By {{Article.AuthorName}} | {{Article.PublicationDate.slice(6, -2) | date:'EEEE, MMMM d, y'}}
Even in good times, construction has one of the highest incidences of business failure in the United States. The Great Recession was tough on contractors, and the recovery has not been much better. Margins are still low, and public funding for construction is far below pre-recession levels.

Construction companies can fail for many of the same reasons as other businesses—lack of adequate planning, poor financial recordkeeping and excessive debt, to name just a few—but the unique aspects of construction bring added risks.

The uncertainties of project financing, uneven profit recognition, weather, onerous contract terms, labor productivity, tight schedules, and reliance on other contractors and suppliers adds risk that many other types of businesses don’t face. Add them all together and it’s no wonder that consistent profitability and long-term success are such a challenge for contractors.

Construction companies come in all shapes and sizes, and the level of sophistication in their internal accounting capabilities can vary widely. Inadequate job cost tracking and breakdowns in the flow of information from the field to the main office can lead to problems that spiral out of control before senior management is even aware of them.

Negotiate Unfamiliar Territory
The Great Recession forced many contractors to look for work outside of their normal operating territories, and the results were frequently negative. New subcontractors and unfamiliar owners, coupled with thin margins, have led to an unprecedented amount of job performance issues and business failures. A measured, systematic entry into a new market can lessen the risks of expansion, but when it’s done in a desperate attempt to maintain revenues and cover overhead, the results can be disastrous. Add in the wild card of it being a large job, and the stakes go up considerably.

Before the recession, work was so plentiful that contractors could be discriminating in the jobs they pursued and the owners had less leverage in negotiating contract terms. That window of opportunity has slammed shut, and more contractual risk is being shifted to contractors. It’s not unusual to see actual and consequential damages incorporated into contracts, and accepting that risk in return for work can lead to expensive problems.

Disciplined contract review has never been more important than it is today. The pendulum has swung to the owners somewhat, but understanding the potential added risk in the contract is the first step toward mitigating it.

Statistics show that more contractors fail during a recovery than during a recession. Everyone seems to know that, but many choose to ignore the warning. As the economy rebounds, work becomes more plentiful, but margins don’t rebound as quickly. This recovery is no exception; if anything, margins are increasing at a slower pace than in past cycles. Too many businesses measure themselves by revenue and are in a race to get back to where they were in the good old days. Smart firms downsize quickly and stay close to the sidelines waiting for margin opportunities and overhead to come back into balance.

Remember Cash Is King
The most fortunate construction companies had the financial wherewithal and backlogs to survive the depths of the recession, but many depleted their capital in the process and lack the cushion to successfully navigate the uncertainties of a protracted and tenuous recovery.

The old saying that “cash is king” is truer now than it has ever been. Construction is a cash flow business, and any unexpected disruptions in cash receipts can severely impact a contractor’s financial condition. The most common cause of cash flow issues is project financing. While some industries are flush with cash and eager to spend it on needed capital improvements, many public owners are stretching out their payments to unprecedented levels. Getting paid within 30 to 60 days was once the norm, but many states and municipalities are paying much slower (e.g., six months or longer).

Developers typically operate with very thin margins and rely on third-party financing to fund projects. The rush to get a project built can lead to projects starting before all the money is committed—often leading the contractor to provide some of the funding. That is a recipe for disaster. For all the risks a contractor assumes to build a project, adding financing to the mix is beyond the financial capability of most construction companies. The most common causes of cash flow problems are slow receivables and disputes over reimbursement for change order work performed.

It’s imperative that a contractor have solid bank support to work through the occasional cash shortfall, but continued reliance on borrowed money to finance operations is a sure sign that a business is overextended. Finding the right balance between overhead costs and the profits a backlog is generating is the basic equation for success in the construction business. If money must be borrowed to make that work month to month, one (or most likely both) of those factors needs to be adjusted quickly. Cutting overhead is not easy, but the contractors that are prospering today make those tough decisions early and often.

Have a Plan
Perhaps the biggest challenge facing contractors today is people, specifically having the field management to build the work successfully in an environment where margins are thin. Getting work at a healthy margin is hard enough, but when a firm has to go outside its personnel and rely on untested project management to build it, earning that bid margin is far from a sure thing.

Running a successful business shouldn’t just be about surviving; outperforming the competition and thriving is the goal. The contractors thriving in today’s market have a solid business plan for the year and long-range strategies for where the market is headed.

Understanding costs, running a lean operation, avoiding onerous contractual obligations and focusing on the bottom line rather than the top line are the keys to success. 

Bill Waters is vice president of CNA Surety. For more information, visit cnasurety.com.

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