Building from strong foundations: why E&C companies need to focus on their working capital management
03 February 2016
Companies in the E&C sector have amongst the highest capital consumption of any industry. That’s why effective working capital management (WCM) is such a top priority. Cash underpins every area of their operations – from keeping projects running smoothly on schedule to paying sub-contractors and procuring new materials. If WCM processes break down, businesses are at risk.
E&C companies face a number of common challenges. This is an industry where it takes a long time to get paid. Extended project timelines with stage payments mean E&C companies are used to operating with unbilled revenues. Because these payments are typically contingent on sometimes subjective assessments by quantity surveyors, unpredictable cash flows are business as usual. Retention is another big issue. A percentage of contract value is often held back for a set period in case defects are found in the final construction. If contractors fail to have this signed off correctly, they risk being liable for ongoing repairs.
So how should these challenges be managed? Robust WCM processes are vital. It’s also vital to drive the right behaviours throughout the organisation. People at every level of the business – from financial controllers to onsite engineers – must be encouraged and incentivised to keep track of cash flow, and provided with the tools and processes they need to do so.
But a need to focus on cash is not new to this sector. Often companies will seek to negotiate contracts that deliver large upfront payments however this can lead to a laziness when it comes to working capital management as work in progress (WIP) and invoices are allowed to build up because the project remains cash positive. Optimising and maximising capital performance should be a primary goal at every stage of the project – being cash positive is not enough. With the right controls and behaviours, this can happen.
We often find that E&C companies focus on the technical challenges they face to the exclusion of administrative issues (including capital performance). By helping them embed the disciplines and awareness they need for effective WCM, we bridge this gap and prevent potentially catastrophic outcomes for large contractors, and the multiple owner-managed sub-contractors that depend on them.
WCM has become particularly important over the past few years. In a slower economy, outstanding payments have become commonplace. On top of that, many companies have been ‘buying in’ work to keep busy and remain in the market. Under these conditions, low liquidity and ongoing capital commitments have sometimes proved to be hugely damaging. Recent initiatives mandating prompt payment for sub-contractors on government projects have added extra pressure – especially where these sub-contractors are failing to invoice on time and in the correct way.
Taken together, these factors clearly show why effective WCM is about much more than cash flow. Multiple sub-contractors must be closely managed and promptly paid to ensure their availability to work at short notice. Contract terms must be scrutinised with WCM in mind. Retention and unbilled revenues must be factored in. And, of course, inventory issues must be identified well in advance.
To keep projects on track, E&C companies need immediate access to key products and components. Whilst there is often good just in time discipline for certain bulk materials such as concrete, hard core and tarmac, other materials are often procured early and stored awaiting demand. High levels of inventory on-site might make sense from a project management perspective. But when late performance delays payment, it can be disastrous for liquidity. We’re often asked to help companies improve their inventory planning and supply chain management to address this risk. Ensuring that the right raw materials are in place when (and only when) they’re needed is a vital element in effective WCM. But as we’ve shown, it’s just one of the areas that needs to be watched closely and de-risked as much as possible.
E&C leaders already excel in WCM. In a volatile market, it’s critical for all companies in this sector to recognise the importance of this discipline.
Our recent survey identified a working capital opportunity of €95bn in the global sector.
We’re here to help, so please contact us if you’d like to find out more.