As with all industries, the construction sector continues to realize the far-reaching effects of COVID-19 crisis. Now, more than ever, it’s imperative for a construction company’s risk management approach to be aggressive and proactive. With postponed and canceled projects, labor shortages, vendor and supply chain constraints, rising costs, and economic uncertainty, construction companies must carefully consider the financial viability of owners, subcontractors, and vendors to maintain their own welfare.
Management should assemble a risk management team for strategic planning that includes general and risk managers, as well as members of the financial, legal, and operations teams. Project representatives should be assigned to supply the team with status information, such as labor or subcontractor issues; pending changes, claims, notices, or owner directives; estimates for completing projects; and cost and schedule updates.
Management should have regular, ongoing meetings to assess the company’s financial standing. Stay on top of your billing, contracts receivable, accounts payable, loan balances, and changes in your bank line of credit. Outside advisors should be consulted on the legal, tax, and financial implications of changes to your business model or contractual obligations.
Job costing data is important in accounting for things like increases in suppliers’ pricing, COVID-19 related costs, additional labor and equipment costs, and change orders, as well as for capturing scheduling and delay costs in a timely manner to prepare for possible future claims. And preparing projections and cash flow forecasts, and periodically measuring them against your actual cash flow, will help you keep a close watch on your financial standing. To help small businesses project cash flow, forecast for deficits, manage shortfalls, assess working capital and liquidity needs, and determine their ability and need to borrow, we have created a cash flow analysis tool which may be downloaded below.
Evaluating Risk for Existing Contracts
An evaluation should be performed for each individual project. Separate the projects categorically, based on financial viability. For projects struggling financially, or with a high potential of becoming insolvent, alternatives considerations, such as requests for financial guarantees for owners or assistance with interim payments for struggling subcontractors and vendors, may be in order.
Assess current contracts to mete out those likely to approach potential contract changes collaboratively versus those more apt to be adversarial. It’s important to promptly address alternatives with the collaborators, and focus any major resources and action toward legally protecting your company’s rights and complying with your contractual obligations for those with a higher potential for hostility.
Consult your attorney to determine whether you should provide written notice to the project owner based on contract and insurance requirements for potential COVID-19-related delays and/or shutdowns. And, if a project is shut down, ensure the site is properly secured. Asset management software that uses RFID or Bluetooth technology can assist businesses with tracking inventory and prevention of product or equipment loss, damage, or theft.
New & Potential Contract Risk Evaluation
It’s important to evaluate risk when bidding on new jobs. Bidding has become much more competitive. Many construction companies are hyper-focused on building their backlog of work, which means they may be bidding on more jobs than they would normally. It’s important not to let fear encourage your company to submit low-ball proposals simply to get the work on the schedule.
Construction companies should develop a project rating system based on things like a predetermined minimum profit and whether you have the appropriate capacity and skills available. Based on criteria such as the type of work, the time frame, and bonding requirements, priority should be given to the time and expense estimates associated with jobs that have the potential to provide the highest profit.
An evaluation of the materials needed for prospective projects should also occur to ensure the current or estimated availability and potential disruptions to the supply chain for these materials.
Companies take on an expanded level of risk when work is subcontracted. You may consider requiring more frequent financial statements from subcontractors. Keep a close watch on liquidity and leverage ratios, surety capacity, and changes in WIP and manpower. Subcontractors that rely on their banks and credit lines for cash flow will be working inside a stricter credit market, meaning they will operate at an increased level of risk.
To assist construction companies in properly vetting subcontractors and minimizing their exposure to risk, ARB has created a pre-qualification form that can be downloaded below.
Profit and business interruption insurance should be considered, if not already in place. While it’s prudent to consider diversifying your suppliers, certain insurance options are available for contingent business interruption coverage that protects you from income losses due to supply chain issues. Additional COVID-19-related insurance may be considered through available options for environmental, management liability, subcontractor default, and workers’ compensation coverage.
Stay in contact with your insurer(s) for information about policy extensions, project insurance pricing quotes given on a project that has been delayed or shut down, or general questions about coverage and eligibility. Rate increases and coverage restrictions are definite possibilities, so initiating contact early and often is best practice.
ARB’s Construction & Real Estate Services Group is committed to your industry. We’re here to help you maximize profitability and reduce risk. Contact us today to get started. We also encourage you to visit our COVID-19 Financial Resource and Tax Center for additional information on related tax and financial matters.
by David Jean, CPA, CCIFP, CExP