Construction is an incredibly complex industry — especially from a financial standpoint. It’s credit heavy and full of hidden complications. When managing credit for construction, it’s essential to be aware of the risks.
In the construction industry, final expenses frequently exceed the original budget. This is a known risk in construction. But the hidden losses — the places where profits slip through the cracks — can catch contractors by surprise, and the money is often lost forever. Common causes of hidden loss are:
- Miscommunication. Clerical error and/or lack of on-site communication can lead to mistakes which may go uncorrected due to lack of knowledge. Clear communication catches mistakes and other potential problems early, so they can be addressed before they lead to significant financial consequences.
- Lack of organization. Construction sites are busy — even chaotic — places. Effective organization prevents potential disaster, both physical and financial. Poor organization can result in expensive losses from delays and corrections.
- Poor management. On-site management is critical to the success of a construction project. If the on-site manager is disorganized, inefficient, or a poor communicator, costly mistakes are more likely to occur.
Hidden losses are not the only complication in credit management in construction. Bleeding money is an eye-catching error, but other possible problems include:
- Payment delays. The payment chain means parties only receive payment when the entity that owes them is paid. Payments occur in descending order, and issues farther up the chain, such as financial disputes or technical delays, affect all parties down the chain.
- Ebb and flow of work. Mistakes tend to pile up during periods of economic recovery due to pressure to take on higher risk projects and less creditworthy commercial clients.
- Confusion. Some aspects of construction credit management are rife with misunderstanding and misinformation. A lack of clear understanding creates confusion and excessive complications in credit management.
Where good intentions meet human error
Good intentions are not a replacement for careful oversight in construction management. When working with construction credit, it’s imperative to keep an eye out for mistakes of the human-error variety. These include:
- Hiding on-site problems. At the on-site level, hidden problems lead to hidden losses. Workers may hide issues for several reasons, but the most common are:
- Believing they can solve the problem before it becomes big enough to bring to management
- Poor management leaving workers afraid of admitting to mistakes or raising concerns about problems
- Accepting risky jobs. In a recovering economy, construction companies are often tempted to accept jobs with a higher degree of risk compared to those they might normally consider. Bravado and overconfidence can lead to profit loss and delinquent debt.
- Overtime. The best way to solve a problem is to keep working on it, yes? Not necessarily. Overtime work — and its associated expense — can quickly spiral out of control in construction, leading to unnecessary losses and potential delinquencies.
Construction is a risky business for commercial lenders. While potentially profitable, it’s also riddled with complexity. It’s essential to be aware of these implicit complications when evaluating the creditworthiness of a construction company. When in doubt, contact a commercial credit expert for assistance.