A cure for the cashflow

In the uncertainty of this post-EU referendum world it is not surprising that the siren call from industry is for government to pump more money into infrastructure. I hope the chancellor will grant this wish in his Autumn Statement.

There’s nothing wrong with this message but, given the appalling low levels of productivity in the industry, the taxpayer could be paying over the odds. Why is that?

I’ll answer my own question with another. What is the biggest killer of productivity in UK construction? Answer: poor cashflow.

Trade credit insurance company Euler Hermes has described 2015 as one of the worst years for payment delays: “Construction companies registered more payment delays than any other single UK sector last year […] the sector suffered a 26% year-on-year rise in the number of overdue payment incidents in 2015 [overdue being more than two months after the payments should have been discharged].”

Poor payment practices are gradually crippling the industry. Bank lending to the sector has fallen by almost half in the years since the beginning of the recession

From my own research, I can add that in 2015 small firms across the UK lost almost £50m worth of retentions following upstream insolvencies.

Poor payment practices are gradually crippling the industry. Bank lending to the sector has fallen by almost half in the years since the beginning of the recession.

The so-called supply chain finance initiative has turned into a profitable income stream for a few of the large UK contractors as a result of the fees charged for having early access to one’s cash (usually after an extension to pre-existing payment periods).

It’s no wonder that construction has the worst record for productivity. Where is the cash for the supply chain (which delivers 85% of the value) to invest in new technologies and skills development?

The state of Western Australia has decided to act:

• As from 30 September 2016 project bank accounts (PBA) will be mandatory on the majority of state government projects
• The state’s Construction Contracts Act 2004 will be amended to reduce payment times from 50 days to 30 days
• Under the above act, cash retentions have to be ring-fenced in a trust but more detailed statutory arrangements will now be introduced to reinforce the existing statutory obligation
• Prospective tenderers will be banned from state contracts for poor payment performance
• There is the possibility of statutory penalties involving fines to firms guilty of repetitive payment abuse of their supply chains.

These measures reflect the frustration of the state’s government in failing to make progress on this issue. What are we doing in the UK? Over here PBAs continue to make strong progress. From 31 October 2016, PBAs will be mandated on building projects of more than £4m procured by Scottish government bodies. But government departments and agencies not using them should be challenged to state the “compelling reasons” for their non-use.

Regulation 113 of the Public Contracts Regulations 2015 - which places a statutory duty on public bodies to ensure 30-day payment clauses are inserted in supply chain contracts - was a welcome provision. However, there is concern it lacks effective enforcement as complaints about non-compliance can only be directed through the Mystery Shopper Scheme.

The government is reviewing the practice of retentions with a view to consulting industry on the outcome of the review. Anything less than a statutory ring-fencing of cash retentions is unlikely to lead to dramatic change.

Other more general initiatives include the appointment of the small business commissioner and the implementation of Section 3 of the Small Business, Enterprise and Employment Act 2015. The commissioner won’t be appointed until the middle/end of next year. The government is about to consult on how the commissioner should handle payment complaints. As I explained in a recent column (“Someone to watch over SMEs”, 27 May 2016, page 42), the commissioner is unlikely to have significant impact on construction.

It is expected that Section 3 will come into force next April. This will require large firms to report on their payment practices and policies. There is real concern that some businesses may manipulate their data. Given the lack of effective auditing, enforcement could be problematic.

I can’t help wondering whether what’s currently on offer will cure our cashflow ills. Perhaps we should take a leaf out of Western Australia’s book and implement the measures they are proposing.

Professor Rudi Klein is a barrister and chief executive of the Specialist Engineering Contractors’ Group