By Sharon McDougall of Scotland Debt Solutions, part of Begbies Traynor Group.
No company is immune to the dangers posed by today’s uncertain economic and political landscape. It is therefore no wonder that insolvency rates have increased across a number of industries over the past year, with construction firms taking the unwanted accolade of leading the pack when it comes to rates of financial distress.
According to latest figures from the Insolvency Service, construction firms accounted for 16.9% of all insolvencies in England and Wales in September 2023. The same report showed a 8.3% increase in construction firms becoming insolvent in the year to September 2023 when compared to the same period in 2022 and a staggering 33.2% increase on figures from the same period in 2019.
What is insolvency?
Insolvency can be defined as when a company is unable to meet its financial obligations as and when they fall due. A company can also be said to be insolvent when its liabilities (its debts) outweigh its assets (things the company owns). Once a company becomes insolvent, swift action must be taken to stem the problems and stabilise the business if any recovery effort is to have a chance at being successful.
Why is the construction sector experiencing insolvency problems?
Unfortunately for the construction industry, an increase in inflation, a drop in demand, and delays to major government infrastructure projects has created the perfect storm for those operating in the sector. Labour shortages and bad debt are also having an impact on profit margins, making staying in business increasingly challenging.
While every company is different, and the problems they are facing unique to them, there are some commonalities causing particular pressure to those within the construction industry:
- Increased costs –The soaring price of both labour and raw materials. In a highly competitive sector, with firms looking to undercut others to secure the job, many were already operating on now wafer-thin profit margins which have now been cut even further. Fixed price contracts which did not factor in the exponential rise in inflation are now proving to be a drain on finances with profit at risk of being wiped out if materials haven’t been purchased ahead of time as the cost cannot be passed onto the customer. Any unexpected delays only add to the pile of problems while a lack of skilled workers mean taking on projects is fraught with difficulties even if the finance side of the contract adds up.
- Late payments and bad debts – 90 day payment terms are not uncommon within the industry which can itself present a challenge to even the most robust company’s cash flow position. However, the construction industry is notorious for late payments, something which can have a significant impact on cash flow position particularly if a defaulted debt turns ‘bad’ and is ultimately deemed uncollectable. When one company’s ability to service their outgoings is compromised, this can have a domino effect where one case of insolvency cascades down the supply chain, leaving a wake of bad debt in its trail.
- Decreased demand – Higher interest rates are impacting the residential and commercial property market, while delays to major government infrastructure developments, including major road and rail projects, has affected demand for services across the industry. Curbed demand from homeowners and home movers alike has led to housebuilders waiting to see demand return before committing to further developments, grinding certain parts of the industry to a near standstill.
What are the options for an insolvent construction firm?
The good news is that insolvency does not necessarily spell the end for a company. There are a range of formal rescue and recovery options which can be considered for a struggling – yet ultimately viable – construction company facing the prospect of insolvency.
Such a restructuring effort could involve entering into formal negotiations with creditors to refinance existing liabilities, placing a company into administration to stave on ongoing or threatened litigation action, or simplifying operations to divest the company of unprofitable or non-performing trading areas.
In some situations a company’s problems will have taken it beyond the point of rescue. If this is the case, placing the company into liquidation by way of a Creditors’ Voluntary Liquidation (CVL) process may be the best option for all concerned.
What does the future hold for the construction industry?
Bringing stability back to the sector is absolutely paramount when it comes to the long-term outlook for the construction industry as a whole; however, while interest rates and inflation remain stubbornly high, firms cannot rely on costs and demand returning to the levels of two years ago, and instead must focus on what they can do on an individual level to provide the certainty and stability they require. Being alert to the warning signs of impending insolvency and having a robust yet flexible plan to navigate likely challenges is vital in such a volatile trading environment.
