Financial risk will be a thorny area in 2014 for CFOs and other credit and financial professionals in the construction industry. The industry news outlets are full of reports that financial risk shifting devices are more popular than ever, and that is coupled with the increased financial risk historically associated with the industry during a rebound economy. What can companies do to navigate through all of this risk?
A pithy and useful answer to that question was published earlier this week by MultiBriefs in the article I wrote titled “Your 2014 Guide to Financial Risk in the Construction Industry.” In this post we’ll review that article and provide you with some of the backup and reference materials used to craft the guide.
Understanding Financial Risk
The MultiBriefs article gives a bare-bones definition of financial risk: “Financial risk is simply defined as the risk of losing money.” This topic is especially interesting to those in the construction industry, since “financial risk shifting” devices are commonly employed to push the risk of losing money on a construction project onto other parties.
What are some common financial risk shifting devices? Consider the following:
- Pay when paid clauses
- Pay if paid clauses
- No damage for delay provisions
- Retainage provisions
- ADR provisions
- Change order restrictions
- Change directive provisions
- Claim notice requirements
- Indemnity Provisions
- Retainage
The list can actually go on and on. Here is a little image I put together to sum up the entirety of your construction contract:
Getting a construction project from plans to completion is a risky affair, and the fact is that every participant tries to put itself in great leverage situations to mitigate the amount of risk it bears for the project’s risk as a whole. While this activity is as old as the construction industry itself, the challenges of the economic recession and recovery has dramatically increased the activity. Here are some resources that back up the MultiBriefs article’s suggestion that “in the final quarter of 2013 many in the industry were talking about financial risk:”
- Owners Shift More Financial Risk As Economy Remains Sluggish – ENR
- Beware the Recovery: What History Teaches Contractors and Sureties – ENR
- Views Differ From Places on Payment Flow-Chart – ENR
Hot To Get Your Company Ahead of the Risk Shifting Game
With financial risk a clear and present danger, what can your company do to mitigate or eliminate that risk? The MultiBriefs guide sets forth three tools or best practices:
- Learn to love your security rights (like the mechanics lien)
- Know what others may do to shift the risk to you, and push back
- Involve your organization’s finance professionals
These are exactly the tools and best practices we examined in our Webinar last week: How 2013’s Construction Industry Trends Can Help You Succeed in 2014. The slide deck from the webinar is embedded below:
[slideshare id=30299390&doc=2013-trends-construction-industry-prepare-financial-2014-140122071849-phpapp01]
The good news, as suggested in the MultiBrief’s article, is that that “there are a lot of tools and choices to position your company well to both take advantage of the recovering market, and to not financially suffer.” Financial risk shifting is certainly a factor in the construction industry, but it isn’t a crushing factor. In fact, for those “bottom of the tier” parties like subcontractors and suppliers, there are a ton of devices to insulate your organization from this risk.
The problem is the trends.
Top of the chain parties are working very hard to shift financial risk down the contracting chain, and that means they are getting more and more creative in the contractual provisions used to accomplish this. Sometimes, unfortunately, bottom of the tier parties get lost in their own volume of work and agree to things without utilizing devices to equalize the leverage with those parties.
In 2014, your organization is smart to get to know the financial risk shifting landscape in the construction industry, and to go further by implementing policies and procedures to utilize available devices to mitigate the risk that falls onto your shoulders.
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