Mitigating financial risk in large construction projects
It’s crucial to make sure the risk of financial loss is limited during a construction project and focus on the budget and construction.
Construction projects are complicated and risky. When the project is large, it’s crucial to make sure that the risk of financial loss is limited. The best practices for mitigating financial risk in large construction projects are to focus on the project’s overall budget and create a detailed construction plan. However, that may not be enough. This article will detail some useful tips to mitigate financial risk in construction.
Five financial risks in large construction projects?
The term “financial risk” refers to the possible loss of revenue and profit that could happen if a project fails. For example, if a project fails to meet its completion date or budget, this could result in significant financial losses.
The financial risk of large construction projects includes:
- Cost overruns
- Delays
- Risks related to human resources, materials and equipment
- Lower revenues than expected
- The risk of scope creep, where when there are changes in the project, or it expands beyond what was originally planned.
There are some basic practices for mitigating financial risk in construction projects.
One of these is to limit the number of stakeholders and make sure that each stakeholder has an understanding of their role in the project. Another one is to have a contingency plan for when a risk occurs so that you can mitigate it as soon as possible.
In addition, there should be a clear communication flow between all parties involved in the project—this will help with accountability and transparency. Companies should also make sure that they have a good relationship with their lenders and that they have a clear understanding of the risks involved before starting any construction project.
Following are some best practices to mitigate financial risk in large construction projects:
Know the mechanics lien remedy
The mechanics lien remedy is a form of property security interest that aims at shielding those who supply labor and materials on a construction project from financial losses. A mechanic’s lien is typically placed on the materials and equipment supplied to a construction project. The “lienee” can secure payments, interest, and other benefits via a statutory notice.
This remedy is available to anyone supplying labor on a construction project, whether they are employees or independent contractors. It helps them to recoup the money they have spent by filing a mechanic’s lien against the property if it is not paid back within 30 days of being invoiced.
Mechanics lien remedy reduces financial risk in large construction projects by allowing contractors and subcontractors to place liens on their work for payment, which the project owner can call on at any time.
Understanding contract and credit agreements
The fate of a large construction project is often already determined by the terms of the contract or agreement signed between the parties. The signature on a contract is no guarantee that the project will be completed on time and within budget. The terms of the contract, as well as the company’s financial situation, can complicate matters.
In the construction industry, building owners, general contractors, and subcontractors often use a construction contract to place the financial risk of a project on the shoulders of subcontractors and suppliers. The terms of the contract are even more critical because they allow the parties to understand what will happen if one party decides not to complete the project.
Here are three types of contracts and agreements worth looking into:
Cost-plus contracts
Cost-plus contracts, also known as open-book contracts, can help you mitigate financial risk in construction. These contracts are the opposite of fixed-price contracts, which require contractors to complete the work at a predetermined cost regardless of whether material or labor costs turn out to be higher than anticipated.
When labor and material costs change, a cost-plus contract can reduce the contractors’ financial exposure to those changes. In addition to the risks of bidding on cost-plus contracts, contractors can be exposed to additional risks when there are changes in laws or governing regulations and existing agreements don’t cover new requirements.
Retainage
Construction companies and general contractors in the construction industry should include a retainage clause in their contracts. A retainage is a type of payment that must be made by the contractor for any work that has not been completed.
In the construction industry, it is not uncommon for contractors to lose subcontractors before a project is finished. This can lead to costly delays and may even jeopardize the project’s completion. A general contractor or company can reduce the risk of losing a subcontractor by withholding part of their payment until the project is finished.
Bonding and insurance
One of the ways to mitigate financial risk in large construction projects is through contractor bonds and insurance policies. Contractor bonds, also known as contract bonds, are a form of surety bond that ensures the completion of a project under the terms specified in the original agreement.
Contractors in the construction industry get contract bonds to ensure that the project owner will be paid in the event that the contractor fails to complete the work or otherwise defaults on the bond’s terms.
There are also insurance policies available from some companies that can shield contractors from the effects of a sharp rise or fall in the price of building supplies. Typically, if the cost of a contractor’s raw materials rises above a certain threshold, the insurance company will pay out a portion of the premium.
A company should always look at the legal ramifications of these contracts and credit agreements before signing with a particular contractor. If there is anything unclear in the contract, it is best to have a lawyer look at it before proceeding.
Check customer credit and continue to monitor
It is vital for construction companies to have strong credit practices to mitigate financial risk in construction. They must establish their creditworthiness by providing trade credit to contractors and subcontractors upon signing a contract. Also, the term “trade credit” does not apply to contractors and subcontractors because they are not providing labor or materials in order to earn this type of credit but signing an agreement with a client to complete the project.
It’s also worth checking customer credit when getting equipment or building materials, as having good credit can be the difference between success and failure. A savvy construction company always checks a new client’s credit before beginning work with them and will continue to do so regularly.
Project-to-project consistency
This final risk-reduction strategy in large construction projects is not only the simplest and least expensive to implement, but it is also the most important. It entails consistently implementing a comprehensive risk management plan for each project prior to its start date. The aim of this strategy is to identify adverse risks as early as possible so that they can be mitigated or eliminated. Consistent strategy and execution will help to reduce financial risk in large construction projects over time.
– Downtown eCommerce Partners (DEP) is a CFE Media and Technology content partner.
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