Managing risk is one of the fundamental principles of running a successful business. Failure to properly identify and manage risks is the reason why many good businesses fail.
As the construction industry moves through cycles of boom and bust, many contractors are caught out by sudden increases in costs and massive skill shortages. These conditions can severely delay the completion of jobs, further compounding losses suffered by a contractor who has taken on the risk.
One of the major contributing causes of these massive losses has been the allocation of the majority of risk to the contractor, via the contract document, despite the contractor having very little control over its management. Contractors take on this risk for various reasons – the main one being the hope that issues won’t eventuate.
As a contractor, if you are going to take on the risk, you need to adequately evaluate the associated costs and properly organise your affairs, or face substantial and unrecoverable expenses. You should be particularly careful not to take on an area of risk that you have no control over.
Some areas to look out for include:
- No provision for extensions of time to contractors for inclement and wet weather
- No provision for extensions of time for industrial disruption
- Contractors held responsible for deficiencies associated with the design and documentation provided by the client
- No variations allowed under the contract
- Contractors responsible for adjoining neighbours and boundary issues
- Contractors taking on insurance conditions that cannot be obtained.
It makes sense for risk to be allocated to the party who is best able to manage it. Simply passing the risk on does nothing to protect or advance the interests of any of the involved parties.
Good contract administration can help to reduce contractual risk.
Credit risk management
Financial and credit risk management are also imperative processes. Before the contract is signed, you should ensure that you are satisfied the owner has the financial capacity to pay the contract price – don’t be afraid to ask them for evidence to support this. If in doubt, you should ask them to deposit the money into Master Builders' holding account for security of payment.
Preparation of budgets and financial recording processes and procedures are integral for monitoring the financial performance of a project and all the elements involved.
The payments process must specifically include:
- Payment claims
- Contract claims
- Interest payments
- Bank guarantees
- Back charges/set offs
Good financial management is essential in the building industry, no matter how big or small your business.
It's important to take a ‘hands-on’ approach to financial management, and not leave it to your bookkeeper or accountant. While your bookkeeper or an accountant can set up systems and produce reports, as the owner of the business you must be able to read and interpret them, and you should understand how your decisions impact on the financial condition of your business.
Managing your cash is vital to ensuring a secure future, both for you and your business. Without proper financial planning and monitoring, your business is unlikely to be successful.
In order to maintain a viable business you need to have access to key financial information to help you estimate and forecast current and future cash flow, as well as control expenditure.
A brief summary of some of the key reports you should be using in your business is provided below.
Cash flow forecast
Cash flow is the money that comes in and out of your business. So, a cash flow forecast shows where cash comes from and where cash goes. It can help you determine if you will have enough cash to meet your debts as they fall due. Predicting your cash flow in advance helps you to diagnose and plan for problems – before they happen.
You should forecast your cash flow on a monthly basis for at least a year out. Importantly, whatever the length of projection, it must allow you to predict shortfalls in your cash flow and give you enough time to take corrective action.
Profit & loss statement
A profit and loss statement is a summary of the financial performance of a business. It summarises the income and subtracts the expenses incurred over a defined period (usually over a month, quarter or year) to calculate if the business made a profit or a loss for that period.
The profit and loss statement is different from the cash flow forecast in that it takes into account more than just cash, things like depreciation. Additionally, a profit and loss report is based on accrual accounting – that is when income and expenses are incurred, not when cash is exchanged.
The balance sheet is a summary of a business’s assets (what the business owns) and liabilities (what the business owes) at a specific point in time. The difference between the assets and liabilities is known as the owner’s equity.
Work in progress
Calculating and understanding your work in progress position is critical to meeting your minimum financial requirements.
Our useful Work in progress guide will help you understand it better.
Need more information?
If you haven’t found the answer to your questions on our website, give us a call or email us.