It's a classic " Good News/Bad News" situation.
First, the good news: America's economy continues to improve. Florida's construction industry is having a particularly good year, with public and private sector projects up 13.5 percent in Q3 2013, according to the BidClerk Construction Index.
Now for the bad news: These boom times are putting many contractors in financial jeopardy, with more than a third of Florida's major builders reporting disturbingly high rates of payment delinquencies.
How can boom times trigger such widespread financial failures?
And is there anything general contractors can do to protect themselves?
The Cash-Flow Conundrum
"No one liked the recession, but some contractors are going to hate the recovery, too," Dr, Thomas Schleifer of Arizona State University's Del Webb School of Construction recently wrote. His pessimism was based on studies that show construction firms are three times more likely to go belly-up during recoveries than they are in recessions.
This counter-intuitive finding springs from the cash-poor situation many builders find themselves in at the end of economic downturns. Expansion requires capital. When orders pick up, most builders have little choice but to spread their diminished resources as thin as possible to take advantage of the new opportunities. Because construction is a credit-driven business, this usually means putting all or most of material and payroll expenses on the customer's tab. With their finances now balanced precariously on a razor's edge, it takes only one or two delinquent payments to push them into insolvency.
This is exactly what is happening right now in Florida. Despite a double-digit rise in construction activity, companies throughout the Sunshine State are facing mammoth cash-flow crises. In Miami, an alarming 38.8% of construction firms’ balances are being paid an average 20 days beyond contracted terms. The situation is even worse in Orlando; 39.4% of balances are being paid an average of 24 days late by construction companies there. Similar to Miami, building firms in Orlando have not shown much improvement from a year earlier.
Here's a more detailed breakdown of delinquency rates for Florida's major metro areas for both Q3 and Q4 2013.
|Metro Area||Q3||Q4||% Change|
|Ft. Myers-Cape Coral||48.65%||47.28%||-2.80%|
|West Palm Beach/Boca Raton||33.21%||33.96%||2.30%|
Delinquency rates remain frustratingly high in other major metro areas as well. For example, Chicago metro reported a delinquency rate of 38.44 in Q4 2013. For Cincinnati metro, the Q4 rate was 41.36%. Across the country in the Pacific Northwest, construction companies in Tacoma, Washington, reported an average delinquency rate of 34.01 percent for the October-December period.
This is not a local phenomenon.
Nor is the solution.
Builders Can Avoid Delinquent Payments by Managing Credit
Scott Wolfe Jr., CEO of zlien, a company that specializes in helping construction firms get paid for the work they've performed, advises contractors to protect themselves from delinquent customers before entering into business agreements.
"Recognize the risks and secure your position in writing," he advises.
Wolfe echoes Schleifer's belief that economic recoveries can be even more dangerous than downturns for construction companies.
" When you're in a growth environment, you need cash to grow. When you are in a recovering economy, all the companies that still exist went through many years of being cash-strapped. So you have a lot of cash-poor companies trying to expand. Basically, you've got a lot of really hungry people suddenly walking into an all-you-can-eat buffet. Self-control goes out the window," Wolfe explained.
Wolfe advises any general contractor preparing to start a new project take several key steps to protect his/her financial position:
- Thoroughly check out your customer's credit situation. Since you'll be doing much of your work on credit, it's critical to know that the money will be there to pay for it upon completion.
- Check out the credit of your customer's customers. Financing in real estate is often a daisy chain with various parties needing to be paid in sequence before all the bills are satisfied. So knowing who's farther up the food chain can be helping in determining a project's financial viability. "You can sometimes approve a customer with an iffy credit rating if the person scheduled to pay him has credit that's rock solid," Wolfe explained.
- Give your salespeople a range of financing options. If a customer has weak credit, perhaps a joint checking agreement with a financially stronger partner can help avoid delinquencies.
- Secure your credit with collateral. Banks rarely issue unsecured credit, why should you? There are a number of compliance tools, such as mechanics liens, that make sure you're not left holding an empty bag in the event of a customer payment delinquency or, worse yet, a customer bankruptcy.
"Construction is a business with a high failure rate, so even the strongest companies need to be careful," Wolfe advised. "It starts with properly rating your credit risk, and then securing that credit with the compliance tool of your choice."
Using such a strategy can leave everyone in a good news/good news situation everyone can be happy with. You can find more information about Zlein's products and services on their web site http://www.zlien.com. If you are interested in additional insights on delinquency rates in the small business sector, please RSVP for our upcoming webinar:
Attend Our Upcoming Business Credit Review Webinar
Join the experts from Experian's Global Consulting Practice and Moody's Analytics on March 18th 10:00 a.m (PST) for a deep dive into the health of small business credit. We will be discussing results from the most recent Q4 2013 Experian/Moody's Analytics Small Business Credit Index, including trends taking shape on delinquency rates in the construction industry, and diving into the macro economic trends which are driving the small business credit engine of the U.S. economy.