Thousands of construction companies fail every year – don’t let your company be one of them.
Is your small construction company going to fail? Of course, our immediate answer is ‘no’! Yet, many construction companies fail each year. I’m sure we can all name construction companies that have collapsed over the last couple of years! Some have been very successful and then, in a short period of time gone from success to failure.
So how can you be sure your company is safe? Are you really safe? Have you taken a good look at your operations lately? Could bankruptcy be waiting for you around the corner?
Often it’s just one project or one bad customer that can sink a company. Sometimes it’s a death by a thousand cuts as the company slowly hemorrhages on every project. Companies become bankrupt or just run out of work.
Why do construction companies fail?
Let’s consider some reasons why construction companies fail:
1. Negative cash flow
This is probably the biggest cause of companies failing. Even profitable projects can sink a company if the project’s cash flow is negative.
If you don’t have the cash to pay your employees, suppliers or subcontractors you will almost certainly go bankrupt unless you’re lucky enough to get a loan from the bank. But failure to repay the loan on time will end in the same result.
Most customers pay for work invoiced monthly or when a milestone is reached. Payments are frequently 30 days after the contractor submits their invoice which could be a month or more after some work was actually completed. Furthermore, customers usually hold retention monies until the project is completed, and often until the end of the warranty period which could be another year after project completion.
In the meantime, contractors have to pay their employees, suppliers, and subcontractors. This often results in contractors funding a project until it’s completed. The bigger the project or the more projects the contractor works on, the bigger the potential cash flow problem becomes.
Contractors need to understand their cash flows, read their contracts carefully to ensure the payment terms and conditions are acceptable and consider what will happen should a customer delay payment or if large unresolved change order claims occur. Cash flow is further impacted when valuations are submitted late, or all completed work isn’t claimed. It’s essential to check your customers are paying milestones and invoices on time in accordance with the contract.
Do you understand your project and the company’s cash flow? Does your team understand how vital it is to receive payment as soon as possible? Don’t take on projects that will push your cash flow into the red unless you have sufficient funds to get the company through this period.
2. Poor reputation
A contractor’s reputation can be ruined in a short space of time. Poor quality work, safety breaches and late completion of projects all adversely impact our company’s reputation. Companies with a poor reputation find it difficult to win projects. Companies with a good reputation form lasting relationships with clients and are often able to secure work with a higher profit margin. Do your employees understand how vital it is to build and protect your company’s reputation?
3. Making errors when you price a project
Contractors sometimes make errors when they bid for construction projects. This may result in them winning projects with a price that’s below what the project will cost them. These mistakes may be simple arithmetic errors or could be due to misunderstanding the RFP’s scope or specifications. Companies have been destroyed because a single project was under-priced. Of course, submitting prices that are too high can also be detrimental and result in the company not securing projects.
4. Theft and fraud
Theft and fraud often happen when there aren’t sufficient controls in place. Sometimes contractors aren’t aware it’s happening. The theft can be theft of materials and equipment from your project sites. It can be time theft in the form of timesheets rounded up to inflate payroll. It could also be suppliers and subcontractors defrauding the company by invoicing for items they haven’t delivered or over-invoicing for items they have delivered.
But fraud may involve your employees and could be as simple as doing work on their private projects with the company’s resources. Often it involves theft or misuse of petty cash and even arranging fake bank accounts for customers to pay money to in place of the company’s bank account. Theft reduces profits, disrupts cash flow, impacts productivity, delays progress and can be demoralizing for employees. Ensure you have systems in place to deter theft and fraud.
5. Over capitalizing the company
The construction industry goes through boom cycles when construction work is abundant to times when work is scarce. In times of lots of work contractors often think it will never end and are quick to purchase new equipment and employ additional people to take on more and bigger projects. As the cycle turns it becomes difficult to keep these resources busy.
Either the company must win projects to keep their people and equipment busy by under-pricing work when it’s scarce or they’ll have machines and people standing. Often this new equipment is purchased with loans from the banks that still have to be repaid in the lean times. If a bank has any doubt that their loan may be in jeopardy they could take action to foreclose the loan. It’s important to purchase new equipment and grow the company, but always take a cautious approach knowing that the good times will almost certainly end.
6. Employing unsuitable and unqualified people
Construction companies depend on their employees. Poorly skilled people or the wrong person for the job can quickly turn to a disaster – poor quality work which has to be redone, accidents and injuries, poor production and even unhappy customers.
Inept people will adversely impact reputation and cost the company money. Continually review your employees, train where necessary, correct their faults and occasionally clean out dead wood and those who are creating problems in the company. Ensure employees know what’s expected from them. But just as important is to look after your good people. A construction company is only as good as its employees.
7. Taking on risky projects
More than one company has sunk (literally) when a storm or flood has disrupted their project. There are many project risks such as industrial unrest, political instability, supplier disruption, scarcity of resources, construction methodologies that aren’t successful, etc.
Some risks, should they come to pass, can cause huge losses and disruption to a project – and if they are large enough impact on the whole company. Understand the risks when you price your projects. Take mitigating actions to reduce the impact of the risk or to lessen the probable occurrence of the event.
Don’t take on projects where the risks are so large that they could destroy the whole company. Ensure your managers and estimators don’t destroy the company by submitting prices for risky projects.
8. Working for the wrong client
Many contractors go bankrupt because their customer hasn’t paid them for completed work. Some customers have a reputation for paying contractors late, or even not paying them at all. Customers can also be disorganized or have a weak design and management team leading to project delays and disruptions.
Budgets may be too small leading to insufficient funds to pay contractors. Occasionally we encounter customers who engage in legal disputes with their contractors and some that are demanding and just plain hard work. Make sure when pricing the projects that you’ve done your homework and understand your client knowing they have sufficient funds to pay for work completed.
9. Buying businesses without doing proper investigations
We often expanded and grew our company by purchasing other construction companies. This enabled us to work in new locations, take on bigger projects, inherit new customers, operate in new fields, find additional skills, and in some instances reduce competition.
Unfortunately, around 50% of these purchases were less than successful, but fortunately few did us long term harm. However, more than one company has gone bankrupt because they bought a business that had problems that weren’t seen until after purchase. They overpaid for the company or bought a company that had projects that were under-priced and bound to lose money. Some projects had major problems, not uncovered at purchase – that resulted in losses.
Sometimes construction companies have unseen liabilities that only become apparent later. Then there’s the difficulty of integrating the new company into the current business, retaining the people that you want and releasing those that aren’t required (unfortunately all too often the opposite happens and good people leave first).
Purchasing another company is something that shouldn’t be taken lightly and it may pay to engage experts to help. Make sure there aren’t any skeletons hiding in the cupboards. Are those projects you’re taking on really going to be as profitable as you’re being told?
10. Becoming too dependent on a particular customer or market
We often become complacent when things are going smoothly. We are happy with our existing customers and the locality and type of project. We can even be sucked into operating in a niche market. But, the world around us is changing; competitors move in, customers who were expanding and successful suddenly aren’t anymore. Before we know it that steady stream of work we had become reliant on has dried up and unexpectedly we have to find new projects, new customers and new markets.
No construction company should become totally reliant on a niche market or one particular customer. We need to be aware of the world around us and ensure our business has a diverse selection of markets and customers. If we don’t, we may find almost over-night the company has no projects.
Many construction companies fail every year. Managers become complacent, the company grows too quickly, sometimes greed plays a part, managers forget the basics, they don’t have proper systems in place, we employ the wrong people, even lose our capable employees, or managers and owners are so focused on the business they aren’t aware that the world around them is changing.
Don’t let your company become another statistic in the list of failed construction companies. Visit your projects, walk the field, talk to your customers, put checks and balances in place. Understand your company’s vulnerabilities and take action to protect these weaknesses.
What actions will you take to ensure your business won’t fail?