Considering credit worthiness
Our finance director, Neil Washington, addresses the issue of credit worthiness and specifically how contractors like ourselves can make sure we remain as attractive to clients as possible. His comments were originally published on the Construction News website.
Following the news that the turnover of the UK’s top 100 contractors is back above the £60bn mark for the first time in five years, many contractors could be forgiven for thinking the future is rosy. However, moving out of recession simply means the risks we now face have shifted, and the implications for clients of selecting the wrong contractor remains as strong as ever.
Recessions are extremely painful. Over supply, low barriers to entry and lack of demand mean firms are forced to be intensely price competitive. Turnover can often shrink and businesses are forced to reassess their operating structures. However, reduced turnover can have a silver lining – contracting business’ main investment is their work in progress, so despite turnover and margins potentially falling it is possible for a responsive contracting business to sustain cashflows as its work in progress requirement shrinks. This can provide some welcome relief for a contractor under pressure, but what happens when the economic cycle swings and can clients finally relax about credit worthiness?
The risk to contracting businesses as the economy recovers are two-fold. Firstly, contracts that have been fiercely competitive to secure have been locked into at prices at the bottom of the cycle. Even with an annual RPI increase these prices can begin to squeeze margins if the industry’s inflation rate runs ahead, particularly if they are long term commitments. Secondly, for the recession survivors a rebound in demand will translate to increasing turnover.
However, now the work in progress equation works in reverse; rising turnover requires more working capital to finance contract positions. Thus a perfectly profitable contractor may find themselves in a cash trap – more investment is required, yet margins remain stubbornly thin and the business fails to self-generate the funds required to support the rising turnover.
As the mantra goes – cash is king, and many profitable businesses have gone to the wall because they managed profits but failed to manage cash. It is therefore critical that as businesses get used to expanding again they have a healthy eye on forecasting and managing their cash requirements.
For these reasons, it is as important as ever that clients when selecting their contractor continue to review the credit worthiness of those businesses they invite to tender. In doing so, they should be looking for companies where the current assets more than cover the current liabilities, with a well-funded balance sheet that does not rely on third-party funding, and one which remains profitable despite the challenges the new economy presents.
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