The term 'credit crunch' is now commonplace as economic slowdown has hit the headlines.

It will have escaped nobody's attention that the economy in general, and therefore construction in particular, is expected to suffer a setback in the coming year. It is expected that this will be driven by the enormous write-downs the global banking community has had to implement due to its exposure to the US 'sub prime market'. Quite what all this means will probably be lost on the small subcontractor facing severe cashflow problems in the heat of battle with his employer. Nor, indeed, will he care. In the final analysis, his problems are closer to home.

In the most cases, construction insolvency is due to cashflow or, more particularly, the lack of it. How many times has it been said that turnover is vanity, but cashflow is king?

All too often, company directors embark on missions of rapidly increasing turnover in the mistaken belief that to do so will undoubtedly improve the bank position and, therefore, profitability. If only they would realise that returning a loss of, say, £10,000, on a turnover of £1m, is more than likely to result in a loss of at least £20,000 on a turnover of £2m, and in all probability much more than that. The wise directors will turn to reducing overheads and costs, while carefully selecting the projects upon which they both wish to be engaged and can afford to take on.

Managing risk
Cashflow is directly related to the management of risk, be it while preparing a bid, performing on site, or dealing with change when on site. Early identification of a contractual problem, followed by swift attention to it, will invariably result in the protection of cashflow. Indeed, this is the main thrust of adjudication under the Housing Grants Construction and Regeneration Act Failure to identify risk to cashflow will inevitably result in problems with suppliers and subcontractors, causing damage to contract programmes and relationships with employers. On some occasions, insolvency may result.

In earlier years, the main subcontractors were afforded some financial protection and enjoyed nominated status, but this is less popular now. The contractual stability and protection that employers want from a suite of contracts cascading down from principal contractor to the very lowest level of supplier is understandable, given the need for diminution of liability. But the financial effects of the economic failure of one of the companies in the chain, while shared by all, is mostly felt by those lower down.

The government's latest initiative to see the introduction of project bank accounts seems laudable on the face of it, but the system will not be legally enforceable at the outset, will only benefit the key subcontractors and suppliers wanting to enter into the trust arrangement, and is likely to be tested by the interruption of an insolvency event.

There is also likely to be much debate about rights to set-off, and the fact that it will only be the main contractor that decides how much is due. Furthermore, from what information is available, monies in such a fund will only represent the current month's certified sums, and will not address work in progress. However, it is a step in the right direction, but may not satisfy small subcontractors.

One issue that frequently arises in dealing with construction company investigations is retention. There are not many businesses in the contracting world that regularly return more than between 4% and 5% gross profit on a year's trading. Some do, some don't. If you were to take an industry average of withheld retention of around 2% to 3%, the significance of this figure to cashflow and profitability becomes apparent.

Subcontractors particularly feel the impact of being denied this money and frequently have great difficulty in recovering it. Indeed, many businesses believe it is irrecoverable in real terms.

Employers have been encouraged to set up trust funds to afford some protection to these monies in the event of an insolvency, but in practice the industry seems not to have adopted the idea. As an alternative, retention bonds can be offered, but it is likely that these have only been economic where sums in retention funds are large.


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