Factors Associated with Insolvencies amongst Civil Engineering Construction Firms in South Africa P D RWELAMILA Department of Construction Economics & Management University of Cape Town Private Bag Rondebosch 7700, South Africa
[email protected] L LOBELO De Beer Marine (contracted from Farrow Laing Davis Langdon) P O Box 87, Cape Town, South Africa
[email protected]
Abstract This paper seeks to evaluate the findings of an investigation into factors associated with insolvencies among civil engineering contractors in the Western Cape Province of South Africa. The paper reports on the basis of the hypothesis that ‘the prominent factors associated with civil engineering contractors insolvencies are related to operational and strategic issues. The analysis of the findings from the questionnaires and liquidators reports support the hypothesis that operational management and strategic factors attribute to the high failure rate amongst civil engineering contractors. From the findings, a number of recommendations are made. Keywords: Civil engineering construction firms, insolvency, South Africa.
INTRODUCTION Insolvency may be broadly defined as an inability of a business entity to meet pending financial commitments. For a construction firm, such a situation creates conditions whereby a business entity is unable to fulfil its contractual obligations with regard to work-in-progress or creditors owing [De Valence (1994)]. There are indications to suggest that during times of adverse conditions, the occurrence of insolvent conditions seem to be on the increase. Whether such adverse conditions and mounting insolvencies are mutually exclusive remains a subject of debate. The occurrence of these financial failures seems to have adversely affected business concerns operating within the South African civil engineering construction sector. According to Hindle [Hindle (1991)], the knowledge of trends in business cycles is paramount to the survival of construction firms. Furthermore, Lansley [ Lansley (1987)] emphasises a need for firms to attune their strategies to the environments they operate in; thus enabling them to be in sync with market trends. He argues that adopting such strategies ensures that competing firms operate on the same level to variable market conditions. Reviewing the world construction sector through the past three decades, Lansley and Langford [Lansley (1987) and Langford (1991)] note the following general trends: 1960s - characterised by long term stability in construction markets; 1970s -the market transformations during this period were phenomenal and could not be handled by tried tested methods for competing and struggling firms to remain in business; 1980s -
the conditions of low levels of demand for construction work and declining role of governments as key players in various economies. The South African construction sector has been part and parcel of the wrath of these worldwide trends. This research study investigates further into the principal causes of insolvencies amongst South African civil engineering contractors.
REVIEW OF PAST WORK Figures released by the South African Federation of Civil Engineering Contractors (SAFCEC) in 1992 were suggesting an expected general decline in the workload handled by this sector [Van Der Merwe (1992)]. He argues that little growth was envisaged in the civil engineering construction sector during that period as a result of the scaling down of heavy infrastructural projects, because of the government shifting focus to housing and other related projects mainly towards meeting the needs of the previously marginalized communities. This trend was confirmed by Symons [Symons (1995)] in the Western Cape province where the value of tenders awarded dropped from R518 millions (1994) to R120 millions (1995) during the January to May period. In October 1995, three, well-established civil engineering contractors in the Western Cape Province went insolvent. In a survey conducted by Henry [Henry (1994)], insolvency causal factors associated with insolvencies in general construction firms were identified. These factors could be broadly classified into categories of operational management, environmental, strategic, personal, cost overruns and technological factors. Feedback from the study indicate that operational and strategic factors are the principal causes of insolvencies among general construction firms. Two forms of insolvency exist as recognised by law, namely commercial and factual insolvency. Commercial insolvency occurs where a business entity is unable to service its debts even though its assets may exceed its liabilities, whereas factual insolvency is where a firm’s liabilities exceeds its assets [S.A.I.C.A (1995)]. The terms of bankruptcy and insolvency are often deemed to be interchangeable, although they may represent the same situation their application differs. Langford et al.[Langford et al. (1991)] refers to bankruptcy as a term pertaining to individuals , whereas insolvency being a broader term incorporating liquidation , receivership and administration of a company by bankers , or others with a financial stake . Liquidation is referred to also as winding -up , involves a process whereby the life of a company is brought to an end when it is unable to pay its debts. Whereas receivership involves an appointment of a receiver liquidator whose main role is to protect the assets of the insolvent company , on behalf of the secured creditors [Ramsey (1985)]. Incumbent upon his or her appointment the liquidator may continue running the affairs of the insolvent firm for a while to sell off its assets or streamline its operations for it to be profitable again and sell the company as a going concern . However , given the uncertainty of recovery from loss by the firm , the process of winding -up the firm usually follows. The process of winding-up can be decreed by the courts of law or may be voluntarily initiated by the members of the firm or creditors [Burnett (1991)]. For lack of space and brevity, insolvency procedures are not explained in this paper. There are economic factors, which are worthy of note , but may be perceived as being external and nonbearing to a firm’s survival. Although they may be external to a firm’s operations , failure by firms to recognise their effects may lead to the termination of their operations. Therefore , given that construction projects necessitates heavy capital investment which attracts interest from the borrowed capital portion , the need to study the way the market behaves is crucial to understanding the cashflow needs of a firm. The amount of investment available is governed by many economic factors such as the level of income , profit , taxation and market conditions [ Ren (1992 ), Symons (1995)]. The role that management plays in controlling and providing vision in a firms activities can be its detriment if not properly managed or strategised . Management needs amongst other things, to adapt their organisations to deal with growth effectively, either by minimising its growth to level off or face the risk of
the business outgrowing its own organisation [Schleifer (1990)]. The nature of construction products is such that, they are a one-off endeavours meaning that, labour, plant and materials have to be assembled separately for each job. This places a heavy burden on site management to co-ordinate and supervise the various trades [Davis (1991)].
Macro-economic factors and their effects There exists a body of thought , which is of the opinion that the advent of insolvencies follows the natural law of selection. A number of authors [Douglas (1985), Laing(1994) and Cooper et al (1994)] concur with this opinion in that nature rationalises by letting go of the weak to ease over-capacity . Douglas [Douglas (1985)] indicates that the positive spin-off of such an effect lays with the removal of inefficient businesses from the industry whilst at the same time forcing existing firms to tighten up their operations, thus placing them in a better position when the situation improves. In addition Cooper et al. [Cooper et al. (1994)] likens the effect to a culling process , whereby the resultant effect creates a market with a super league of contractors whom can achieve better margins through well managed resources with weaker companies left trailing. Economic factors such as the level of income , profit , taxation and market conditions govern the amount of investment available for capital investment [Ren (1992)] . The degree to which these factors affects the industry hinges on its nature.
Nature and characteristics of the construction industry The civil engineering contracting industry focuses on the development infrastructural works. Davis (1991) identified four primary areas distinctive of the contracting sector . The first area being the construction of roads, railways, bridges and tunnels. The second being the erection of harbours, docks, waterways, dams, reservoirs and sea defence and land reclamation works . The third area, focusing on the energy industry and the construction of power stations, transmission lines and electricity substations. And lastly, the construction of plants for water treatment and waste management . The characteristics, which make the construction industry distinct from others and susceptible to failure are described elsewhere [Ren(1992), Jach(1985), Kangari(1988) and Davis(1991)].
Effects of the business environment on the industry Close monitoring of the business environment is crucial in a contracting firm’s strategic planning, given the highly sensitive nature of the industry. Small shifts in the interest rate often dictates development intentions of important clients [Langford and Male (1991)]. Monitoring market conditions allows construction organisations to synchronise their activities with their environments thus enabling them to right size their resources.
Impact of inflation and the interest rate on the industry Through the banking system the government controls the credit and interest rates thus influencing the construction industry a great deal. Therefore the demand for construction products is largely influenced by the government’s monetary policy. Hence, any increase in interest rate and mortgage rate can dramatically reduce investment and demand for the services from the industry [Ren (1992)]. Newcombe et al. (1990) and Kangari (1990) all support this view that government fiscal policy affects patterns in government expenditure and income, whilst the monetary policy affects the supply of money and credit facilities (i.e. interest rates). Therefore , the fiscal policy on one hand affects the construction industry directly through the demand for new buildings and works, whilst on the other hand the monetary policy indirectly affects changes in interest rates (i.e. any increases reduces the demand for construction ).
Business cycles and their effects on the environment Douglas [Douglas (1985)] emphasises the analysis of peaks and troughs in the economic cycle as being
relevant to the contractor, in that the company’s level of success is affected and dependent on the outcome of these cycles. Hindle [Hindle (1991)] echoes this assertion as well, in that the analysis allows management to detect and react to changes in demand for their services. Douglas and Hindle [Douglas (1985), Hindle (1991)] concede to the fact that there’s an apparent neglect in the marketing of construction services during boom times, given that work and capital is easily obtained. Whereas in a recession, work and capital is scarce and the marketing of construction services become important.
Importance of cash flows in the construction industry The most prominent cause of insolvency results from inadequate cash resources and failure to convince creditors of the availability of money [Hsing-Hui (1989), Ren (1992), Jach (1985) and Tong (1990)]. Jach [Jach (1985)] concurs with this view that even profitable firms could be forced into liquidation , because the demand for payment or settlement of outstanding accounts could not be met at the critical time despite the fact that the assets are tied in long-term investments. Furthermore, capital is often required to smoothen out the strains on the cash flow resulting from the occurrence of cost and uncertainty [ Ren (1992)]. Escalating materials prices coupled with high interest rates have forced management of construction firms to focus on the control and flow of money as being critical to its survival [Ryder (1978)]. Moreover, the terms of payment stipulated in the contractual conditions and the escalation formulae (on contracts with escalation) require a great deal of expertise to apply, coupled with the task of ensuring promptness in the submission and payment of bills to ensure that the cash flow situation is controlled and improved upon (i.e. preventing the possible erosion of profit).
Sources of finance to contractors Growth in a firm necessitates the injection of capital, given that at a certain point in time its fund requirement will exceed its fund generation [ Hsing-Hui (1989)]. The financing of construction projects may be external and internal to an organisation [Tong(1990) and Bathory (1984)]. Internal sources: Includes the contractor’s retained earnings from previous projects or investments; depreciation income obtained through depreciating assets, thus the depreciable amount being claimed from the government through tax savings; and disposal of the contractors assets through their sale. External source include large source of external finance is through bank loans and other financing mechanisms , these may be short or long term.
THE ROLE OF MANAGEMENT IN CONTRACTING FIRMS Good management implies an awareness of all factors making up a successful business namely good strategy, marketing, pricing and financial control[Douglas(1985)]. Financial mismanagement and management incompetence have been cited among the attributes that lead to the prominence of construction failures [ Kangari (1988), Henry (1991), Schleifer (1990), Potgieter and Frank (1990)]. Potgieter and Frank [Potgieter and Frank (1990)] assert from their study that, there needs to be training amongst entrepreneurs on matters relating to financial management such as bookkeeping, tax planning, budgeting and cash flow management . Additionally, the lack of management information also contributes to the failure of businesses . The use of financial ratios and inter-firm comparisons have been cited as the most useful tools in providing management information which measures the overall effectiveness of any business [Potgieter and Frank (1990)]. Furthermore, management information permits management to monitor, measure and evaluate performance of the company at certain time intervals, with the attainment of an improvement of profitability in view [Potgieter and Frank,1990)].
Strategic management in construction Langford and Male [Langford and Male (1991)] perceive the function of a strategic planner in a construction company, being to synchronise the company’s activities with those of the industry albeit being consistent with the resources of the firm. The uncertain environment within which the construction industry operates, dictates that management adopts varying approaches to manage change based on their experience. The strategy adopted by management in contracting firms is reflected in the quality of service delivered in terms of programme, budgetary control and conformance to specification ( i.e. realisation of the project objectives) [Winch and Snyder (1993)]. The nature of the construction environment has forced prudent firm to adopting a policy of subcontracting where the demand for construction services is less predictable [ Langford and Male (1991), Langsley (1987 )].
Financial management in construction firms Management is the key, which determines business growth [Young and Hall (1991)]. Proper financial management in a company ensures that resources are properly controlled and planned for . Tong [Tong (1990)] affirms this view in that, where a firm experiences uncontrolled growth, conditions may arise where financial needs are in excess of available resources thus increasing the vulnerability of the firm towards an insolvent state.
CAUSES OF INSOLVENCIES WITHIN THE CONSTRUCTION INDUSTRY There exists no comprehensive study explaining the causes of insolvency among construction companies , moreover research covering the subject matter has tended to identify the symptoms rather than causes, a number of authors [Young and Hall (1991), Henry (1994), Davis (1991), Schleifer (1990), Kangari (1988) and Bathory (1984)] have attempted in their studies to ascertain the causes of insolvencies in the construction industry. Kangari [Kangari (1988)] ascribed the high failure rate amongst construction firms to the: a highly fragmented industry; industry highly sensitive to economic cycles; fierce competition as result of an over-capacitated market; relative ease of entry; management problems; trading, including competitive quoting, outsize projects, high gearing, resistance to change or technological advance and deterioration of service; accounting, where inconsistencies occur in the financial data generated for management; increase in project size; unfamiliarity with new geographic areas; moving into new types of construction; changes in key personnel.
Mechanisms of minimising the advent of insolvent situation Given the highly uncertain environment of the construction industry, most contracts necessitates the use of guarantees which act as security in the event of a contractor/subcontractor defaulting on completing their contractual obligations, thus ensuring that the resulting defects are remedied . De Valence [De Valence (1994)], perceives surety /performance bonds to be the solution to matters which although separate but inter-related and are deemed to be problems areas in the construction industry. The problems relate to: performance guarantees for clients, security for payment of subcontractor in the event of the principal contractor going insolvent , barriers to entry and improving the capital adequacy in construction contractors by increasing their usable working capital. Such bonds are often packaged to carry the total risk besides those brought about by an Act of God, in the event of any default in the performance of the contract. The project covers the final cost of the project after adjustments for variations, extensions of time etc. The prominence of such surety bonds is common in the USA and Australia, whereby the public works departments of those countries require contractors to be covered by such bonds against non-performance. Surety bonds are current development in South Africa. Insurance companies, whom eligibility for such bonds hinges on the risk rating of the contractors, handle the issuing of such bonds. By bringing third parties into such contractual arrangements, clients are absolved from shouldering the risk of the contractor
going insolvent. Should the contractor default on performing, the insurance company may recover such loss from the defaulting party through the personal security given as a condition to having access to the surety bonds [De Valence (1994)]. The insurance companies acting on the client’s interest carry out a regulatory function by evaluating the financial and technical ability of contractors through the use of quality assurance systems(QA). According to Blyth [Blyth (1995)], a well implemented quality assurance (QA) system of evaluating contracting firms adds to client confidence and provides the practising organisations with a benchmark by which to measure their performance.
THE STUDY Purpose of the study The main purpose of the study was to determine factors, which are perceived by active civil engineering firm’s management to be the prominent causes of insolvencies in the civil engineering contracting sector. Furthermore, these factors were to be tested against the analysis of the liquidators reports obtained from insolvency courts under the auspices of the master of the supreme court. It was expected that a comparison between liquidator’s reports and responses from active civil engineering firms management will provide a body of knowledge regarding the actual causes of insolvencies within the civil engineering contracting sector.
Research proposition It was intended to test the statement that: "the prominent factors associated with civil engineering contractors insolvencies are related to operational and strategic issues".
Method of approach In order to obtain the necessary information on the subject matter, a literature survey was carried out, a circulation of questionnaires to all civil engineering construction firms registered with the Association of South African Civil Contractors (ASACC) in the Western Cape chapter and structured interviews with the receivers administering insolvent civil engineering firms.
Analysis The questionnaire was designed with the intention of eliciting a response(s) from the management of civil engineering contracting firms, towards determining the principal reasons for the failure in civil engineering contracting. It was assumed that the respondents would be sufficiently familiar with the reasons stated . The questions were kept simple and straightforward, and the language employed was at a level commensurate with the survey population in attempting to increase the response level. The information obtained was to reveal the perceived causes of failure in civil engineering contracting firm and provide a body of material constituting opinion as to the causes of failure of construction companies. The perceived causes of management and those elicited from the liquidators report will be compared with those gleaned from the literature to establish a common ground or areas deemed to be problematic to the survival of civil engineering construction firms. The style of the questionnaire was in a manner, which allowed the manager completing it, to indicate in an appropriate block with varying degrees of belief , his perceived cause of failure. The questionnaire was based on a survey done by Young and Hall [Young and Hall (1991)] and a preliminary study done by Henry [Henry (1994)] on the subject matter. The questionnaire made an allowance for commentary , where the manager could cite reasons than those stated which ascribed to the failure in civil engineering contracting firms.
Of the 15 questionnaires sent to civil engineering contractors, only 10 were returned (66%). The response from the questionnaire was relatively good with half of the respondents providing additional information in the commentary section as to the factors responsible for failure in civil engineering contracting firms. The liquidation report: The information relating to reasons for insolvency of civil engineering construction firms was accessed through the offices of the Supreme Court. A company, which goes insolvent, is assigned a case number (e.g. C993/95). Where C refers to the judicial district area, which in this case is the Cape Region. The 993 refers to the case number for the year 1995 (indicated by the 95 after the stroke). Gaining access to the files of insolvent civil engineering contracting firms or under judicial management, was done by looking through the documents made available to the public at the Insolvency courts of the Supreme Court. Within the documents available at the desk are companies, which have registered, insolvent, and are listed alphabetically or by the date the companies went insolvent. The case numbers extracted of insolvent civil engineering contractors were from the years 1993-1996. Once located, the notice of motion, statement of affairs and liquidators reports were retrieved from the files. Analysis of the questionnaire: The approach followed, was first to present all factors associated with insolvencies along with their varying degrees of belief options (i.e. strongly agree, agree, unsure and strongly disagree).The varying degrees options were totalled separately under each cause, the total being contingent with the response from management. The choice option totals were expressed as a percentage of the total number of respondents. The results are shown in Table 1. The table reflects that the two perceived causes of insolvencies, where the respondents "strongly agreed" to were inaccurate costing and estimating (70%) and under pricing (63%). These were the only two causes receiving more than 50% under the "strongly agree" option. Conversely, the reliance on a few suppliers, disagreement with partners, ill health, fire and exchange rate were considered to be the most unlikely causes of insolvency , all of them equally achieving 40% in the "strongly disagree" option. Table 2 classifies the causes into categories of operational management, environmental, strategic, marketing, personal, rises in costs and technological factors. The table facilitates the analysis to be consistent with the terminology used in the proposition and literature survey. The results reflected in the table are actual. A summation of these amounts are determined under each of the choice options of the causes in the categories, to arrive at an option total for the category . A percentage was then calculated for each of the category to evaluate the response of management to the categories, as being the prominent causes of failures in civil engineering contracting firms. CT represents the total that each choice option can get under each category (e.g. in the category of operational management the total that ’agree’ option can get is 60 with the other options being 0). The choice total is then assigned a percentage from the aggregate total.
Table 1: Response from Questionnaire (%) Causes of insolvencies Strongly agree Agree Under capitalisation 10 60 Poor management of debt 30 30 Inaccurate & Estimating 70 20 Poor management accounting 40 30 Poor supervision of staff 30 40 Skill shortages 30 20 Lack of demand 30 30 Reliance on few clients 0 50 Competitor behaviour 40 50 Reliance on a few suppliers 10 20 Disagreement with partners 10 10 Ill health 10 10 Excessive remuneration 10 10 Inferior product 20 30 No previous experience 20 30 Use of inferior materials 20 20 Inferior plant 0 30 High interest rate 10 40 Fire 0 0 Theft 0 20 Exchange rate 0 0 Under pricing 70 30 Rise in overhead costs 30 40 Rise in labour costs 20 10 Rise in material 10 20
Unsure 20 30 0 20 10 30 40 30 10 30 40 40 50 40 20 30 40 40 60 50 60 0 30 40 50
Table 2: Reasons for failure (Sample size = 10) StronglyAgree Agree Unsure Operational Management CT = 60 Strategic Factors CT = 40 Personal CT = 30 Technological CT = 40 Environmental CT = 10 Marketing CT = 10 Rises in costs CT = 30
Strongly 10 10 10 10 20 20 0 20 0 40 40 40 30 10 30 30 30 10 40 30 40 0 0 30 20
Strongly disagree
21(35%)
20(33%)
11(18%)
8(13%)
8(20%)
15(38%)
11(28%)
6(15%)
3(10%)
3(10%)
13(43)
11(37%)
6(15%)
11(27%)
13(33%)
10(25%)
1(2%)
6(15%)
21(53%)
12(30%)
7(70%)
3(30%)
0
0
6(20%)
7(23%)
12(40%)
5(17%)
The table facilitates an analysis of the respondent’s approach to the questionnaire, indicating whether they were truly confident or cautious in the approach by selecting the "strongly agree " or "agree". The varying degrees of belief chosen, could be equated to the respondent’s experience in dealing with the particular cause. From the table it is quite apparent that the marketing factor of under pricing is deemed to be the most prominent cause of insolvencies amongst civil engineering contractors with the "strongly agree" option receiving 7 of the available 10 respondent’s votes.
Revised analysis: The revised column was achieved by merging the information in Table 2 into two columns instead of four. The new columns are now headed "agree" and "disagree". The merged results are shown in Table 3. The average percentage is shown for each category, thus enabling the categories causing most insolvencies to be identified. It is apparent from the table that the marketing and operational factors appear to be the most prominent cause of insolvencies according to the respondents. The following is an analysis of the individual categories based on Table 3. Table 3: Reasons for failure - merged results from Table 2(Sample size = 10) Agree Disagree Operational Management 41(68%) 19(32%) CT = 60 Strategic Factors 23(58%) 17(42%) CT = 40 Personal 6(20%) 24(80%) CT = 30 Technological 17(42%) 23(58%) CT = 40 Environmental 7(18%) 33(82%) CT = 40 Marketing 10(100%) 0 CT = 10 Rises in costs 13(43%) 17(57%) CT = 30
Operational factors All the factors in this category attained a response above 50%. Inaccurate costing and estimating was selected in this category to be 90% responsible for causing insolvencies amongst construction companies. Skills shortage was the lowest scoring factor (50%) in the category, and this could be attributed to the contractor having confidence in the skill of their employees. It has been pointed out in the literature that, in most situations, when market conditions are bad, the level of highly skilled labour is in abundance [Hindle (1991)]. Factors concerning under-capitalisation, poor management accounting and poor supervision of staff also scored high in this category (all of them 70% respectively). These factors deal with the financing and management of the companies’ resources, and the high response indicates the importance that management places on them and on their ability to cause failure. Furthermore literature has indicated that this is an area which management has tended to ignore but chosen to concentrate on the technical aspect of the business. Whether this ignorance is attributed to their lack of knowledge on the subject matter its still a point of much debate. However there are those authors who have advocated that construction companies should employ someone on a full time basis to specifically with the financial aspect of things.
Strategic factors The response to this section was fairly above average (58%) which goes to show that management does consider this category to be relatively important as an attribute, which causes failure in civil engineering construction firms. However what was worthy of note was the response to the competitive behaviour factor as a prominent cause, 90% of the respondents ascribed the failure of firms to this factor. The literature research also concurred with this opinion, in that the competitive behaviour between construction firms may lead to their detriment given the tendency of those firm to undercut each under with their profit margins. The reliance on a few clients was deemed to be the least cause of insolvency in this category accounting for
70% of the respondents. The reason for the high response may be that management feels that this factor can not unilaterally cause the failure of a construction company, if the are other suppliers trading as well. What is odd though is that the lack of demand factor response was 60%, and naturally one would have expected this factor to score high given that the turnover of a company is dependent on the consistency in the demand for construction services and relationship with clients. This low scoring might indicate an oversight on the part of management to recognise the importance of these factors in a firm’s survival.
Personal factors This category scored high in terms of respondents who felt that this category was the least cause of factors associated with insolvencies among civil engineering contractors. What was interesting to note was that all the factors respectively scored an 80% response. The assumption to make from this response would be that the management of the firms interviewed got along well with each other and were prudent in the financial benefits they received from their companies.
Technological factors This category scored an average of 58% in terms of respondents who felt that this category was not the prominent cause of insolvencies. Almost all the factors except for the inferior plant averaged 50% in the response rate. Such a response might have been attributed by the cautious approach taken by the respondents where no extreme views were taken. This can be an expected response, since any valuable information regarding these factors would be adequately responded to by the clientele dealing with these contractors, as they would affect the quality of service offered. One would have expected the inferior product and no previous experience factors to score slightly higher than the response gained. In that these factors invariably affect the quality of service offered and ultimately affects the relationship with existing and potential clients. Burnett [Burnett (1984)] did however indicate in the literature survey that change and technological innovation is necessary for business to continue trading profitably, because the benefits derived make firms efficient in their operations.
Environmental factors These are factors perceived to be beyond the control of management. The response to the factors was generally negative where almost all the respondents disagreed with the factor except for the interest rate factor. The highest negative response being the fire factor (100%), exchange rate factor (100%) and the exchange rate factor with the whole category receiving an 85% negative response. The high negative response rate for the fire and theft factors may be plausible given that their occurrence of these are usually covered by insurance, thus minimising the risk to the contractor. The negative response to the exchange rate may have been assessed in terms of acquisition of assets by management. However literature does indicate that the exchange rate may have far reaching implications to the construction industry than may be perceived by management. An unfavourable exchange rate may often restrict the borrowing capacity of the ruling government because of the high interest costs associated with foreign capital loans. Therefore given that the government plays a major role in influencing activity within the construction sector. An unfavourable exchange rate is likely to limit government disposable income, thus forcing it to expend its resources on meeting its immediate needs as opposed to infrastructure works. The neutral response (50%) on the issue of high interest rates gives an impression that management of civil engineering firms doesn’t consider gearing to warrant attention as to its effect on the company’s survival. It has been noted from the literature survey that management needs to plan its borrowings very careful, to coincide with its commitments in minimising interest costs associated with bank loans.
Marketing factors This category received the highest positive response (100%) perceiving it to be the prominent cause leading to insolvency. Burnett (1984) explains under-pricing as a practise where profit is minimised in anticipation of increased profits from subsequent business. This practise of trading thin adversely affects the cash liquidity position of a company. Therefore should that project not be delivered within the required time, quality and cost constraints, the penalties could cripple the contractor’s financial position. Under pricing is usually undertaken as a marketing exercise in acquiring work for the contracting company. However, the ability to execute this properly without compromising the financial position of the company is a skill commensurate with the experience of management in that company. Under pricing is a factor that is brought about through competitive tendering, resulting in inaccurate costing and estimating of projects subject to uncertainty. The three factors mentioned scored very high in response as to their prominence in bringing about failure in civil engineering contracting firms.
Rises in costs This category achieved a 57% positive response, which cast a bit of doubt as to the significance of its factors being the prominent causes of insolvencies. However when assessing the individual factors, overhead costs (70%) were perceived to be contributory to the financial failures of civil engineering contractors.
Other factors associated with insolvencies There are other causes of insolvencies which were perceived by management, liquidators and arbitrators to be the prominent, but which were not furnished in the questionnaire. These are: Poor cash flow management: the nature of the industry where payment of work done is in arrears, has necessitated the need for management to be able to plan their financial commitment thus ensuring that there’s always bridging finance. Adverse gearing: a highly geared company ’s profits goes towards meeting the interest payments of the loans taken, this can create cash flow problems in that working capital is reduced. Poor labour productivity: poor control over staff, site management and sub-contractors can seriously affect the quality of work produced. Failure to ensure proper quality control often results in remedial work being done, which strains the financial resources of a company. This can detrimentally affect a contractor operating on a contract with low profit margins covering high snagging costs. Poor productivity also delays the completion of works thus incurring penalties that have to be borne by the contractor. Taking on contracts at low prices in a rising market: low margins, declining turnover of projects and static overhead costs creates conditions which may lead to a point where overheads exceed overhead recovery from work done thus increasing the chances of the company going under. Monopolies: given their economies of scale with regard to financial and technical resources, they can easily tender in on projects at low margins without it affect their liquidity positions, because of the number of jobs which they could be running concurrently thus spreading their risk over many projects.
ANALYSING THE LIQUIDATORS REPORT The report details the financial position and the state of the company’s activities at the time of insolvency; furthermore it furnishes the opinions of the owners and liquidators as to the causes, which may have led to its failure. This section will not prove the data on a statistical basis but a qualitative approach will be
adopted were the data is analysed through interpretation. This approach would reflect the true situation, without inference being made from the statistical information given the small statistical sample. Each case will be individually assessed to determine reasons for its insolvency and the activities that led to this. The cases assessed were of firms having gone insolvent from the years 1993-1996. Case 1: this company went insolvent in 1993. It had been trading for 41 years in the civil engineering sector; therefore it was a relatively large company. The company had other interests in the building contracting division, plumbing, plant hiring, and manufacturing of steel and wooden products. When it went insolvent its assets were in the region of R24 million as opposed to liabilities of R40 million. What becomes highly obvious is the way in which the company was highly geared. The ratio of the inability of its assets to cover its liabilities was more than double. The company went into liquidation at the insistence of its creditors whom wanted its financial affairs to be investigated. Poor management accounting and debt seems to have led the company to insolvency. Management failed to constantly monitor and update the company’s financial commitments. The literature survey does emphasise the need to constantly monitor the financial needs of firms, because failure to do so may affect its operations. Case 2: the contractor went insolvent at the initiation of his creditors in 1995. His activities did not concentrate on the civil engineering contracting sector only but had interests in the building industry sector where the market seemed relatively better. The problem with this contractor is that he had entered into an agreement with a certain client to complete a project whose payments would be staggered instead of a lump sum amount. What ensued after the completion of the contract is that the client delayed in making the full payment and ultimately went into liquidation. The outstanding amount affected the contractor’s liquidity position and given the downturn that the industry had taken it ultimately affected the turnover in trade. He was able to recover a third of the amount from the client’s insolvent estate, but the shortfall meant that he had to borrow money from the creditors whom applied for his liquidation. The other contracts which he had been involved with experienced severe labour problems affecting productivity and hence profitability. He had also purchased building materials companies in anticipation of the RDP projects taking off. However this was a bad decision in that the company was losing money whilst it was waiting for this taking-off to occur. This case indicates how a delay in the payment of one project can have a knock-on effect on the viability or operations of others. The need for management to strategically plan for their resource needs and for their growth goals to be consistent with the company resources needs to be emphasised to recognise its importance in affecting the survival of contracting firms. Case 3: the company went into liquidation at the insistence of its bank. The contractor was a civil engineering firm dealing with the construction of roads, services, pipe laying, and general heavy-duty engineering of any kind. The company had a subsidiary, which provided the main company with all its plant needs. The company was engaged in contracts, which were secured at exceedingly low margins. This was done to maintain its staff and operations, and did not contribute towards overhead expenses. They have however not been able to secure contracts to meet the overhead expenses because current contracts stipulate that contractors provide "performance guarantees bonds" as security against default. To continue operating, it had to delay payment to creditors; this resulted in the number and amount of creditors owed increasing. The financial position of the firm at the time of insolvency had its assets at R3.5 million against liabilities of R14 million. The reasons given in the liquidators reports as being the main cause of failure are directly related to the very competitive climate that existed in the civil engineering section of the economy with resultant low margins tendered in on most of its contracts. Therefore, it seems as if the company had been overtrading through discounting of contracts and high gearing to service the needs of its operations. The danger with this kind of practise is dependent on the scale and extent to which its done (Burnett, 1984).
Case 4: The contractor had his assets valued at R297 000 whilst his liabilities were R900 000. This meant that the contractor was unable to pay all his creditors if they were to call on their accounts. The liquidators report indicate that the cause of the company’s failure appears to have been inexperience of management in tackling the contract they were given. Case 5: The insolvent company had its assets valued at R370 000 as opposed to liabilities of R431 000. Although the shortfall seems to have been minimal, what was worthy noting was the causes ascribing to the failure of the firm in liquidators report. The contractor had entered into a contract whereby he would be remunerated on the basis of material removed from site. Shortly after commencement of the work, the machinery of the company struck underground rock and this resulted in the works progress being slowed down substantially with the contractor having to bear the excessive costs for the repair and maintenance of its plant and machinery. As a result of the excessive maintenance and repair costs the company suffered a loss of about R200 000. Under the strategic management section in the literature Tong (1990) strongly advised management to be critically aware of the contingencies within the scope of their contracts which they cannot anticipate through no fault of their own or inexperience e.g. soil and rock conditions. Case 6: the insolvent contractor had assets of R1 200 000 against liabilities of R1 900 000. The contractor’s activities were focused on roadwork and parking area construction. The contractor had been experiencing cash flow problems in the previous years but had expected that the implementation of the RDP would result in a boom for the civil engineering industry. This did not materialise, and the petitioning creditor could not extend the company’s credit facilities. In addition, the contractor had been unable to contain his rising labour and operating costs or pass these onto his clients in terms of existing contracts. To compound the problem even further he was facing a wet winter period, which is inevitably poor for production purposes. It can therefore be seen that the lack of demand for and timing of construction services coupled with bad climatic conditions made the survival of this firm unfavourable.
TESTING THE PROPOSITION The testing of the proposition will be twofold, the first being to test the proposition against the result from the questionnaire and secondly against the analysis from the liquidators reports. The response elicited from the questionnaire from management of civil engineering contracting firms was only consistent with the proposition on the issue of operational management being one of the prominent causes of insolvency. The strategic factors were deemed to be not significant a cause in attributing to insolvencies amongst civil engineering firms. However the marketing factor was overwhelmingly responded to as the most prominent cause of insolvency amongst civil engineering firms. It was interesting to note that the inaccurate costing and estimating and competitive behaviour factors had a significance response under the categories of operational and strategic factors. The liquidators report indicated that both operational management and strategic factors are the primary causes of insolvency and in addition due regard should be given to the marketing and market conditions factors in attributing to business failures. Failure to take cognisance and properly planning for these will inevitably lead to failure by contacting firms.
CONCLUSIONS AND RECOMMENDATIONS Conclusions Based on the findings in this dissertation, the following conclusions may be drawn:
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The demand for construction products is usually for investment rather than for consumption, therefore the need to construct can always be postponed when resources are scarce. The construction industry activity is dependent on the state of the economy and the government’s monetary policies. This bears directly on the demand for construction services at any point in time and is usually variable thus making it difficult for contractors to predict their future workload. The marketing strategy chosen by the contractor in tendering for his services will be dependent on the market conditions. Unfavourable marketing conditions are characterised by declining workloads and increased competition. This results in competing firms undercutting each other by tendering their services with reduced mark-ups thereby creating an unhealthy situation whereby any delays in the completion of the contract adversely affects the cash flow of contractors. Situations where demand becomes less predictable, a policy of sub-contracting is often deemed to be the next prudent step. And without doubt this might be the next trend taken by service industries to minimise the burden of fixed overheads. Contractors will also need to reinvent ways to market their services, when market conditions take a downturn to enable them to trade profitably during this period. Management needs to heed the importance of understanding the operational management aspects of their companies; to enable them to plan their resources needs well. This needs to concurrently occur with proper strategic planning so that risk can be highlighted and planned for. The need for the industry to be properly regulated to bar "chancier " contractors, is a matter which needs immediate redress, because the presence of such contractors minimise the real costs of providing quality service through unnecessary and imprudent price undercutting. Quality Assurance systems have been deemed to the solution in dealing with the above noted problem, in that it provides a benchmark upon which companies can evaluate their performance against. It enables companies to streamline their operations by adhering to the standards set, thus evolving into effective and efficient companies and minimising the incidence of financial failures. The viability and implementation of a Quality Assurance system is an area, which warrants further research, as to its applicability in redressing the state of the civil engineering contracting sector with regard to insolvencies. Operational and strategic factors were found to be the major causes of insolvencies in civil engineering contracting firms and were thus consistent with the hypothesis. Moreover, under-pricing as marketing factors was considered to be the most prominent cause, which often led to deterioration in the quality of service, offered.
Recommendations From the conclusions of this dissertation the following recommendations are made: •
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Operational management and strategic factors have been flagged by management of civil contracting companies as being danger areas in running a contracting firm. The particular factors receiving an enormous response were those dealing with inaccurate costing and estimating and the competitive behaviour of contractors. Therefore the experience of personnel and management in dealing with these functions should be at a highly competent level to minimise the risk inherent in construction work and this should hopefully avert the possibility of the contractor going insolvent. The feasibility of the insurance industry opening a division that deals with construction risk could be explored. Contracting firms would then be risk rated and awarded guarantee certificates contingent on their ability to provide quality service. This would free up the capital tied in performance bonds and hopefully improve the cashflow situations in contracting firms and minimise the proliferation of "chance" contractor who force credible contractors to erode profit margins Potential knock-on effects experienced by subcontractors as a result of insolvency by the main contractors is an area requiring further research. Especially with regards to the extensive use of the retention system used by principal contractors against subcontractors.
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