Don’t let bad debt drag you down

Bad debt is a killer for businesses, particularly in the construction industry, which has a high liquidation rate. Here’s some tips to help you protect your company

A New Zealand-based study conducted in 2012 found that:

• On average, it takes 18 months to receive settlement of an unsecured debt in the construction industry.
• At the end of the liquidation process, almost half of all trade creditors will receive nothing.

These findings align closely with anecdotal evidence from the construction sector: most trade professionals we talk to will either have experienced it themselves or know someone who has.

Alongside good risk reduction measures, such as robust credit control, using Construction Contracts Act-compliant payment claims and registering your interests with the PPSR, there are a number of insurance options available to reduce the effects of bad debt on your company. 

Even the most rigorous and disciplined credit management cannot prevent bad debts; any business with these exposures should ensure they are protected.

Protecting your retentions

Despite changes to the Construction Contracts Act (CCA) – which mean that, from 31 March, 2017, retention money must be held “on trust” by a main contractor – there is still no guarantee that subcontractors will get their retentions back if they haven’t been accounted for correctly, or have been spent by the head contractor as they try to avoid insolvency. It also only applies to commercial building.

In any case, your money is tied up in their business and is not helping your cash flow.

Retention bonds

Instead of agreeing to cash retentions, you can provide a bond instead. A bond is a promise from a surety provider, such as your bank or an insurance company, to the head contractor for the value of the retentions they want to hold.

You’ll pay a premium for an insurer to provide a bond on your behalf, but it means there is no risk of your retentions –  often the profit on the job – being lost if your main contractor goes bust.

Protecting your accounts receivable

Your debtors ledger, which is the amount of money owed to you by your customers at any one time, is probably one of the biggest assets a trade business has. Unfortunately, it is probably the least insured. Self-insurance or a bad debt reserve does not replace the money lost, whereas credit insurance can put cash back in your hands.

Subcontractors payment guarantee insurance

A Subcontractors Payment Guarantee policy will pay 75% of the money owed to you by a head contractor when they become insolvent. It has a 30-day stand down period and does not apply to retentions or contracts you have already started.

The policy is aimed at smaller trade businesses, typically those with a turnover of less than $2m and where an event such as losing money to bad debt could have a significant effect on cash flow. It’s simple to arrange and you can choose an annual limit of cover of $25,000 or $50,000. To work out what amount best suits you, consider what is the maximum amount you could be owed by a single contractor at any one time.

Payment guarantee claims are generally settled within a few weeks, compared to waiting many months for settlement through a liquidation process, from which most trade creditors will only receive cents on the dollar.

Trade Credit Insurance

If your outstanding debtors are large and/or you want to insure payment default as well as insolvency, trade credit insurance could be suitable.

When a bad debt happens there is an immediate effect on cash flow, which could even lead to your own business failing. The proceeds of a credit insurance claim inject liquid funds back into your business so you can continue to pay your own bills.

In a nutshell

Your accounts receivable is probably one of the biggest assets your business has. Yet despite the best credit control and debt management practices, external factors outside your control can negatively affect this asset. If that happens, your cashflow can be substantially affected. That’s why it’s as important (if not more so) to insure your financial risk as it is to insure your other assets.

For more information on any of the above, visit: www.builtin.co.nz/financial-risk

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The information contained in this article is general in nature and not intended to be personal advice.
Builtin Insurance specialise in insurance for builders & tradespeople. For more information visit www.builtin.co.nz, email Ben Rickard at ben@builtin.co.nz or call him on 0800 BUILTIN.