Construction Outputs Warning Sign
Mark Halstead, partner at financial risk and business intelligence firm Red Flag Alert, tells UK Construction Online that the sector should prepare itself for billions of pounds in unpaid invoices.
Although the latest ONS data shows construction output grew by 8.2% month-on-month, this is against a backdrop of outputs falling by a record 29.8% in the three months to May 2020.
One of the biggest warning signs of such a decline in outputs is that financial distress is not far behind. This brings with it a significant risk of insolvent debt, meaning invoices go unpaid.
The construction sector operates on low margins and has to regularly contend with unexpected operational challenges because of the very nature of work. Additionally, in some cases, companies also have to deal with balloon payments for projects. All of these factors combine to create a perfect storm for jeopardising cash flow and putting companies under immense financial strain.
When these businesses are hit by a significant drop in outputs and new work, which fell by 30.3% in the three months to May 2020, according to the ONS data, their ability to survive becomes even more difficult. Many companies simply don’t have the cash in the bank to last a period of weeks or months of low or no income.
Granted, some of the Government’s COVID-19 financial support measures will help these businesses through lean times. Unfortunately, though, for some operators this will be a case of delaying the inevitable. Levels of debt in construction are already the highest amongst the UK’s sectors and this situation will only get worse over the next 18 months. This will cause a spike in companies going out of business, which will leave a long tail of debt.
Red Flag Alert analysis shows that at 31st May 2020, insolvent debt in the construction sector stands at £336million. Based on analysis from the past three years, we know that around 3% to 4% of struggling businesses will fail each year. The economic impact of COVID-19 will see this rate of failure rise substantially, reaching well into double figures. Taking this into account, it’s conservative to estimate that construction sector debt will double this year to £772m and could be around £1.4billion in 2021.
Essentially, these figures mean that construction companies are facing over £2billion worth of invoices going unpaid between now and the end of next year.
Businesses need to act now to protect themselves against this debt. They should prioritise collecting money owed to them and also properly due diligence their supply chains. This includes both customers and suppliers.
Using sophisticated software like Red Flag Alert, it is possible to run a comprehensive financial health check of a company. This can be done in minutes and is based on extensive data that’s constantly updating. If businesses are about to undertake a project for a customer, they need to know if that client has the ability to pay their invoices. Having this knowledge can help construction companies avoid the risk of incurring significant expenses for materials and labour, which they may not recoup.
The financial insight can also be used to adjust credit terms. If a construction company realises a customer is a higher financial risk, they may decide to address this by asking for part payments up front or reducing payment terms to identify and act earlier on any potential payment issues.
Looking beyond customers, the long tail of debt will put suppliers at risk. Unpaid invoices can have an immediate impact on the security and operation of a company. This will be accelerated as insolvent debt rapidly increases. Companies may find that suppliers which were in a good shape just weeks ago, are now facing collapse. Spotting the early signs of their difficulties can protect against costly supply chain disruption and expensive project delays.
The ONS data provides an extremely important insight into the mood and confidence of the construction sector. This is likely to change as the Government continues its attempts to drive the economy forward but will take a long time to catch up and to return to any level of ‘normal’. Companies are best advised to protect themselves by concentrating on the security of their cashflow by regularly checking levels of financial health throughout their supply chains.
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