The AiG Australian Performance of Construction Index declined to 38.9 in December 2019, marking a fall to its lowest level since May 2013. Activity in the construction industry has contracted for 16 consecutive months. This is surprising, as the housing market has recovered well since the crisis in July of 2019. The soaring home values marking the recovery are expected to boost real estate investment, however orders for new houses and apartment units, as well as commercial construction projects have continued to drop. According to experts, this is the result of low consumer and investor confidence in recent months, spurred on by economic uncertainty at home and abroad.
For construction companies, and the subcontractors who rely on them, this creates a problem. The construction industry is built to operate with a long cash conversion cycle, which makes it vulnerable to economic shocks, such as unexpected shifts in demand. A drop in sales translates to a reduction in revenues, and available working capital for builders. By using supply chain finance, these businesses can keep themselves hydrated with cash, so their current projects stay on track while sales make their projected recovery.
Construction companies need financing support
Long payment terms are the norm in the construction industry, which is natural considering the amount of time needed to complete a construction project. This puts financial pressure on large developers and the subcontractors they work with. During construction, builders typically need to purchase materials and pay wages for months at a time before receiving any payments on their contract. Because of this, the amount of working capital they can bring to bear limits the number of projects they can work on, and the rate at which they can work. If the builder’s finances become less stable for some reason, it can cause interruptions and inefficiencies that may drive up overall costs, exacerbating the problem further.
As the number of orders for new construction declines, builders of all sizes are faced with a drop in revenues, which impacts their available pool of working capital. This is unacceptable for businesses that need to pay subcontractors on time, who, in turn, need to purchase materials and pay wages to avoid operational disruptions. To prevent this, many are turning to supply chain finance as a way to make sure existing projects are completed reliably.
Supply chain finance makes construction firms more competitive
Supply chain finance facilities like that offered by Fifo Capital help businesses to become more resistant to financial shocks, such as those created by temporary shifts in sales. It does this by improving the working capital position of both larger builders, and their entire supply chain—in this case, subcontractors and materials suppliers.
Large builders can use supply chain finance to pay subcontractors through their financier. If needed, the subcontractor can even request early payment in exchange for a discount. In both cases, the builder can then defer their own payment to the financier up to 90 days after the invoice date.
This extends the builder’s payment terms, effectively buying time to react to economic changes. More importantly, it ensures that payments can continue to be made to suppliers, even if sales figures turned out to be underwhelming in that particular month. As a result, subcontractors can count on steady revenues for their own work, ensuring that ongoing projects are kept on track.
SCF offers breathing space to prepare for the future
Builders are currently dealing with a lack of new orders, however high property prices and their rapid rebound suggest that recovery should be imminent. Currently, global economic uncertainty is depressing investor sentiment, this is unlikely to persist as some of the biggest problems at issue—Brexit, the US-China trade war, and the ongoing bushfire crisis—are currently being resolved. Also, experts indicate investors are switching focus away from freestanding homes to denser apartment housing. These projects have long lead-times, accounting for some of the delay, because developers need to sell a high number of units before they can access the financing needed to break ground on a tower.
Supply chain finance provides businesses with the financial security they need to react to changing economic conditions and cash flow issues. Critically, it allows them to keep subcontractors working, so that ongoing projects aren’t disrupted. As a result, the industry as a whole can better weather cash flow shocks, keeping their supply chains stable. When construction activity recovers and growth returns, builders who use supply chain finance, as well as their subcontractors and materials suppliers will be better prepared to take advantage of new opportunities than those who don’t.