Construction – managing your liquidity challenges
COVID19 has changed the way we live in almost every aspect of life, especially our careers and the way we run our businesses.
The construction industry took a massive hit with COVID as many of you are aware. The volume of construction projects and future orders reduced as an effect of national lockdowns; however, the government did class construction as an essential service, therefore allowing companies in the industry to continue operating in a COVID safe environment.
It has never been more relevant to adapt with the times and think about certain management processes and operations, and to come up with ways of saving costs and making the most out of the current situation.
An important aspect of company management within the construction industry, particularly at the current time, is maintaining the right level of working capital, or access to funds to meet short-term obligations – especially when profit margins generally are very tight.
Liquidity – the ability to meet obligations as they arise – is generally prized as the greatest strength, with leverage and profitability close behind. Working capital – current assets, less current liabilities – is a liquidity shown as a monetary figure, as opposed to a ratio. For this reason, bigger is usually better, but the quality of working capital counts too.
It is vital that contactors have sufficient short-term liquidity, otherwise things can take a turn for the worst very abruptly.
If contactors do not have sufficient short-term liquidity, they may find themselves having to stretch working capital due to delayed payments from clients and other external aspects, potentially creating a need to finance the delays with debt, which is not recommended.
Contractors have several risks that could impact their business’s liquidity, such as:
– Delays in projects
– Issues with the supply chain
– Slow-paying clients
– Shrinking pipelines of work with lower revenue, reducing future cash flows.
It is generally expected that projects will maintain a positive, or at the very least a neutral, cash position. The payment terms agreed with customers and subcontractors is a key tool used to manage this.
Ways of improving liquidity
Both traditional and alternative sources of cash provide liquidity options that may support a company’s financial stability. These include:
– Traditional: cash on balance sheet, line of credit, or additional bank financing.
– Alternate: bonds, government stimulus, or divestiture of assets.
The majority of construction companies require traditional lending from banks to meet typical cash flow management, plus any additional capacity to “bond” each project undertaken.
Most banks will group standard lending with bank guarantee limits under a multi-option facility. So, if you are running numerous projects at once, the banks often issue large aggregate values on bank guarantees, therefore reducing the amount in the facility for working capital or to satisfy guarantees needed for new contracts, meaning contactors need to carefully balance their available limits.
A surety bond is an undertaking from an insurer to pay a specific sum to a beneficiary on certain specified conditions, such as company insolvency or contractual default. It is a contract involving three parties:
– A principal: the party that needs the financial support provided by the bond.
– An obligee: the party requiring that there be a bond.
– A surety: an insurer guaranteeing that the principal will be able to meet its obligations to the obligee.
Surety facilities are unsecured and treated as a contingent liability and are therefore off the balance sheet. The surety company will be placed alongside other unsecured company creditors by way of an indemnity agreement, allowing construction companies to make best use of their assets.
Alternative bank finance
Surety bonds are increasingly common; however, some beneficiaries still require standby letters of credit (SBLC). They could be issued for different reasons such as including the posting of collateral, caps on surety bonds, internal limit and liquidity constraints, legal/regulatory requirements, and beneficiary preference.
These bank front surety transactions can meet a beneficiary’s requirements of presenting SBLS’s, while allowing the company to use its surety lines instead of bank facilities.
Benefits of this solution:
– The beneficiary receives a bank-issued SBLC that complies with its requirement, while the surety-backing is not visible.
– Bank-fronted surety solutions can improve an applicant’s working capital and liquidity ratios.
– They increase availability under credit facilities by using a principal’s surety limits, rather than its bank lines.
– They can provide comparable or more competitive pricing, by leveraging the financial strength of highly rated insurers.
– A panel of sureties can deliver large capacity.
Stabilizing the business comes first, however. By segmenting operational liquidity from strategic liquidity, construction companies can understand the funds available for investment. This enables them to take advantage of opportunities that come from a destabilised market, such as improving or expanding talent, entering new markets, or considering vertically integrated opportunities.
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Contact our Head of Commercial Insurances, David Baker, today to discuss your business’s insurance requirements.
T: 01245 449060