By Chirag Shah, Managing Director, Nucleus Commercial Finance
Cashflow impacts SMEs in all areas of business, but certain sectors – and most notably construction - have struggled more than others to find the funding they need to prosper and grow.
Part of the reason has been the parlous state of the industry, but with the change in fortunes now being reported (a growth in infrastructure construction work is predicted to increase by 5.2% in 2015 on the back of a 3.4% rise last year), what options for finance are available?
The issue with funding businesses working in or supplying to the construction industry is in understanding how the industry works, how it is funded and how it gets paid. It has been a lack of understanding that has made ‘traditional’ lenders unwilling to commit funds. This issue has been further compounded by challenges around late payment; a parliamentary inquiry into the late payment of commercial debts last year found that businesses employing construction companies were some of the ‘worst offenders’ in terms of late payments and poor treatment of suppliers.
A recent survey of smaller building and specialist contractors has revealed that an estimated £2bn is being written off as bad debt each year. The staggering estimate comes from a survey of 200 small and medium-sized building firms and specialist subcontractors employing up to 250 staff and turning over on average £1.8m.
Rather than payment easing with improving workloads there is evidence that getting paid on time or by the full amount is becoming more difficult. 70% of firms quizzed said they write off an average of more than £10,000 each year, according to a recent survey. Almost 60% of firms said they do not always receive the amount they have invoiced for but they are forced to accept lower settlements because they cannot afford or wait for dispute resolution or court rulings.
Construction firms, in keeping with many other businesses, have relied on overdrafts and loans to bridge the funding gap while they wait to get paid. But both have their risks, and can be expensive, especially if overdraft limits are exceeded or repayments missed. Another alternative is Invoice finance, which at its simplest is a product that advances a company a percentage of an invoice that has yet to be paid for. If a construction company needs an immediate injection of cash, then invoice financing gives a company that fast access to cash without the red tape. By receiving an almost immediate advance on a project, a company can pay for supplies, wages as well as any other eventualities that may arise during the life span of the project. It also means that regardless of the payment terms, the business is not dependent on the customer paying him before he can pay his own partners within the supply chain.
Invoice Finance alone, however, is perhaps not always enough, which is why certain hybrid solutions are being developed. One, for example, developed in association with a team of Quantity Surveyors, provides pre-payments against applications, stage payments and milestones for sub-contractors. It combines a ‘traditional’ factoring model but with a fixed fee to ensure transparency on cost, and advances cash at an agreed percentage of the outstanding invoice/application value, taking into account the longer contract terms typical within the construction sector.
Such products are finding a willing audience, and from every spectrum of the construction sector, including those specialising in environmental services, refurbishment and M&E projects.
And other new products are also being developed, including an early payment scheme for medium-sized contractors with a turnover of over £20 million that enables them to make early payments to their own sub-contractors, thus ‘protecting’ the critical supply chain.
The construction industry is highly complex and varied. Projects can range from large-scale national activity, such as the London 2012 Olympic Games, to building a house. Whatever the scale of a project, sub-contractors need to be paid on time. Until traditional lenders fully understand the industry and support it, there will always be a need for alternative finance.