Why subcontractors fail in the construction industry
Cash flow is king in any business, and it’s no different for subcontractors. It comes as no surprise then that the most common reason that subcontracting businesses fail is that they run out of cash. This happens most often because, while they’re good builders, some contractors are not good at running a small business, and can often leave the financial side of operations unattended. Add to this the expectation that most subcontractors are expected to float a project’s costs and you have a recipe for disaster. I’ve looked at this and the other main reasons subcontractors have traditionally failed.
Cash flow problems
Construction businesses eat cash. More so than almost any other business. Being so hungry necessitates huge levels of cash flow, and with a mountain of outgoing costs, including being expected to float a project’s costs, supplying construction materials on terms, paying wages weekly, 5% of the project cost as retention, 30, 60 or even 90 day payment terms which can stretch longer with late payments, it’s easy for your cash flow to quickly run dry. These factors often lead to insolvency, at which point the business will either stall in growth as it desperately tries to cut costs and stretch payments in order to survive, or attempt to get funding in order to cover the cash gaps.
Lack of access to capital
When a subcontractor’s cash flow does run dry, lack of access to working capital can further exacerbate an already potentially fatal business problem. Due to the risky and cash-hungry nature of the job, subcontractors can struggle with a lack of access to capital from traditional banking sources. This can be especially prevalent when the industry as a whole is on the downturn, and lenders are already more reluctant to fund than ever. The results are often that a struggling subcontractor will be forced to accept a higher rate of finance, the high rate of interest payments only compounding their problem, not alleviating it.
Once a subcontractor is struggling with cash flow, it can be quick for things to go from bad to worse. Due to the highly competitive nature of the construction industry, it can be common for subcontractors to underquote jobs not just to beat out the competition, but simply to try and get some cash flow from the work. Even if you get your entire contract price, with an underquoted job it is possible, and even likely, that the project will come at a loss. This loss will often be far greater than actually anticipated, especially when a construction project can cost up to six times more working capital on 90-day payment terms than it can on 30-day terms. What seemed like a quick cash flow fix can end up draining significant resources and putting subcontractors even further behind with liquidity.
Any standard retail transaction is fairly straightforward, a buyer gives the seller money in exchange for goods. If the goods do not work, the resolution options are simple, and the issue is easily rectified. This is not the case with subcontracting, where work is often dependant upon numerous other parties, and approval is subjective. There are many issues that can arise on a jobsite outside a subcontractor’s control, but which can create trouble for them. These issues can result in subcontractors requiring a certain level of flexibility in order to coordinate with all other parties on site, and is yet another strain on cash flow.
Outside the obvious financial challenges, subcontractors, like many other small businesses, can be plagued by high staff turnover and shortages in skilled labour. It’s not up for debate that as employees are a subcontractor’s primary asset, high staff turnover creates shortage that is bad for the bottom line. On average it costs more than twice an employee’s salary to train a replacement, not to mention the cost in overtime to fill the gaps in their absence. Employee retention is especially important in the face of a skilled labour shortage, when an employee shortage can be lengthier and cause a greater negative impact. When a subcontractor does suffer the loss of a valued employee, retaining a labour hire firm or recruiter is often the most efficient way to replace them with vetted candidates and in a timely fashion. This makes it especially important to have a good flow of working capital in order to minimise loss.
How to Strengthen the Balance Sheet
Accessing Invoice Finance
As a subcontractor, one of the most efficient ways to strengthen your balance sheet and access affordable finance is to check if the major contractor has implemented a supply chain finance or early payments program. If they have, subcontractors working for them will be able to access payments ahead of their specified payment terms, and allow them more working capital flexibility.
If they haven’t, an independent invoice finance service is also a viable alternative. This is sometimes referred to as “factoring”, however invoice finance products have evolved significantly since the first factoring finance products of the 1980s.
Keep the Quotes Realistic
Relationships are key. Fostering strong relationships with major contractors with whom you regularly work increases the likelihood you’ll work with them again. Managing a major contractor’s expectations on a project is a key factor in how your successes will be perceived. Don’t promise what you can’t deliver, and make sure the buck stops with you. Ensure you’re accountable. It’s possible on a large job that the main contractor will oversee hundreds of subcontractors, so ensuring you make it as simple as possible to be managed will ensure you develop a reputation as reliable, accountable and trustworthy. If a contractor is only buying on price, you probably can’t win.
Reward Loyal Staff
As a contractor, employees are the key to your business. We’ve already covered the detrimental effect high staff turnover can have, so to avoid this problem, it’s important to make them feel valued. Incentivise good work and ensure you keep morale high; negativity breeds.
If you require help with your cash flow, please feel free to contact Timelio or call 1300 FUND ME.