Model house sinking into sand to support construction insolvencies article

Construction Insolvencies Rise: What’s Behind the Numbers?

The construction sector in the UK is facing an increasing rate of insolvency, with recent data revealing that construction firms accounted for 16.9% of all insolvencies in England and Wales in June 2024. This represents 397 registered construction businesses becoming insolvent, highlighting a significant upward trend in financial distress within the industry. Over the past year, the total number of construction firms that have become insolvent reached 4,690, a 2.1% rise from the previous year. The sector’s vulnerabilities are evident, with a 53.3% increase in insolvencies compared to 2020 figures.

While the construction sector has historically experienced volatility, the current rate of insolvency still falls short of the peak levels witnessed during the 2008-09 recession. However, various economic factors—including rising interest rates, delayed rate cuts, and cost pressures—are converging to place additional strain on firms across the construction landscape.

Construction Sector at a Crossroads

The recent data from The Insolvency Service paints a concerning picture of the construction sector’s financial health. As of June 2024, 4,690 construction firms had entered insolvency within the preceding year—a 2.1% increase from the 4,595 recorded in the year to June 2023. Moreover, this figure marks a staggering 53.3% increase from the 3,060 insolvencies recorded in 2020. Construction continues to lead other industries in terms of the sheer number of insolvencies, underscoring the sector’s disproportionate exposure to financial difficulties.

Historically, construction has been a high-risk sector for insolvency due to its unique business model characteristics. A heavy reliance on project-based work, long contract cycles, and often thin profit margins make the industry particularly susceptible to economic fluctuations. While the current insolvency rate of 54.7 per 10,000 companies is lower than the 113.1 per 10,000 seen during the 2008-09 financial crisis, it is important to note that the number of companies on the effective register has more than doubled since that period. This increase in the total number of firms partly explains why the overall rate appears more subdued despite the rising number of insolvencies.

However, even with this context, the construction sector remains disproportionately affected. In 2023, construction firms made up 13.8% of all registered businesses in the UK, yet they accounted for 16.9% of all insolvencies. This disparity suggests that construction firms face specific, underlying vulnerabilities that need closer examination.

Sub-Sector Vulnerabilities in Construction

Within the broader construction sector, certain sub-sectors are particularly prone to financial distress. Companies involved in specialised construction activities—such as demolition, site preparation, electrical and plumbing installation, and finishing work like plastering and glazing—are consistently among the most affected. These firms, often operating on a subcontract basis, are exposed to fluctuations in project volume and contract payments, which can lead to cash flow challenges.

Recent analysis from EY-Parthenon indicates that 48% of companies in the Household Goods and Home Construction FTSE sector issued profit warnings over the last 12 months, with nine warnings issued in the first half of 2024 alone. Notably, while housebuilders have historically been a focal point of concern, the balance of profit warnings has shifted towards household goods manufacturers and suppliers.

The construction industry is grappling with a variety of pressures. Higher interest rates, which directly impact mortgage payments and, by extension, housing market activity, are still being absorbed. Despite some easing of cost pressures, housebuilders are adjusting their business models to cope with reduced transaction volumes and ongoing delivery issues on legacy projects. In contrast, household goods suppliers face intensified pressures due to a slower pace of transactions and constrained consumer spending.

Factors Driving Construction Insolvencies

Several interrelated factors are driving the current wave of construction insolvencies in the UK. One significant contributor is the ongoing impact of higher interest rates and delayed rate cuts, which have exacerbated borrowing costs for businesses and consumers alike. For many firms, especially those operating with thin margins, increased interest rates have made it more challenging to service debt and manage cash flow effectively.

In addition to interest rate pressures, the construction sector faces unique challenges related to its business model. The industry is heavily dependent on long-term contracts, which are often fixed-price. When inflationary pressures lead to rising costs for materials, labour, and other inputs, firms with fixed-price contracts can find themselves squeezed financially. As a result, many construction companies, particularly smaller subcontractors, struggle to maintain profitability.

Further complicating the financial landscape is the issue of cash flow management. For firms operating on a subcontract basis, cash flow can be highly unpredictable, dependent on the payment cycles of larger contractors or clients. Delays in payments or unexpected expenses can quickly create a liquidity crisis. According to data from The Insolvency Service, 24% of self-employed or trader bankruptcies in England and Wales in the year to April 2024 were in the construction sector, highlighting the acute financial vulnerability faced by smaller entities.

Mitigating Financial Risks in Construction

While the financial outlook for many construction firms appears challenging, there are strategies that can help mitigate insolvency risks. One such strategy is the adoption of fluctuation clauses in contracts. These clauses, which link payments to work category-specific inflation indices, can help firms manage the impact of cost changes more effectively. Tools like BCIS CapX provide detailed indices covering over 200 work activities, enabling firms to plan more accurately for potential cost increases throughout the project lifecycle.

Moreover, proactive cash flow management is crucial for firms to navigate economic uncertainty. By utilising budgeting tools and forecasting models, construction companies can better prepare for cash flow challenges and minimise the risk of insolvency. Investing in financial management software, establishing strong relationships with suppliers, and negotiating favourable payment terms are additional steps firms can take to strengthen their financial resilience.

Finally, industry stakeholders, including government bodies and financial institutions, can play a role in supporting the sector by providing access to finance, creating supportive policies, and fostering a stable economic environment. As the construction industry continues to navigate these turbulent times, a multifaceted approach to risk management will be key to minimising insolvency rates and ensuring long-term stability.

Sources:

sarahrudge , 6 min read
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