Insolvency risk management in the Australian construction sector
- Supply chain disruptions and regulatory shifts are forecast to impact those operating within the construction sector over the coming months and years
- High inflation, tighter monetary policies, post-pandemic delays, and increased costs have contributed to an increase in insolvencies
- Companies operating within the construction sector should be aware of the warning signs and manage risks early
The Australian construction sector is currently facing a range of challenges. Construction and building companies with a reputation for reliable and quality work are now facing the risk of insolvency, or have gone into administration due to a variety of economic and industry-related factors.
According to the latest data from the Australian Securities and Investments Commission (ASIC), 7,742 companies entered external administration between 1 July 2023 to 31 March 2024 – representing a 36.2% increase compared to the same period in the previous year.1
Approximately 1 in 4 of these insolvencies were from the construction sector, further highlighting this adverse trend.2
QBE’s recent Australian Construction Sector Outlook report forecasts a modest increase in the industry’s health for FY 2024, however, predicts a 5% decline in both residential and non-residential building work for FY 2025,3 raising important questions around what companies in the industry can do to manage the risks they are facing.
Why is construction insolvency on the rise?
A range of factors are placing pressure on small and large business within the construction industry, contributing to the increase in insolvencies.
The construction industry is grappling with delays on projects post-COVID-19, affecting cash flow and project completion. Consumers encouraged by the HomeBuilder stimulus program signed up for fixed-price contracts that some building and construction companies were later unable to fulfil due to the rising cost of building products and labour.4
Supply chain disruptions and increased costs for materials have further compounded the issue, leaving many builders and contractors vulnerable to economic pressures. Labour shortages have been another setback for some, with trades and blue-collar labour vacancies almost double the pre COVID-19 average.5
Despite the industry showing some signs of renewal post-pandemic, conditions remain stifled by the reluctance of many clients and customers to sign new building contracts. This is partly due to general worry about the ability of building and construction companies to meet their obligations amidst uncertainties, as well as several high-profile cases of substandard work and building defects.6
Construction insolvency risks: identifying warning signs
The construction industry needs to keep building, and for businesses working in this sector, it’s important to be on the lookout for red flags – including late payments, project delays, and compromises in quality.
“Subcontractors not getting paid is often a sign of financial distress in the construction industry,” says Craig Rogers, Manager, Risk Engineering, QBE Australia Pacific.
This issue often triggers a domino effect, impacting not only the subcontractors but also the overall project timeline and quality. When payments are delayed, subcontractors may lack the resources to complete their tasks efficiently, leading to further delays and potential cost overruns.
Additionally, a failure to pay subcontractors can erode trust and damage long-term business relationships, exacerbating financial issues.
Another thing to look out for is a frequent extension of contracts. While it’s not uncommon for construction projects to extend beyond their original timelines, significant delays can be a sign that a business is in trouble.
“If a project intended for 12 to 18 months extends to over three years, for example, it’s impacting cash flow and putting significant financial pressure on the business,” says Matthew Boon, Head of Underwriting, Heavy Industries at QBE Australia Pacific.
These delays could be worsened if the original contracts were fixed-price and fixed-term, especially given that inflation and rising costs can render the initial estimates unrealistic.
“We’ve observed large-volume builders with a substantial pipeline of fixed-price and fixed-term projects now facing costs 30% to 40% higher than initially quoted two years ago,” says Boon. “This is untenable with average margins of 10% or less, forcing these companies to void or renegotiate contracts to cope with the situation.”
Building standards are another clear indicator. “Cutting corners in construction quality, flagged during certification or compliance checks, is another obvious sign that cost pressures are mounting, as companies may compromise on quality to reduce costs,” Rogers says.
Proactive risk management for construction businesses
What steps can construction companies, builders, contractors and other industry operators take to mitigate risks in an uncertain environment? Both Rogers and Boon provide valuable insights on navigating the challenges effectively, acknowledging that larger construction companies have unique challenges in staying on course under the current market conditions.
A clear and rigid project plan is a must. “Sticking to the plan is crucial, and it should include penalties for non-compliance to ensure accountability,” says Rogers. “This way, if project milestones are not met, the responsibility falls back on those accountable for delivering the work.”
It’s also important to work with reliable suppliers and subcontractors. “Building strong relationships with trusted partners can provide a stable foundation and lessen the risk associated with project delays and quality issues,” Boon adds.
As always, building supply chain resilience is vital. Builders should focus on optimising their procurement processes to ensure that materials are sourced at competitive prices and meet stringent standards.
“This means doing your due diligence when selecting new suppliers, establishing strong relationships with reliable vendors, and continuously monitoring the supply chain for improvement,” Rogers says.
A quick guide to construction risk management
By following these steps, construction companies and their advisors can better manage the inherent risks of the industry and navigate through uncertain times more effectively.
- Diversify client base: Avoid over-reliance on a single client, or category of clients, to reduce vulnerability if a major project falters.
- Optimise supply chains: When engaging new suppliers, do so with cost and quality control at the front of mind to ensure project efficiency, and maintain high standards.
- Plan and monitor: Plan projects with care, ensuring regular accountability and compliance checks.
- Implement stringent cash flow management: Regularly monitor cash flow to ensure liquidity, particularly during project delays.
- Regularly review contracts: Ensure all contracts are meticulously reviewed to understand and mitigate potential risks before they materialise.
- Secure comprehensive insurance: Having the right insurance policies in place can help protect your business against unforeseen liabilities and potential financial loss.
Building a resilient future: Download the Australian Construction Sector Outlook report
To navigate the current economic landscape, it’s crucial to stay informed and proactive. For a deeper understanding of the latest industry trends, challenges, and actionable insights, read our article on QBE’s Australian Construction Sector Outlook report.
1 Australian Securities & Investments Commission, ASIC Insolvency data, April 2024
2 Australian Securities & Investments Commission, ASIC Insolvency data, April 2024
3 Australian Construction Sector Outlook, QBE Insurance, 2024
4 Some loved it, others hated it. Either way, the $25,000 HomeBuilder grant was ‘life-changing’, ABC, January 2022
5 Australian Construction Sector Outlook, QBE Insurance, 2024
6 Insurance challenge: rising building defects claims, Insurance Business Mag, June 2023
