Contractor Failure: Recognize the Warning Signs

How to Recognize Warning Signs Early and Determine the Best Course of Action

The construction industry has always been a volatile and risky business—past economic downturns have forced the industry to face significant hardships—and many contractors have not been able to weather the storm. The contractors that have been able to survive are those who recognize the warning signs early and determine the best course of action. 

Interestingly, studies have found that industry or economic weaknesses are typically not leading causes for company failure in the construction industry.  In fact, any business can fail even in a strong economy. The most cited reasons for failure are financial, managerial, and operational causes. Fortunately, there are warning signs that indicate a contractor has hit financial trouble. Recognizing the warning signs early and addressing them promptly is critical to the survival of contractors. 

Be aware of the following financial, operational, and managerial warning signs to prevent failure: 

Financial Warning Signs

• Deteriorating cash flow and/or liquidity 
• Insufficient working capital to meet backlog 
• Noncompliance with debt covenants 
• Accounts receivable aging issues 
• Increased use of vendors to finance operations
• Inconsistent/crisis-driven collections process 
• Insufficient profits and capital to meet general, administrative, and debt service requirements 
• Denial of surety bonds 

Operational Warning Signs

• Operating in crisis mode 
• Inability to determine cost to complete and job status 
• Cost shifting 
• Claims and unapproved change orders lack proper substantiation 
• Accepting less than full value for change orders and/or retentions at job completion
• Increased number of claims and/or lawsuits 
• Increased employee turnover 
• Profit fade 
• Poor job closeout 

Managerial Warning Signs

• Poor leadership/leadership transfer 
• Lack of business knowledge and poor financial management 
• Unrealistic growth or overexpansion 
• Poor project selection 
• Poor internal controls and an inadequate cash flow system 
• Inability to provide timely and accurate financial reporting 
• Increased overhead 

If any of these warning signs exist, immediate action is necessary. Honest communication with employees and key outside partners, such as the company’s bonding agent, CPAs, and bankers, is extremely important. In order for a company to survive, everyone has to work together to achieve a common goal–the success of the company.   

Recognizing the warning signs is only part of the solution. Putting together a recovery plan is the final step in the process of turning a company around. The recovery plan should address items such as: 

• Upgrading financial controls 
• Reviewing overhead for possible reductions 
• Analyzing debt obligations 
• Developing various tools to assist in the monitoring of the plan 
• Developing various performance metrics in order to provide continuous feedback on the progress and success of the plan 

Profitability of the construction contractor is always vital, but particularly in a difficult market. Fewer projects to bid, slower paying customers, project financing problems, and less dependable vendors or subcontractors are just a few obstacles that pose problems for contractors. 

Ultimately, the key to survival is focusing on profitability in the near term. Recognize the warning signs, analyze profitability issues, and determine the best course of action. Enlist the aid of Sikich’s construction experts to help you weather the storm and prevent error before it occurs. Contact us today.    

Paula Harmon CPA, CCIFP, CGMA 
Director, Entrepreneurial Services 

Paula has been serving clients with the firm for nearly 30 years and is a valued resource for clients seeking guidance in running their business more self-sufficiently. Having previous experience in the fields of audit and assurance services, Paula has in-depth knowledge of accounting applications, preparation of meaningful financials, and controllership services. Paula delivers subject matter expertise with strategic functions such as budgets and forecasts, improves accounting procedures and plays a key role in the growth and success of her team and clients.