, you just need to ask the right questions and be objective about your assessment of the opportunity. It is easy to let a project into your business by agreeing to tender, but it can be incredibly difficult to get it out. People work overtime to deliver the bid, they become emotionally attached to it, and optimism bias kicks in: the sun really will shine for the entire contract duration.

When it comes to your business liquidity, one of the most important decisions you will make is whether to pursue an opportunity or not. Having good market intelligence and a wide range of opportunities will place you in a position to say 'no' to an opportunity, as well as having the strength of mind to stick to your principles, no matter how bright those neon lights might be or how much the client convinces you that that are "collaborative" and want to work as "one team".

Contract terms

Closely coupled with bid decisions, is the need to have red lines when it comes to negotiating contract terms. You should not take any risk you cannot control; you should have the right to recover time and cost for risks that are outside your control, and the mechanisms which result in payment to you, and the basis on which those payments are made, should be clear and unambiguous.

That is, before we get onto things like payment terms, advance payments, bonds, etc. Can you really cash flow the programme to the extent that you are being asked to cash flow it? What if you the cash flow requirements are more onerous than you expected because the programme is delayed, can you live with it? Will the cash drain impact your performance, which in turn exposes you to LD’s? What is your LD exposure – will this become a guillotine above your head when EoT is not granted?

You should always take legal advice when it comes to contractual issues; however, the quantity surveyors will help you understand what that means from a financial perspective and model different scenarios and implications. This should help inform decision-making about what you can live with, and what your walk-away position should be: never be afraid to walk away from an opportunity if it doesn’t feel right.

Contract administration

Once you are in contract, there are several things you can do to protect your business and improve liquidity (or at least stop it from worsening).

The most obvious one is submitting applications for payment (and I sound like a broken record with this) which are compliant with the contract and include all the information necessary to support your valuation.

This is more straightforward than administering your time and cost entitlements, which can be more challenging. Yes, submitting notices is a good start, but it does not end there. You will not be paid just because a notice has been sent, you will be paid because you have established entitlement, you have assessed the impact of time and cost, and you have persuaded the person on the other side that you should be paid.

If, in the first few months of the project, your cash position looks good because the certified amount is healthy, but do not fall into the trap of thinking that all is fine. It may bite you in the future when the certification of measured works slows down and the cost of achieving progress does not. If you are not on top of your entitlements, then you will quickly see that cash balance drain.

Performance sureties

Given the recent press regarding the availability of bonds and how the six big surety bond providers have pulled out of the construction market in the last two years, I thought I would squeeze in a section on performance sureties.

Whilst giving a bond might just seem like a fee is needed to cover the cost, the provision of a bond has a much wider impact because it ties up a contractor’s lending capacity. Just think about what that lending capacity could do if it was investment-focused, rather than being tied up underwriting current and historic projects.

Given the issues in the construction industry, it is unsurprising that bond providers are running for the hills, so, given this, is it time to start asking the question about the value of providing these sureties? Must they be a de facto requirement at tender stage, or does this give us the opportunity to look at alternatives?

I am surprised that there is no more discussion about this, and the current answer seems to be “get more bond providers”, but maybe there are other solutions that generate a more equitable outcome. Maybe contractor's need to promote this discussion and put forward alternative solutions.

Final Reflections

It is undoubtedly a tough industry to turn a profit. However, I remain steadfast in my view that with improved knowledge and skills, we can improve industry practices and project financial performance, to reduce the levels of insolvency experienced by the construction industry.

When I stop and think about this, a lot comes down to decision making and the path you choose for your project or business. And a big part of that is following your gut and saying no to an opportunity that doesn’t feel right. That is possibly the best protection you have - your judgement.

I hope the article gives you some food for thought or maybe even makes you stop and reflect on a current situation. Keep an eye out for the next article and, in the meantime, enjoy the rest of your week!

Bringing The science of Quantik® to you

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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