In January 2018 something remarkable happened in the UK construction industry. Carillion, one of the country’s largest contractors, collapsed under the weight of its debt after failing to secure a rescue deal with its banks and the government.
Despite working on more than 400 public sector projects, including a £1.4bn (AU$2.45bn) joint venture deal on HS2, and appearing to have come through the worst of a tough period of trading the preceding year, Carillion went bust owing its lenders £1.3bn (AU$2.3bn). More alarmingly, the firm had a mere £29m (AU$52m) in cash.
Carillion’s collapse sent shockwaves through the UK construction industry, leading to many smaller firms going out of business and a reappraisal of how the contracting sector operated, particularly its financing.
After all, how could a company of the size of Carillion – at one point it employed 42,000 staff – get into such financial trouble? Why did it have so little cash in the bank?
Basically, Carillion was prepared to undercut itself to secure work, to do jobs that might not generate a return. Its inability to convert reported profits into cash led to more debt, according to a major investigation into the firm’s collapse. It led to a spiral of problems that ultimately had dire consequences.
Construction Cash Flows Along with having enough money to fund the work involved in a project, forecasting how much cash will be required to complete it is essential.
If a firm takes on too much work for small margins, and if problems then arise around completing jobs on time and within budget, its cash position – and its ability to service its expenses – comes under threat.
Experts advise companies to monitor projects, quickly identifying how each scheme is likely to affect the firm’s overall budget. Securing the best possible terms from suppliers is vital, as is punctual invoicing and the ability to track spending.
In 2011, the Royal Institute of Chartered Surveyors (RICS) published a guidance note on cash flow, in which it highlights that cash is the ‘lifeblood’ of the construction industry. The note spells out the issue as follows: ‘Cash drives all businesses, and the management of the flow of cash in and out of a business is essentially to the survival of any company. It is also important for sole practitioners for their own business planning and forecasting.’
The note reminded the industry that payment terms of most contracts meant that work was usually paid in arrears, ‘so it is important that contractors and consultants understand what their liabilities are and when they are likely to be paid’.
‘Overdrafts with banks are often used to manage any shortfalls, but delays in payments, disputes with clients or renegotiation of overdraft terms can have disastrous consequences to the future of businesses’, the document adds.
Construction cryptocurrency and blockchain – a cash flow cure-all?
The digital transformation of the construction industry continues, with companies adopting Building Information Modelling (BIM) and next-generation technology such as digital twins, so construction’s recognition of cryptocurrency and blockchain in assisting cash flow management shouldn’t come as much of a surprise.
The Institution of Civil Engineers (ICE) published a report in 2018 outlining the benefits of blockchain technology, also known as distributed ledger technology. The fragmented nature of construction’s supply chain and the potential for mistakes, delays and accidents at various stages of a project’s life could all be aided with blockchain, the ICE says, by enabling transparency, traceability and accountability.
‘One of the most applicable uses of blockchain in the construction industry is to embed a blockchain-based platform into the project execution practice, which can initiate payments based on digitally approved work, contractual terms and smart contract actions’, the ICE report says.
The application of so-called ‘smart contracts’ would activate faster payments, enabling contractors and their suppliers to avoid the risk of not being paid.
And what of blockchain’s cousin, cryptocurrency? According to Steven Cooke, group director for strategic growth at consultancy Linesight, since cryptocurrency is digital it can be used to make instant virtual payments.
This helps solve cash flow issues and opens the door for automated payment processes, such as smart contracts, making it possible to create incentivised instant payments that can enhance productivity.
‘Construction firms can also pay contractors swiftly, based on valuations, or easily enforce financial penalties for late work’, Cooke said.
As with any new technology there are going to be risks when using cryptocurrency. It’s still in its relative infancy, regulation is scant and taxation issues are yet to be settled. Those opting to use cryptocurrency would need to be up to speed regarding the potential pitfalls as well as the benefits.
Still, the prudent use of cryptocurrency could help streamline cash flow construction management. It could lead to a more transparent, traceable and accountable construction industry, one where cash reasserts itself as king, suppliers are paid promptly and projects get completed without fear of financial ruin.