From inflation to insolvency

Inflation’s omnipresence in the wider economy, and its immediate visibility on cost schedules, mean it is front of mind for everyone in the construction industry. But as examined in the preceding section, the inflationary threat has been joined by a more disruptive force – insolvency.

As build costs have increased, risk allowances have inflated just as credit availability and affordability have fallen. The net effect of this is putting heightened stress on contractors, and this is already evident.

The number of construction sector insolvencies in Q2 2022 increased by 72.1 percent compared to the same quarter last year after peaking at 158.6 percent in Q1 2022. Insolvency in the construction of buildings increased the most in Q2 2022, growing by 8.9 and 91.5 percent on the quarter and year respectively.

As a result, in the four quarters to Q2 2022, 3,850 construction firms across England, Scotland and Wales became insolvent. Construction accounted for almost a fifth of all company insolvencies, earning the industry the unwanted honour of having suffered more company failures than any other sector.

Economic gravity strongest for those already at the precipice

Such an increase in construction insolvencies might seem at odds with the uptick in client demand seen over the same period.

Yet behind the relatively robust construction output figures, economic reality has been catching up with the industry’s most vulnerable companies as the Government’s COVID-era support measures were gradually withdrawn.

The flagship furlough scheme – which subsidised the wage bills of 11.5m UK employees during the pandemic – closed at the end of September 2021. By the end of March 2022, the temporary easing of insolvency rules was gone too.

Furlough’s vast scale meant it served as an economic and employment lifeline to thousands of successful businesses temporarily prevented from carrying out their normal business. But it also allowed many contractors with weaker balance sheets to enter a ‘suspended animation’ and arguably delay the inevitable.

With that crutch gone, pain has been felt in the supply chain.

Contractors that were at risk of insolvency before COVID-19 struck now look increasingly exposed. Companies that relied entirely on furlough to pay their staff or loaded up on Bounce Back Loans to cover overheads, may now be on borrowed time.

The pandemic led many businesses to accrue debt, but the burden has fallen disproportionately on SME’s rather than large companies. In fact since Q1 2020, when COVID-19 first reached Britain, SME’s balance of outstanding loan payments has increased by 35.9 percent, while large businesses saw their balance fall by 8.0 percent.

With almost all construction firms (98 percent) classified as SME’s, the industry is therefore likely to have a high number of overly leveraged contractors who are particularly at risk of insolvency.

Although inflation and insolvency risk are often intertwined, the latter may soon overtake the former as the most common barrier to project success.

Defective work and increased adversarial practices by a distressed contractor are often a precursor to insolvency, but when a contractor falls into insolvency, the impact is instantly apparent – works are left incomplete and key suppliers and sub-contractors not paid. The sequential nature of construction means that knock-on delays soon follow, which can in turn delay end user occupation. Over time, the fallout from an insolvency typically leads the final cost to far exceed the client’s original budget.

© 2022 Turner & Townsend