6 key factors causing financial distress in construction companies

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Financial distress in the construction industry is a growing concern, with many companies facing mounting pressures that threaten their stability and long-term viability.

From mismanaged cash flow to regulatory pitfalls, the causes are often complex and interconnected. Construction firms operate in a high-risk environment where large upfront costs, delayed payments, and tight margins are the norm. Without robust financial strategies and operational resilience, even well-established companies can quickly find themselves in trouble.

1. Poor financial management

A lack of good financial management can severely damage a financially distressed construction company, often accelerating its decline and pushing it into insolvency.

In an industry where cash flow is king, poor financial oversight can be fatal. Construction projects often involve high upfront costs, delayed payments, and retentions. By monitoring cashflow accurately, a company will have a greater oversight of whether it can cover payroll and supplier costs and well as remittances to HMRC. Monitoring costs will also help avoid projects running at a loss, providing greater ability to make corrections.

2. Loss of Gross Payment Status under the Construction Industry Scheme (CIS)

Under the CIS, subcontractors can register for Gross Payment Status (GPS), which allows them to receive payments from contractors in full, without tax deductions at source. Without GPS, contractors are legally required to deduct 20% (or 30% if not registered) from payments and send it to HMRC. For a company in distress, this sudden reduction in income can be devastating, especially if margins are already thin or liabilities are piling up. It is therefore essential for companies to understand their CIS registration requirements.

3. Asset Finance

Asset finance allows companies to acquire equipment, vehicles, or machinery without paying the full cost upfront. The cost is spread over time but this comes at a price. Asset finance is typically more expensive than traditional loans. In distressed companies, the interest rates or terms may be even less favourable, increasing long-term costs.

Asset finance agreements require fixed monthly repayments and assessing so it is whether leasing or renting equipment is more cost-effective can be key, particularly during downturns. Having a contingency fund to cover fixed repayments will also avoid missed payments when cash flow is unpredictable.

4. Invoice discounting

Invoice discounting is a form of short-term borrowing where a business borrows against the value of its unpaid invoices. The lender typically advances up to 70–90% of the invoice value, and the remainder, minus fees, is paid when the customer settles. But it can be a double-edged sword - improving short-term cash flow, while introducing risks and dependencies that could worsen the situation if not carefully managed.

Agreements often include strict covenants, and breaching these may trigger facility withdrawal, and lead to an immediate repayment demand and it’s therefore important to closely monitor compliance and use invoice discounting selectively.

5. Force majeure

A force majeure (FM) claim is made when unforeseen events -  extreme weather, war, pandemic, or materials shortages - prevent or delay a party from fulfilling contractual obligations.

Such a claim often suspends payment obligations, causing a sudden cash inflow stoppage, especially if the construction company has already incurred labour and material costs. This will lead to further problems when payroll and supplier costs cannot be met. Maintaining a reserve fund will help if faced with unforeseen events, while having appropriate insurance will also cover business interruption.

6. IR35

IR35 is aimed at identifying ‘disguised employment’. It applies when a contractor is effectively an employee of the client, even though they’re paid as self-employed. In the private sector, medium and large companies are responsible for determining whether IR35 applies, and if so, must deduct income tax and National Insurance Contributions (NICs) as if the contractor were an employee. Construction companies should conduct regular IR35 assessments and ensure compliance.

While it is useful for companies to use contractors, in order to be flexible, allowing them to scale up and down as projects demand, having a balance of permanent is often a viable strategy.  Where construction companies are inside IR35, contractors may refuse to enter into contracts because of loss of income, which reduces the available talent pool.

Navigating financial challenges

Construction companies must prioritise robust financial strategies, operational resilience, and compliance monitoring to navigate these common pitfalls, which can lead to financial distress. If your construction company is experiencing any of these pressures, seeking expert advice can be the critical step to restoring stability.