Credit Crunch

Aug 1, 2008 12:00 PM, By Beck Ireland, Staff Writer

Stricter credit standards demand disciplined cash flow management practices

Cash flow — managing the collection of contract revenues and payments of the costs of contracted work — is a leading indicator of bankruptcy for construction contractors. Of the 400 contractors that went bankrupt last year, according to the “2007 Construction Industry Annual Financial Survey,” conducted by the Construction Financial Management Association (CFMA), Princeton, N.J., half resulted from mismanaged cash flow. Too often, companies that may have been considered profitable have had to close their doors because of lack of cash.

Compounding this problem is the current economic climate in which banks and other financial lending institutions have tightened their standards and cut back on lending for an industry that relies on external credit as a necessary component to positive cash flow in a construction contract. “External financing is almost a necessity,” says Sam Thacker, partner in Business Finance Solutions, Austin, Texas. “In a perfect world, you wouldn't rely on it, but in the real world there are only two places to get that cash flow — and that's external financing and trade credit.

In 2007, the CFMA survey found that the availability of bank credit for construction companies improved for the fourth consecutive year. Of the 756 respondents to its survey, 42% indicated that the availability of bank credit was better than the previous year, and 57% indicated it was about the same. Similarly, 33% of respondents experienced an increase in their working capital line of credit. Yet, despite this upward trend, many industry economists are forecasting an impending end to the availability of bank credit.

“The banks are just being a lot tougher and much more careful,” says James Sudbury, an Austin, Texas-based financial consultant for the construction and manufacturing industries. “The market's changed dramatically in the last three months. There used to be plenty of money all over the street. You'd be hard-pressed not to be able to get a deal done. Now, it's difficult to get it done with any major banks.”

Credit climate

With most bank lines of credit negotiated on an annual basis, firms probably won't be faced with a major crisis until their lines come up for review. “Nine months ago, we weren't in the credit crisis we're in now, and my company had no difficulty at all renewing and expanding the line of credit,” says Steve Lords, former president of CFMA and current CFO for Martin Harris, Las Vegas. “Will we experience a little more difficulty in June or July when we do that again? Probably.”

Tighter credit standards may affect smaller businesses first. “The small business contractor is not going to have access to as much external capital as a large contractor will,” Thacker says. “Right now, a small contractor is going to have to close its doors if it can't get some external financing during tough times. That's how bad it really is. Banks are just not loaning money to small subcontractors.”

There are a few sources, other than banks, such as commercial finance companies, that will finance working capital in the construction industry. “They mostly cater to the small contractor,” Thacker says. “The big contractor is likely to still get bank credit.”