Businesses in the construction industry will have welcomed David Cameron’s announcement of a house-building crusade at the Conservative party conference. But now autumn is here, and the weather worsens, firms in the sector will still feel a chill. July and August are the busiest months for building, but work levels often collapse come November, and cashflow can slow to a trickle. Yet, small and medium-sized enterprises (SMEs) in construction should plan for the quieter months, introduce processes to minimise the impact of leaner financial times, and discover the growing choice of funding providers to keep themselves afloat until conditions brighten.
Construction by numbers
Small companies dominate the construction sector, with 950,000 SMEs operating in the industry, according to Government figures, versus about 300 large enterprises. About one in five of all small and medium businesses in the UK is in construction.
But, despite their large numbers, construction businesses are at a disadvantage to other enterprises financially. The SME Finance Monitor shows:
- They are less likely to apply for bank finance than firms in other industries.
- Those that do seek a loan or overdraft are more likely to be rejected than companies in other fields.
- Business owners in construction-related areas tend to ask to borrow less money.
- Only one in three construction SMEs uses any form of external finance.
Avoiding late payment
Late payment can break a small business, and construction companies are even more prone to being left out of pocket than those in other sectors. More than 70 per cent of smaller construction businesses have written off unpaid invoices as bad debt in the last three years, a recent study by The Vinden Partnership and Bibby found. And the sums involved are sizeable – the average amount lost was just under £30,500, totalling more than £1.9 billion across the industry annually.
There are some basic practices SMEs can undertake to avoid being paid late.
- Check new customers’ credit rating, and discreetly ask industry contacts about an unknown client before agreeing to start work.
- Always agree terms of payment in writing before starting a project.
- Cultivate existing customers who are proven payers in the hopes of winning repeat business.
- Stay up-to-date with any variations on the original contract. Changes to a project should be agreed along the way, with payment terms renegotiated to avoid disputes on completion.
- Keep communicating. If you are talking to your client throughout the job, then potential problems with payment will emerge early on.
Another problem is the need for construction companies to order building supplies in advance of starting a job. Trade credit is commonly used in the industry as a result, far more than in other sectors, according to research by University College London. Even more construction firms have employed trade credit since bank lending dried up for smaller businesses.
Trade credit may be low-cost, but it comes with risk. The cascading nature of this type of credit throughout the industry means each tier is vulnerable to the next being compromised. Smaller firms are particularly vulnerable, since they are more likely to extend trade credit than their larger peers, and are more often the sub-contractors on a big building project. However, given trade credit is a fact of life in construction circles, smaller businesses should protect their position by having a written credit policy, the Association of Chartered Certified Accountants recommends. It also advises clear credit terms, and rigorous processes to issue invoices regularly and to collect receipts from customers efficiently.
Access to finance remains a major concern, and it regularly comes out as one of the top problems for construction SMEs, according to the Construction Trade Survey. As said previously, the industry has a poor record when it comes to dealing with conventional financial institutions, and this has only worsened since 2008. But the growing influence of alternative funders over the intervening years has widened the pool of funding choice for construction firms.
The Government has committed to improve the range of financial products available to SMEs working in the construction sector as part of its action plan Construction 2025. And research by innovation charity Nesta shows more construction firms are already turning to alternative finance, with the industry being particularly keen on peer-to-peer lending, and pension-led funding, where directors use their pension funds to invest in their own businesses.
Factoring and invoice discounting are other popular options with construction firms, advancing finance against invoices as soon as they are raised, smoothing over bumps in cashflow, and raising short-term finance.
Cash will always be king to any business, and SMEs should undertake regular cashflow forecasts to stay abreast of how much money they have now, and in the near future. Once you know a funding shortage is looming, there is the chance to act to avert disaster. A little forward planning and awareness of what funding options are available can mean unforeseen circumstances and a financial shortfall need not be a disaster. Taking such measures means construction firms can safely weather the winter months, and look forward to the blossoming of spring - as well as the new business it brings.
By Willem van Lynden, Director of Sales and Marketing, Boost Capital