Although it sounds counter intuitive, subcontractors who tighten their belts and survive an economic downturn sometimes fall apart at the seams during the subsequent recovery. In their exuberance about new job opportunities, subcontractors sometimes take on more work than they can handle and find themselves unable to fulfill all of their obligations. Contractors can take some basic steps, including the following, to manage their exposure to this risk.
1. Pick the right people. Use subcontractors you know and with whom you have developed a good relationship. Good communication will be crucial in avoiding bad outcomes.
2. Prequalify all subcontractors. In addition to reviewing their financial statements, interview their sub tiers, vendors, and employees to see if payments are being made on time (make sure you have the contractual right to do so) and work is progressing as expected. Ask a lot of questions.
3. Diversify. While it is important to use familiar subcontractors, don't expose every project you have to the same risk, especially for major subcontractors.
4. Watch for signals of distress. Aging of receivables and payables or a decline in working capital may be signs of liquidity problems. Failure to return phone calls or e-mails or to show up at regularly scheduled meetings are also red flags. Train project managers to report any early signs of distress.
5. React promptly. If appropriate, help the subcontractor over a short-term hurdle, but don't throw good money after bad. When a default occurs, take remedial steps quickly to avoid a domino effect on other aspects of the project.
These are just a few basic steps contractors can take to mitigate the risk of subcontractor default and to minimize the impact if a default does occur.
Compliments of IRMI Construction risk
Call Debbie Klisch at debbie [at] scicteam [dot] com 719-329-4441 to assist you with the controls needed in your business
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