Contractors shoring up supply chain contribute to structural funding gap

It was a challenging year in the construction sector, with insolvencies up 33% from July to November 23 compared to the FY23 monthly average. McGrathNicol Advisory's Working Capital Report 2023 examined the working capital cycles of ASX-listed construction and engineering companies and highlighted the pressure on larger players as they seek to shore up their supply chain.        

As detailed in the chart below, whilst the incremental move in Days Working Capital (DWC) showed a minor decrease of 0.6 days to 38.9 days in FY23, this masked larger offsetting movements in Days Sales Outstanding (DSO), Days Inventory Outstanding (DIO) and Days Payable Outstanding (DPO). The sampled companies shortened their customer collection cycle (DSO down 6 days to 56.9 days), held less inventory (DIO down 2.9 days to 22.8 days), and paid suppliers more quickly (DPO down 9.8 days to 50.2 days).

Lower DSO was recorded by 92% of the sample, reflecting process improvements but also positive improvements in collaboration across the industry. A willingness by government agencies and developers to work with head contractors meant payments were processed more promptly.

In recent years, there has been a trend of larger contractors slowing supplier payments where possible to improve their own cash flow. Our analysis showed a reversal of that trend, with average DPO the lowest it has been in six years, driven by a requirement to improve the cash flow of subcontractors to prevent distress within the supply chain, coupled with increased reporting and social pressures for prompt supplier payments.

What’s ahead for 2024?

We expect this pressure to keep supplier payments cycles low across the industry to remain for the foreseeable future.

The most recent data from the Payment Times Reporting Scheme (based on the reported data of over 8,000 construction-related companies for the six months to June 2023) outlines that the average small supplier payment time was 31 days, significantly below the 50.2 days reported in our sample.

Interestingly, the average DPO (50.2 days) is now below the average DSO (56.9 days), which indicates that companies need to pay suppliers more quickly than they are receiving cash from their clients and customers. This has resulted in a “structural funding gap” which must be managed carefully.  

With rising costs of capital and ongoing disruption through the supply chain, a focus on working capital and cash management will be key to survival and achieving a competitive advantage throughout FY24.

In our experience, better processes result in better outcomes and a strong working capital management framework with standardised procedures, agreed accountability, and clear roles and responsibilities is essential to drive discipline in converting WIP to invoicing and collections. Robust cash forecasting is also important. Both short- and medium-term forecasts, coupled with variance and sensitivity analyses, will be instrumental to ensuring the cash cycle is well understood and improvements can be made to build resilience against any sudden shocks or supply chain failures.