How to Deal With a Company in Financial Distress

The banking crisis and economic recession have created a new playing field for construction firms in which margins are extremely tight, bid lists are expansive, larger and non-local contractors are entering unchartered territories and construction firms are trying to identify ways to stabilize the financial viability of their businesses. With all of these factors at play, it is no wonder that more companies are exposed to financial distress due to risk concentration, deteriorating margins and an inadequate amount of work to cover fixed operating costs. 

In order to understand how to properly deal with a company in financial distress, it is important to understand the key indicators. While it may seem obvious to measure financial distress by a lack of cash to operate the business, many warning signs are present before the financial storm actually hits. 

Construction companies should look for five telltale signs of financial distress:
  • inability to secure profitable work and complete work within budget;
  • inability to consistently secure enough work to generate an adequate backlog to protect current and future balance sheet stability;
  • difficulty funding basic operating costs such as payroll, payroll taxes, union benefits and health insurance, as well as receiving increased vendor collection calls
  • a balance sheet showing no working capital, no cash, no equity and no ability to borrow on the firm’s bank line of credit; and
  • inability to secure bid bonds and performance bonds.
Once a construction company finds itself in financial distress, it should chart a proper course of action to address the issues at hand. First, evaluate whether the financial distress is so severe that the company should wind down its operations. If the situation is not quite that dire, determine how the financial distress and operations can be resolved effectively. Once a determination has been made, the company needs to prepare a complete and accurate statement of its financial situation.

The balance sheet must be scrubbed to accurately report contract accounts receivable, percentage of completion accounts, contract accounts payable, and final estimated realization of any outstanding disputed change orders and claims. This allows the company and its advisors to address the reality of the situation and not have a balance sheet cluttered with account balances that are meaningless and will not convert to cash.

Once the financial position of the company is accurately presented, the next step is to work with a financial advisor to prepare a plan to address the turnaround. Make sure the advisor has significant turnaround experience specific to the construction industry and is well versed in addressing financial distress. To identify the best advisor for the job, obtain recommendations from a bank, bonding company, insurance firm or CPA firm.

Some business leaders question incurring the added cost of a financial advisor during a time of financial distress. However, it’s important to realize that an effective financial advisor is a necessary investment in the company’s future health and wellbeing. The risk of not hiring an advisor far outweighs the cost of bringing one on.

Together, the company and advisor will need to assemble a monthly operating plan that details the firm’s financial operations. This may include: backlog production, collection of contract accounts receivable, payment of contract accounts payable, payment of operating expenses and other financial obligations, including bank debt payments. The plan must address both the company’s financial reporting and its cash flow management. 

During this process, review all operating costs—including payroll, rent, family perks, insurance and other expenses—to determine what should be reduced as part of the monthly operating plan. While cost reduction decisions are difficult to make, it is absolutely imperative to understand it will be impossible to improve the financial position of the business without these cuts.

From there, do a detailed review of the company’s real estate and equipment holdings to determine if any liquidation is needed. If the carrying costs of the building, including debt service, are too high, then sell the building. Cost reductions, real estate liquidation and excess equipment liquidation will relieve cash flow strain and reduce the related bank debt.

Then, address any remaining cash flow shortfalls. If a shortfall continues, then the company will need to consider payment plans with vendors, reduce owner compensation, and seek potential infusions into the company to stabilize its equity position and manage cash flow. While not all vendors and subcontractors will agree to a payment plan, it is generally advisable to pursue payment plans to make cash flow more predictable. The company must comply with its legal construction trust fund obligations as best as possible to avoid job liens or other factors that would have a negative impact on operations.

As soon as the plan is finalized and all financial matters have been fully addressed, the company should present its plan to the bank and bonding company. During a turnaround situation, it is critical to provide accurate, credible and timely information to key financial partners and to foster open, frequent dialogue. The company will need to manage the plan and work with its financial advisor on a monthly basis to determine the level of success and potential opportunities to improve or reassess the course of action.

As with any financial turmoil, there are no guarantees of success, but a well-thought-out plan will present a greater likelihood of a positive outcome. Remember, success is measured in many ways. For some, success is improving operations to a point at which the business thrives again. For others, success is limiting the financial hardship caused to family members, banks, surety companies and employees. And for others, success could be a wind down of the business in which the vendors, bank and bonding company get out unharmed. 


Todd A. Feuerman is a director in the audit, accounting and consulting department of Ellin & Tucker, and chairman of the firm’s construction services group. For more information, email tfeuerman@ellinandtucker.com.