Financial Model for Small Construction Firms

Financial Model for Small Construction Firms

Introduction

The construction industry is recovering slowly after the great recession caused by the Financial Crisis. Mr. Basu (chief economist for Associated Builders & Contractors) states that a number of issues were created due to the hard hit faced by construction. Mr. Baker (chief economist for the American Institute of Architects) responds to this problem by advising that a creation of jobs would increase the recovery duration. He states that American architects are indicating that business is starting to pick up in several residential areas. This includes activities such as a new house construction and remodeling have on the rise and this trend looks to have a positive outlook (Silva, 2013).

The most problematic issue in construction is the financial requirement for daily activities. These include liquidity and working capital issues that cause several construction firms to leave their business. Due to the interdependent nature of construction, the industry firms have a greater rate of failure those other types of organizations. While observing the American Census information during 1989-2002, the mean rate of failure was about 14 percent while for all other industries, it was 12% and below (McIntyre, 2007).

Construction Industry versus Other Industries (1989-2002)

In 1990, there were 8000 failures of construction companies while close to 2000, there were over 10,000 failed firms. The most optimum reasoning behind these failed companies is the inefficiency of financing. The discussion below critical evaluates the problems in construction financing and provides a project financing framework for small and medium construction contractors (Nesan, 2011).

Problems Faced by the Construction Industry

The problem in financing faced by small contractors is observed in the diagram below. The initial issue begins for a starting construction firm once the company is capable of handling cash flows for the company's projects. It is after this situation that a working capital need is recognize to obtain multiple projects for execution and bidding. Within a period of four years from initialization, the fund's requirement is based on the capacity of cash flows due to restrictive credit from suppliers. Once this period is surpassed, and the firm achieves stabilization, there is a sense of direction for higher growth with a need for more funds. The strain facing the financial position of the company is caused by unplanned segment growth, excessive bidding, and work orders. The project financing issues are determined below (Rounds & Segner, 2011).

The Problem with Liquidity

Construction firms face several internal issues regarding liquidity. The popular ones include several contracts taken at once and cash flow estimation. When these factors are collaborating with weak structure measurement processes, small construction companies become financially redundant. There have been extensive studies that identify the liquidity issues stemming from the cash management dilemma. The issue of expense outflow or cash flow has been evaluated from various perspectives. Some of these researchers suggest that cash flow estimation should include the schedule and cost while others indicate cash flow forecasting models for a specific project (Druml, ...