At the start of 2013, many construction industry economists predicted a "rebound" for the industry. While construction spending grew during the calendar year overall, it wasn't quite the rebound originally anticipated.
We're now turning the page to 2014, and the industry is excited about lots of positive economic indicators. Are we really on the cusp of a strong market rebound?
The answer is probably yes, but the result of that is not as rosy as it may sound. In fact, a rebounding economy is riddled with extra financial risk, and this article presents a guide to understanding and addresses those risk.
What is financial risk?
Financial risk is simply defined as the risk of losing money. The construction industry is already riddled with these risks, as it claims the nation's highest debt ratios, lowest margins and highest business failure rates. Since construction projects are layered in complexities, scheduling challenges and payment flow abuses, a contractor or supplier takes a lot of financial risk on every project.
When the construction industry was hit by the Great Recession, a lot of companies struggled to survive being on the losing end of this financial risk equation. Equity in properties and projects plummeted, payments didn't make it down the contracting chain, and contractor bankruptcies made contracts uncollectable.
Interestingly, just as the downturn exasperated financial risk, so too will the upturn. In fact, according to research published in ENR’s Viewpoints column, the risk of contractor failure is historically three times greater in a recovering economy than a downturn.
There are many explanations for this unexpected result, but they mostly revolve around cash flow problems. Access to capital in a recovering economy is limited, cash reserves within companies are relatively low, and the high growth demands of a quickly recovering economy is cash hungry.
This is why in the final quarter of 2013 many in the industry were talking about financial risk, and strategies to shift financial risk between one side of the project (owners/lenders/GCs) and the other (subs/suppliers). See, for example, ENR's October 2013 Risk Summit talk about payment flow debates, and CFMA's September 2013 conference Financial Risk Shifting Discussion.
How to insulate your company
Now that you know what financial risk is and why the 2014 economy is laced with it, you may be wondering what you can do to insulate your company from that risk. The good news for your organization is that there are a lot of tools and choices to position your company well to both take advantage of the recovering market, and to not financially suffer.
1. Learn to love your security rights
The laws, regulations and customs of the construction industry are built for financial risk management, and the star of all the tools available to companies is the mechanics lien instrument.
Just like a bank can (and always does) take security or collateral before issuing a loan, those in the construction industry can claim collateral before furnishing materials or labor to a construction project. The way to do this is by simply preserving your mechanics lien rights. In a recovery economy that presents higher-than-normal financial risk, it's more important than ever to fall in love with lien rights.
2. Know what others may do to shift risk to you, and push back
"Know thy enemy" is a common mantra for people in battle. Since there are so many ways to get financial risk shoved onto your company, one of the best ways insulate your company from the risk is to understand the risk world, and not get blindsided by it.
Where should you be looking? You can start with your construction contract, which is laced with financial risk-shifting provisions like contingent payment provisions (e.g., pay-if-paid clauses), indemnity clauses, liquidated damage provisions and the like.
When dealing with contracts, many of the clauses are negotiable. Negotiate. Push back. Refuse to take the risk that you can't take, and take only the risks that you calculate as acceptable.
3. Involve your organization's finance professionals
We're talking about financial risk, therefore it's smart to heavily involve your organization's financial professionals.
Deloitte, a global risk management and consulting firm, published an article in the Wall Street Journal stating that in 2014, CFOs will be called upon to play a larger role in their company's innovation process in order to achieve success in new market challenges. This includes financial risk mitigation.
CFOs and other company finance professionals must take the lead for their organizations to adopt technologies that can enable their company to leverage data, the cloud, automations and more, all to insulate from and deflect financial risk on construction projects.
