In conversation with a BSc dissertation student this morning, Jan Hillig and I were talking through various methods of financial protection that are used in construction projects. The idea is that the buyer would usually like to find some way of underwriting the risk of a seller's non-performance or insolvency. I have done research into this area in the past (see below), and was aware of many alternatives, the cheapest and most common of which is called cash retention, where a small part of each payment is kept back by the buyer, to accumulate a fund that can be used if the supplier fails to perform or becomes insolvent. Since contracting is a cash-flow business, with money paid for work done to date each month, the manipulation of cash flows becomes extremely important. Contractors can make a lot of profit from utilizing the cash that is passing through their books, because there are plenty of opportunities to make sure that they get cash in before the incur the liability to pay cash out. Therefore, the bigger their positive cash flow, the better off they are. I characterized cash retention as being an option that buyers have, because they could alternatively use a retention bond, parent company guarantees, performance bonds, and many other alternatives. Many suppliers would prefer not to have cash retentions, becuase it would improve their cash flows. And an idea came to me, which might be useful for frequent clients, such as government departments. Why not have some form of a contractors' club where members are not subjected to cash retentions and non-members are? Membership would be earned if the last 2-3 projects were completed on time without defects. As soon as a project is delayed of over budget, through some fault of the contractor, membership is cancelled or suspended. This would be a way of incentivizing and rewarding performance. I wondered if this had ever been attempted. Could this work?
Hughes, W.P., Hillebrandt, P and Murdoch, J.R. (1998) Financial protection in the UK building industry: bonds, retentions and guarantees. London: Spon. 190pp. ISBN 0-419-24290-2.
Hughes, W.P., Hillebrandt, P. and Murdoch, J. (2000) The impact of contract duration on the cost of cash retention. Construction Management and Economics. 18(1), 11-14.
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