The bankruptcy and liquidation of U.K. construction giant Carillion, and its impact on suppliers and other small businesses underscores the importance of contract risk management and maintaining margins for firms in the European engineering and construction sector.
According to a recent report by Fitch Ratings, the sector is mostly sub-investment grade, but the situation may be better for companies that are managed well and keep a close watch on their balance sheets.
Carillion went into liquidation last week with estimated debts at $2.4 billion due to cost overruns on several key projects. The company wrote off over $1.3 billion worth of receivables in 2017, which in part were due to construction delays, “but also suggest poor risk assessment regarding contract bidding,” Fitch analysts said. “With margins in the construction and services industries under pressure, strong contract discipline has become more important in recent years. In its absence, companies may find themselves bidding for new contracts to cover cash shortfalls on existing contracts.”
Assessing risk in the contract bidding phase, and monitoring them closely to watch for unexpected capital outflows due to cost increases are important factors in a viable risk management strategy, Fitch said.
As companies step in to replace Carillion on its projects, credit managers should watch for the replacement costs in play, how near completion the replacement projects are and how much money is already owed to sub-contractors, analysts said.
– Nicholas Stern, managing editor