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
Construction companies are particularly vulnerable to cash flow problems, which can lead to insolvency. One of the main causes of cash flow problems in the construction industry is late payments and bad debts. However, taxes can also be a major contributor to cash flow problems.
Construction companies often have to pay taxes in lump sums, at specific times, or make multiple payments at the same time. This can put a strain on cash flow, especially for small businesses. Additionally, penalties for late tax payments can further exacerbate cash flow problems.
Unfortunately, HMRC is less pragmatic and flexible in regard to VAT liabilities than in the past. However, it is still possible to negotiate a settlement for substantial VAT liabilities with HMRC.
If you are unable to pay your VAT liability upfront, you have two options:
- Agree to a Time to Pay arrangement with HMRC
- Negotiate a settlement
VAT settlement negotiations are best handled by professionals, as you will be quizzed about the company’s financial status, legal organization, past tax debts, and more. HMRC tax collectors can only act on the information they are given, so it is essential to provide as much information as possible during tax negotiation meetings. Failure to do so can impact the decision HMRC reaches.
Unprofitability in Construction Causes Insolvency
The high level of competition and price sensitivity in the construction industry make it difficult for companies to be profitable. In many cases, the only way to win a contract is to charge the lowest price. This can lead to construction companies operating on tight margins, which can make them vulnerable to insolvency.
Research has shown that the return on investment in construction is higher than in other sectors. However, this return is concentrated in the hands of larger companies. Smaller companies often struggle to compete on price and profitability.
It is possible that the return for larger companies is made at the expense of smaller companies. For example, larger companies may be able to negotiate better deals with suppliers or subcontractors, or they may be able to spread their costs over a larger number of projects.
Domino Theory Contributes to Construction Insolvencies
Another factor contributing to the high rate of insolvency in construction firms is the domino effect caused by suppliers and clients going out of business. Clients may go out of business with unpaid bills, and main contractors may fail while owing money to smaller contractors. In general, construction companies tend to delay payments to creditors when they are struggling financially. During this time, more work may be done and larger debts incurred. As a result, construction companies tend to have larger debts on insolvency than other firms.
The Availability and Cost of Credit
As we have already discussed, credit is essential for construction firms, as they need access to external sources of working capital to maintain a healthy level of cash flow. However, credit can be expensive for construction firms, given their size and lack of capital assets to act as collateral for bank loans. Additionally, many smaller construction firms have poor credit ratings due to cash flow problems, which further impacts the cost of credit.
The Perils of Construction Industry Scheme (CIS) Tax Arrears
Another common cause of cash flow problems for construction companies is CIS tax arrears. CIS requires all contractors to register with HMRC, verify the employment and CIS registration or payment status of subcontractors, deduct the appropriate amount of tax from subcontractors, and submit monthly CIS returns and statements to HMRC and subcontractors, respectively.
CIS arrears are treated similarly to unpaid VAT liabilities. Construction companies in arrears have effectively collected money on HMRC’s behalf but have not remitted it. If you receive a demand for CIS arrears from HMRC, it is essential to act quickly. If you are able to pay the arrears before the next CIS payments are due, HMRC will usually agree to this without further issue. However, if you are unable to make the payment, you will need 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: email@example.com today.