The UK construction sector finds itself in a difficult position. Data from the Insolvency Service reveals that construction firms accounted for 17.3% of all insolvencies in England and Wales in April 2024.
This has created a perfect storm that’s rocking the entire construction supply chain. The instability has placed the relationship between procurement teams, contractors, and suppliers at a critical juncture.
While trust, based on legacy relationships, might once have been valuable currency, that isn’t the norm today. Cash flow has regained its throne as king — and managing credit risk is imperative to those navigating this storm.
The trouble starts with legacy communication methods
Historic relationships have been the lifeblood of the construction sector since its inception. The relationships between contractors’ procurement teams and their supplier networks run deep. Yet, even the most solid bonds are straining under the weight of the current economic climate. As cash flow constricts, evaluating credit risk more stringently is essential.
By objectively assessing the creditworthiness of potential partners, contractors can start identifying (and avoiding) potential partners at high risk of defaulting on payments. This evaluation reduces the risk of bad debt and inconsistent cash flow. Getting this wrong can be a critical error.
Yet, this evaluation is difficult to carry out manually. Legacy relationships have created overreliance on manual communication methods such as phone calls, text messages, and emails. When it comes to accurate and efficient credit risk evaluations, these outdated processes give rise to human error through misheard details over the phone, typos or lost paperwork, leading to inaccurate credit risk assessments. Furthermore, chasing down financial information, verifying it with multiple sources, and keeping everyone informed consumes valuable time and resources and delays engaging with potential trade. When business processes are too long-winded and inefficient, shortcuts are made, and with that, poor decision-making.
It’s time for change.
Embracing digitisation as the solution
Research is essential when evaluating the credit risk of potential partners. In construction, oftentimes, procurement managers are speaking to different entities that fall under a larger company. At the most basic level, contractors must understand which entity they are invoicing and therefore bear the credit risk. While the group might be well-funded, it can collapse specific entities. This makes it difficult to receive payment, which potentially leaves procurement managers with a bad debt write-off.
But the research doesn’t end there. Contractors should also look at financial statements, paying close attention to the Balance Sheet. It’s also worth looking at up-to-date Companies House filings as well as the background of the Directors at the entities they are considering working with, particularly when working with SME or micro-size entities. This is where using online credit referencing agencies becomes essential. They integrate with financial institutions to provide access to real-time financial information, eliminating delays or inaccuracies caused by outdated or self-reported data.
Tightening their credit risk criteria and processes is the next step. By standardising the credit application process and ensuring it includes financial statements, bank references, and trade references, companies can access a clearer picture of the financial health of potential partners. While this sounds like a lot of paperwork, the more this information can be transferred and stored digitally, the less burdensome it is.
Making more informed decisions reduces the risk of payments defaulting later down the line, bad debt and inconsistent cash flow.
Internal credit and better understanding of risk
Companies might also consider implementing an internal credit scoring system based on financial health indicators. Such measures could help to streamline the evaluation process and remove subjectivity from decision-making. Digitised credit risk services and tools can help monitor and assess risk continuously. In a rapidly changing landscape, it pays to be ahead of the game when you might need to collect payments from a failing business.
Making accurate credit data more accessible drives efficiencies throughout the business, too. This can expedite approvals for credit lines, streamlining the onboarding process and reducing delays in project execution.
By better understanding credit risk, contractors can negotiate better payment terms and manage their cash flow more effectively. The more confidence and trust that can be built with a supplier through smooth financial operations and reliable cash flow, the more likely you are to see extended credit terms.
Entering a new era
We can navigate the current storm by acknowledging the detrimental impact of outdated processes and manual communication on construction industry procurement.
Automating credit risk data and evaluation, and embracing technology to gain transparency over the supply chain, are essential steps in revitalising the industry. Through prioritising cash flow, implementing digital solutions, and fostering collaboration, suppliers and contractors can pave the way for a more resilient future.
