The case for contractors adapting their models to improve supplier payment terms is more compelling than ever

Stefan Friedhoff

It is unlikely that there has ever been a time in the world of construction when payment terms with suppliers has not been a major issue in the sector. And clearly the situation was only exacerbated by the economic downturn in 2008. As already tight margins were squeezed further, some businesses – perhaps understandably – took longer to settle debts, with inevitable knock-on effects for their suppliers.

Today, the issue remains. While controversy surrounding the payment of suppliers is not exclusive to construction, it does carry a unique pertinence in an industry in which failure in the supply chain can imperil projects.

However, as the economy continues to improve – with the superior revenue positions and margins which should follow – comes the chance to reconsider the debate from a different perspective. By handling their working capital in a proactive way, contractors are able to take charge of how they manage payments to their supply chain. The case for doing so is compelling.

Firstly, the awareness around payment terms continues to be driven in part by the procurers of major developments and public sector organisations in particular. In this environment, many contractors have taken advantage of supply chain finance in which banks – including Lloyds – work with larger firms to ensure suppliers can access payment for their goods and services more quickly.

While supply chain finance schemes have helped bridge the gap between extended payment terms and supplier cash-flow requirements, public sector procurers have led the way in inserting supplier-payment requirements into contracts, ensuring major contractors are obliged to settle invoices within defined timeframes. Importantly, the evidence suggests such an approach has worked and has not created significant issues in the quality of bidders for large-scale public sector construction work.

This way of working inevitably has profound and beneficial implications for relationships with suppliers. Some observers have suggested that in recent times the balance of power has shifted from contractors to their supply chain. Industry surveys increasingly paint a picture of a sector challenged by a shortage of sub-contractors. Clearly this puts suppliers in a position of strength, with greater negotiating power over prices, as well as on other terms. Against this background, larger firms must necessarily consider the strength of their strategic relationships with suppliers.

Indeed, in the same way a weak relationship with a sub-contractor can be a major weakness, strong links can therefore be a huge asset. Companies with short payments terms, or at the very least those that strive to manage their working capital to settle invoices on time, are inevitably viewed more favourably by suppliers.

Nevertheless, it remains the case that for many construction firms, cash-flow is an issue, a problem compounded by project overruns and those aforementioned razor-thin margins. In this context, well-managed finance and treasury teams must use all available tools at their disposal to mitigate risks and look to reap the benefits of sound working capital management.

Among these, supply chain finance initiatives remain a sound way of managing risk and ensuring suppliers are paid on time. Elsewhere, procurement cards are increasingly being used by construction firms as another way to manage cash-flow, creating efficient administrative management of supply chain payments. Other financial tools such as traditional trade finance – including letters of credit and financial guarantees – can also act as effective cash substitutes.

Despite some recent downbeat official data from the Office of National Statistics, other pulse-checks suggest the sector is relatively buoyant. Indeed, Markit’s most recent monthly Construction Purchasing Managers’ Index pointed to business confidence residing at its highest level for almost a decade.

Consequently, as the climate continues to become more benign, construction firms must be proactive and take charge of their cash-flow so they can better manage payments to suppliers. If they do so, the rewards will be considerable – not just stronger, more fruitful relationships with those in their supply chain, but the optimum position from which to capitalise on an improving economic climate and thereby drive growth.

Stefan Friedhoff is global corporates managing director for construction at Lloyds Bank Commercial Banking.