Managing business risk – Financial

Last month, we discussed the liability risks your business faces and how best to manage them. In our third article in this series, we focus on finance 

Construction is a risky business, more so than most, yet many builders don’t spend enough time really understanding their risk environment and putting in place strategies to manage, avoid or transfer that risk.

FOUR AREAS OF RISK

• Property
• Liability
• Financial
• Personal/Family

Unfortunately, it is a fact that over half of all New Zealand construction businesses will have failed after just four years*. Mainzeal’s 2013 collapse served to highlight the risk facing many sub-contractors working for a principal contractor: the danger of not getting paid for work done and/or losing retention money that has been withheld. More than 1,000 sub-contractors and other unsecured creditors have made claims in excess of $150m and, two years on, are still waiting to hear if they will receive any of their monies.

Alongside the risk of a big collapse are smaller bad debts that can seriously affect the viability of small building companies. Margins are tight in construction; we have heard many times of a builder gone bust because just one customer failed to pay, leading to a cascade of cashflow issues, inability to pay creditors on time and, ultimately, liquidation.

However, there are a number of ways building companies can reduce their risk of financial failure:

Contract terms

The agreement you have up front will set out how you are to be paid and when; getting this right is crucial. Trade associations have comprehensive contracts that include protections for builders.

Invoices/payment claims

Don’t wait until the end of the month to do your invoicing. Where possible, they should be issued immediately upon job completion or when a relevant milestone is achieved. Modern accounting systems will allow you to do this quickly and easily; talk to your accountant. You can even email invoices and take card payments using your smartphone these days, so you get paid straightaway; talk to your bank about this.

“Rather than allow retention money to be withheld from your payments, you could supply a retention bond. This is a promise to the main contractor that you will fulfil the contract and it is backed up by a bank or insurance company

 

Additionally, the Construction Contracts Act includes provisions to enforce your rights to be paid for the work you have done in a timely manner. Make sure your payment claims comply with the requirements of the Act and you’ll be in a much stronger position to get paid if there is a problem. Trade associations and some merchants offer templates of these.

Credit control

Your accounting system should immediately alert you if a payment you’re owed has not been made by the due date. Having a robust system for chasing these is another key tool to manage cashflow and avoid bad debts building up. Again, modern accounting systems will do this for you.

Cashflow forecast

Knowing in advance when you’ll need to make payments and when money will come in is critical to being able to plan for any “pinch points”. A rolling six-month forecast will give you a good idea of what the future financial health of the business is, and what actions you’ll need to take to correct any issues before they become a problem. Your accountant can help you with this.

Regular financial reviews

Ideally, every business should have a monthly review of its financial health. How profitable is it? What is your return on capital? What is your working capital situation? Back-costing jobs will also mean you’re learning from past projects and ensuring future ones are profitable. With a good accountant and modern accounting system, this is achievable for even the smallest building business.

Payment guarantee insurance

Possibly, as in the case of Mainzeal, an event out of your control could put severe financial strain on your business, and, consequently, your family, employees and suppliers. Insurance is available to cover the risk of a main contractor going bust and leaving their subbies unpaid. Called a trade or sub-contractors payment guarantee, it pays 75% of the money owed, up to a chosen limit. For more information on this visit: www.builtin.co.nz/SCPG.

Retention bonds

The government has announced plans that will require all retention money to be held “in trust” by the main contractor. This means they can’t use it for their own day-to-day operation, and must keep it separately. However, your money is still in their bank account instead of yours.

Rather than allow retention money to be withheld from your payments, you could supply a retention bond. This is a promise to the main contractor that you will fulfil the contract and it is backed up by a bank or insurance company.

Instead of having your cash locked up in retentions by your main contractor, you simply pay a non-refundable premium to the bond provider and they make the promise for you, thus freeing up your cash to be put to better use. For more information on this, visit: www.builtin.co.nz/retentionbonds.

Even though the industry is a tough one, with good financial systems, procedures and forecasts, as well as the right contract terms and insurance in place, withstanding unforeseen financial shocks is possible for any business.

The final article in this series will focus on how insurance can help manage the risk of personal injury or illness and its effects on your ability to continue working and providing for your family.

*Table 11, New Zealand Business Demography Statistics: At February 2012, Statistics New Zealand

About Builtin New Zealand

Builtin New Zealand is a specialist in insurance for the construction industry. For more information visit www.builtin.co.nz, email Ben Rickard at ben@builtin.co.nz or call him on 0800 BUILTIN