“Financial risk” on a construction project is an expansive topic, and includes problems with under-funded or underbid projects, contractor default problems, misappropriation of project funds, contractor failure, and more. A prudent construction industry participant, and a quality Construction Finance Manager (CFM), can take steps to drastically reduce these risks, however. This article will outline some of the steps that can help avoid various types of financial risks in the construction industry.
Related: An introduction to financial risks in construction
Use Security
The mechanics lien remedy is a security interest in property that was invented explicitly to protect parties who furnished labor or materials on a construction project from financial risks on that project. In theory, properly used mechanics liens, (or just remaining in a secured position where a mechanics lien may be successfully filed) can keep those furnishing labor or material to a construction project as secure against non-payment as a bank. The question, therefore, is why wouldn’t every company in the world use these rights?
While many companies do work to stay in a secured position on every project by sending preliminary notices, the associated rules, requirements, and deadlines can be difficult to manage. Luckily, technology exists that enables companies to manage these complex requirements without the need for extensive paper-heavy credit departments. By making the security process accessible to all companies, technology has removed the barrier for every construction company to remain financially secure on their projects. Savvy companies understand this, and they lean on their mechanics lien rights to insulate them from financial risk.
Examine Your Contract / Credit Agreement
Financial risk in the construction industry routinely comes back around to the contract itself, and/or the credit application. In many cases, a company has already determined its fate prior to furnishing any labor and/or materials to the site by virtue of the contract or agreement that was signed. This first contracting stage of the relationship can have severe consequences down the road in the event of non-payment, so it behooves the CFM to examine these documents carefully (or, have them examined by a competent construction attorney).
Construction contracts are a battlefield of risk shifting, property owner, general contractors, and others at the top of the payment chain insert provisions and language to shift the financial risk of the project onto unsuspecting subcontractors and suppliers. And, on the other hand, suppliers who issue credit in the absence of a quality credit agreement are playing a dangerous game.
Check Credit – Know Who May Be On Shakier Ground
Anyone furnishing labor or materials to a construction project is furnishing on credit. Suppliers typically call this “trade credit,” but, while it should, the parlance does not carry over to contractors and subcontractors. Contractors and subcontractors, like suppliers, furnish their labor and materials to the property developers and then wait for payment. Pay applications are always seeking compensation for work completed.
Regardless of role, the construction industry runs on credit, and because of this, it is critical to have strong credit practices. An intelligent construction industry company and CFM should check a customer’s credit at the beginning of the relationship, and then monitor it throughout the relationship. While some slight credit problems may be covered up with a strong and fully utilized security policy, it’s very important that your customer has the ability to pay you without the necessity of filing a lien.
Create a Policy and Use It Consistently
Potentially the most important aspect of mitigating financial risk in any industry is to approach the problem with a consistent policy. Consistency in efforts will breed consistency in results. If a thorough policy is implemented and always followed, there should be limited surprises throughout the process. It’s unfortunate, but accounts sometimes go unpaid simply because a company doesn’t have a consistent commitment to some (ANY!) method of signing new customers and following up with them for payment. A step-by-step process can work wonders. Everything you need to create a solid credit policy, from soup to nuts, is available at the following link.