Common Causes of Insolvency in the Construction Industry

Insolvency rates in the construction industry are disproportionately high when compared to those in the rest of the UK economy. But why is this industry so susceptible to company insolvency and failure?

In this blog, we’ll take a look at some of the common causes of insolvency in the construction industry, and help you understand what can you do to counteract these problems and build the solid foundations you need to remain viable and profitable.

The Impact of Recessions on the Construction Industry

Recessions are unkind to the vast majority of businesses, but they tend to affect the construction industry in a slightly different way. Construction is one of a handful of industries that typically experiences a lag in times of economic recovery due to the inherent delay between the initial upturn in confidence in the wider economy, and the start of new construction projects.

Potential investors take the time to commit to projects following an upturn in the economy, and the design and development stages of these projects cause further delays to construction. The result is that in many cases, the construction industry can experience a lag of around two years before it experiences the same upturn.

Many construction companies are only starting to see the first signs of recovery in their industry as commercial and residential clients are now finally ready to put their expansion plans into action. The delayed recovery of construction companies is one reason why so many struggles after an economic decline.

Cash Flow Issues are a Main Trigger of Insolvency in Construction Companies

Although late payments and bad debts are the main triggers of insolvency in construction companies, the payment of taxes also contributes to cash flow problems for a substantial number of business owners. Having to pay taxes as a lump sum; having to pay at a specific time; having to make several payments at the same time, and paying penalties on late tax payments are all causes of cash flow problems for construction companies. Unfortunately, as HMRC know only too well the temptation VAT has for directors to ease cash-flow and once the director has used the VAT it is an upward struggle to catch up.

Negotiating a debt and reaching a settlement for substantial VAT liabilities with HMRC is possible but by no means easy to achieve. In the past, HMRC inspectors were given the discretion to assist small business taxpayers who were struggling to pay VAT liabilities. Sadly, times have changed. HMRC is generally less pragmatic and flexible in regard to VAT liabilities, but as we found recently by agreeing on settlements for a combined VAT liability of £1.2million, it is still possible.

If you fall behind on your VAT payments, you should contact HMRC’s business payment support service immediately to let them know. If you are unable to pay the VAT liability upfront, you have two options. You can:

1. Try to agree a Time to Pay arrangement with HMRC
2. If that fails, your next best option is to try and negotiate a settlement

VAT settlement negotiations are best handled by the professionals as you will be quizzed about the company’s financial status, legal organisation, past tax debts and more. HMRC tax collectors can only act on the information they are given, so in these tax negotiation meetings, it’s essential you provide all the information you can. Failure to do so can impact on the decision HMRC reaches, which is why professional assistance with HMRC tax negotiations can really help.

Unprofitability in Construction Causes Insolvency

One of the most obvious causes of insolvency in the construction industry is a lack of profitability. Given a large number of firms in the construction industry, the process of winning work is highly competitive and price sensitive. In many cases, the only way to win a contract is to charge the lowest price. However, research into the capital productivity of the construction industry has shown the return on investment in construction is higher than other sectors. Over the period 1948 to 1994, capital invested in construction made a return of around 24 percent, compared to 9.5 percent and 8.3 percent for manufacturing and agriculture respectively. So, the indicators are the bigger companies are getting a far greater return on their investment than smaller companies. You could argue the return for the larger companies is made on the backs of smaller companies whose profit is taken by the larger companies.

Domino Theory Contributes to Construction Insolvencies

Another contributory factor in the high level of insolvency in construction firms is the frequency with which suppliers and clients go out of business. Clients can go out of business with unpaid bills and main contractors can fail while owing cash to one or more smaller contractors. Generally speaking, firms in the construction industry tend to delay payments to creditors when they are struggling. During this time more work could be done and larger debts incurred. For this reason, construction firms tend to have larger debts on insolvency than other firms.

The Availability and Cost of Credit

We’ve already identified the importance of credit for construction firms, who need access to external sources of working capital to maintain a healthy of level cash-flow. Given the size of many construction firms and the lack of capital assets to act as collateral on bank loans, credit can be expensive. The problems construction companies often encounter with their cash-flow also means many smaller firms have poor credit ratings, further impacting the cost of credit.

The Perils of Construction Industry Scheme (CIS) Tax Arrears

Another common cause of cash flow problems for construction companies is the Construction Industry Scheme (CIS). Every contractor is required to register with HMRC; verify the employment and CIS registration or payment status of sub-contractors; deduct the appropriate amount of tax from the sub-contractor to pay HMRC, and submit monthly CIS returns to HMRC and monthly statements to sub-contractors.

CIS arrears are treated in much the same ways as unpaid VAT liabilities. Construction companies in arrears have effectively collected money on HMRC’s behalf and then withheld the payment. If you do receive a demand for CIS arrears from HMRC, it’s essential you act quickly. If you are able to pay the arrears before the next CIS payments are due, this will be usually be agreed without further problem. However, if you are unable to make the payment, again you will have to try to make a Time to Pay arrangement with HMRC or reach a settlement.

Concerned Your Construction Company May be Insolvent? Free, Confidential Advice

The good news is that CIS or VAT arrears don’t have to mean the end of your construction business. We have had success negotiating substantial tax arrears in recent months, but it’s essential we get involved in the early stages of the process. If you have received a demand from HMRC VAT or PAYE/CIS that you cannot pay, or have been threatened with a winding-up petition, we can help. Call us on 0800 074 6757 or email: info@companydebt.com today.