Assessing the financial viability of key contractors
Assessing the financial viability of key contractors
In an escalating cost environment, understanding the financial health of key subcontractors before engaging them in new projects is an important risk management process.
More and more, we are being asked to assist construction clients in assessing the underlying financial health of potential subcontractors before they enter a key subcontract as part of their construction project.
While subcontractors are understandably reluctant to provide detailed financial information, there are procedures that can assist your due diligence.
We often recommend our clients take a three-phase approach to assessing the financial health of potential subcontractors:
- Red flags assessment
- Impact assessment
- Risk evaluation.
The challenge of limited information
When conducting due diligence on potential subcontractors, detailed financial information can be difficult to obtain. Often, the most a subcontractor is willing to provide is their last set of annual financial statements, which may be several months old.
It’s important to note that conducting a due diligence review based on outdated financial data (several months old) or without the ability to query key finance staff, presents limitations. These include:
- Time lag: Financial situations evolve rapidly. Data from months ago may not reflect the current reality
- Management insights: Without discussing the financial position with an organisation's management, critical context may be lacking
- Material limitations: These constraints hinder the ability to definitively assess the present financial health.
- Depending on the materiality of the contract being awarded, insisting on access to further information should be considered as part of the process of awarding the contract.
Taking a closer look - Financial and non-financial assessment to uncover red flags
A due diligence or ‘red flags’ report enables contractors to consider a contractor’s financial viability by assessing both financial and non-financial information available.
Diving into the financial statements identifies risks or concerns related to financial viability, while non-financial information assessments explore publicly available non-financial data that can provide critical insights. Key areas of scrutiny include:
- Financial statement analysis: Assessment of key ratios and other KPIs that help understand financial performance and position. This will often be based on the last set of annual financials, which is why the following non-financial assessments are important.
- QBCC licensing information: Is the organisation compliant with licensing requirements?
- Credit reports: Are there any credit quality concerns raised?
- Company searches: Have PPSR charges or external administration appointments been uncovered?
- Director searches: Were related companies with common directors identified? This may lead to further investigations.
- Legal/litigation searches: Have potential legal matters been unearthed?
- Real property title searches: Do you understand the property assets and encumbrances?
Impact assessment
If red flags have been identified during the due diligence process, the next steps involve understanding the potential impacts.
As an example, the red flags report may have identified a potential legal matter where the subcontractor is the defendant. Further analysis of the materiality of this matter to financial viability would then be recommended.
Risk evaluation
In our reports, we typically categorise risks identified as low, medium, or high to help our clients make informed decisions about the next steps required.
We can help with your due diligence needs
Our deal advisory team has a thorough understanding of the due diligence process, and the information required to determine an organisation’s overall health. Contact us to discuss your unique circumstances and due diligence requirements.