Construction Economics And Finance Construction Essay

The economic downturn while unfortunate is real life problem that needs to be managed and controlled by construction companies. Construction is experiencing particular suffering as it relies on large capital expenditure to finance projects and the unavailability of a steady cash flow has resulted in many companies being forced into bankruptcy despite making a profit. Cash flow management has been described as the most important of all a company’s resources as its inadequate management can lead to liquidity problems whereby day to day activities cannot be supported (Navon, 1996; Singh and Lakanathan, 1992). As contractors have to wait a number of months before being payed for completed work, this places increased pressure on credit facilities that they have agreed with banks, sub-contractors, suppliers, etc. This is why there is such agreement within the industry towards the importance of cash flow forecasting and control (Navon, 1990; Carr, 1993; Cook, 1991).

The UK Government’s policy has been to provide a fiscal stimulus by increasing spending on large public projects so as to inject money into the economy which will filter down through all sectors (McFall, 2008). Green (2009) forecasted that the recession will match up to the recession of the late 80’s and early 90’s but that it will recover quicker. Once again public spending is the underlining reason for the upturn but it is questioned whether the continuous spending can be sustained.

The logical relation between high inflation which causes a rise in borrowing costs and a reduction in construction investment and thus a fall in the construction cycle is shown below in Figure 2.2 (Ren & Lin 1996). These ups and downs in the economy in general used to be called “business cycles” but “cycles” implies predetermined or automatic recurrence and according to Myers (2008) we are not experiencing automatic recurrent cycles and we should refer to these activities as business fluctuations instead. Construction companies need to analyze these cyclical indicators so that they can plan activity and investment depending on the fluctuations.

Whitten (2009) writing for Construction News explained how The Civil Engineering Contractors Association has warned of an emerging trend of firms pricing below cost. Both Whitten (2009) and Scully (2009) argue the point that below cost tendering is unsustainable and will increase the risk of contractors facing insolvency. Reductions in material and plant costs have been exceeded by the drop in tender prices. Insolvencies are predicted to occur firstly among contractors who tender correctly but fail to win the contract and then among those who win the contract with unsustainably low bids (Whitten, 2009).

Cash flow management is extremely important and despite interest rates being at their lowest levels in a number of years borrowing is still a cause for concern as profit margins have been reduced and in some causes wiped out as contractors take on jobs at cost. Methods to improve the cash flow are described below at the different stages of a contract but in general firms need effective financial planning and control to monitor its position. Before a contract begins issues such as plant ownership, labour, subcontractors, materials, etc need to be discussed and the right mix found for each project.

Better buying and terms for sub-contracts involve negotiating improved deals either from suppliers or sub-contractors and therefore improve the cost of the project (Coates, 2009). This is widespread in the current climate due to the reduced amount of work available. The last three methods will bring in early money but must be done before submitting the priced bills (Cooke and Williams, 2009).

On site, the use of skilled labour increases efficiency and allows tasks to be completed earlier without the need for expensive and time consuming repair work. For complex tasks which the workforce could perform but not efficiently, specialist sub-contractors should be used. Plant costs can be extremely high which means that any plant that is not being used should be off-hired immediately and if any plant is owned by the company then there should be added emphasis on its use.

Strategic tendering and project mix become even more crucial to a company’s success during times of a recession. As the private sector feels the impact of a recession firstly and for a slightly longer period it is in a company’s long term interest to carry out a more aggressive bidding policy towards the public sector (Ren & Lin, 1996). Another advantage of the public sector is its transparency and openness during the tender stage. While the public sector may be susceptible to mal-practice, construction companies know that they will be impartially assessed and receive feedback. Strategic planning can be very beneficial as it seeks to align a company in a certain direction. In todays climate contractors need to evalute the client when deciding to tender as many contractors have commenced work on a project only to instructed to withdraw as the funding has been restricted (Edum-Fotwe & McCaffer, 1999). A number of contractors have also begun to take on jobs at cost or even a loss in an effort to win work with the chance of repeat work. Also this keeps the company name in circulation and also to hold onto valued staff that might otherwise have to be made redundant.

Partnering has been widely adopted in construction in the last number of years as it offers the opportunity for improving the project outcome aswell as benefiting the whole supply chain (Dozzi et al., 1996; Larson and Drexler, 1997). It utilizes each participant’s expertise and resources so that the required business objectives can be met or exceeded (Bennett & Jayes, 1998).

The use of sub contractors has increased as there is less overheads involved (Langford & Male, 1992). The benefits of partnering can be applied to co-contracting (main contractor-sub contractor) and supply chain integration (contractor-supplier), (Edum-Fotwe & McCaffer, 1999). This allows greater flexibility as both partners are working for a common goal and greater economies of scale can be achieved when tendering as contractors will have their own list of preferred suppliers or sub contractors which allows them to price new projects quickly and efficiently. As suppliers account for such a high percentage of building costs their involvement at an early stage should be welcomed as they can contribute new ideas, products or processes (Cartlidge, 2002).

Tyreman on the other hand draws attention to the fact that the construction industry is inherently mis-trusting and while benefits do exist he doubts whether it will be fully supported within the construction industry. This opinion is similar to that of Wood and Ellis (2005) who estimate that it will still be some time before a fully genuine relationship exists as there is an engrained culture of mistrust and deception. Successful partnerships offer the opportunity for repeat work but the client must be assured that tenders remain competitive within the relationship of trust.

As Project Programme Management provides training and technology advancement, it has allowed them to move into new markets which owing to the current high unemployment rate are particularly busy. They have also looked towards cheaper marketing tools such as over the internet to keep their overheads down while still keeping potential client exposure high.

At Laing O’Rourke, Tyreman discusses how credit checks are performed on all potential clients to rate them but they also use strategic tendering which has led them to tender more aggressively for public sector contrasts which is in line with the theories put forward by Ren and Lin (1996) and discussed in the literature review. Supply chain integration has also helped to achieve greater economies of scale.

The importance of cash flow cannot be overstated for construction firms and regardless of its time consuming requirements is particularly worthwhile. Despite many construction firms making a significant profit they can run out of cash and have to cease trading. If firms fail to correctly forecast when cash flow is required they can become insolvent as the cash is not available to pay their debts as they fall due. Effective communication will strengthen your existing relationships and help you to form positive bonds in future interactions with clients, banks, sub-contractors, suppliers, etc.

The importance and basic need for cash flow analysis has been stressed in the literature review and by both interviewees. Cash flow analysis is an essential day to day activity in construction and it is recommended that effective planning is carried out by experienced management. They need to establish good terms with suppliers and sub contractors and to put in place an efficient cash flow reporting system. Cash flow analysis can refer to both day-to-day analysis (short term) or economic forecasting (long-term). As discussed by Myers (2008) business fluctuations have been occurring since the start of business and while they are complicated and rely on a number of variables they can help to provide a company with the potential to forecast market conditions and thus position itself accordingly.