Contracts, cashflow and equity: Five signs a building company might collapse

The last year has been tough on the building industry with around eight in 10 construction companies forced to use their own funds in order to complete a client’s home.

With three-quarters of residential building companies operating on net profit margins of less than 3% and construction costs rising by 25%, it’s really no surprise that many businesses are facing financial difficulties.

On Wednesday, Queensland-based residential builder Oracle Platinum Homes became the latest building company to call in liquidators. The company reportedly owes $14 million to hundreds of suppliers and subscontractors, while 70 jobs are at risk.

It is the latest in a string of collapses in the construction sector, with the likes of Waterford Homes, Solido Builders, Pivotal Homes, Next, Condev, Probuild and Privium also falling on tough times in the past 12 months.

Fortunately, new construction is cashflow positive which has allowed many builders to take a temporary hit on their profits across one or more jobs, yet still pay their suppliers and subcontractors on time.

That said, if these losses continue unchecked they could lead to a company being unable to pay its bills and being forced to call the liquidators in.

By the time a building company gets to this stage, it is generally too late to be helped. However, if assistance had been sought earlier there is a very good chance the building could have avoided its traumatic fate.

Here are the five stages of construction company decline to help Aussie builders avoid financial ruin. 

Stage zero: Potential loss on a contract

Stage zero is the very first sign of trouble. When a building company enters into an unprofitable contract that has not yet started, they are left in a position whereby they are unable to cover the proportional company overheads. 

If they don’t reach their gross profit target, which can be seriously eroded by rising construction costs, then they lose money. This is why builders are being urged to re-price their projects before construction commences in order to check that they are still commercially viable.

If the contract is no longer profitable, then re-negotiations with the client must occur. Legal advice should be sought if the client is unwilling to enter into these conversations. 

Stage one: Actual loss on a contract

If a company loses money on a project once the proportional fixed expenses have been factored in (or even before these costs have been incorporated), they have moved to the first stage. This could be due to a number of contributing factors ranging from the increasing cost of materials to estimating errors or prolonged delays.

Stage two: Company loses money

The second stage describes a situation in which a building company has made an overall loss during a full financial or calendar year. When a building company reaches this stage it is critical that swift action is taken.

When a business loses money it is essentially eroding their reserves and reducing their working capital. This makes the business vulnerable to future events and it may require additional funding in the form of a loan or an injection of shareholder capital in order to continue trading. 

Stage three: Negative equity

If a builder loses enough money to wipe out its entire reserves in a single year or accumulates losses over multiple years, it will become a stage three company. These businesses pose the biggest threat to the construction industry. They are extremely high risk and vulnerable because their liabilities exceed their assets.

These companies are still able to trade legally thanks to their positive cash flow which allows them to pay their suppliers and subcontractors on time, classifying them as trading solvent. However, they will need expert guidance and hard work to truly turn it around.

Stage four: Insolvency

A building company reaches stage four when it is no longer able to pay its invoices. This is the point at which a business is classified as insolvent. 

By the time a building company reaches this stage, the situation is dire. It is likely the company will have entered into a payment plan with the tax office effectively deferring the due date and will have poured in every available cent in a bid to keep the business afloat.

This is a genuinely distressing time for the owners of a building company. Unfortunately it is a situation that could have been easily avoided had they sought help and changed direction in any of the previous stages.

Even the most efficiently run businesses can be caught out by changing environments and a financial situation that they did not see coming.

The best advice for Australia’s residential building companies owners  is to ask for help and not try to solve all your problems alone.