Balfour Beatty has confirmed it is running a three-month pilot on “supply chain finance”, the controversial mechanism that gives subcontractors access to sums owed by Tier 1 contractors earlier than the contract states in return for paying an interest charge.
The pilot is being overseen by Balfour Beatty’s new director of procurement and supply chain management, Martin Chown, and is a response to the government’s Supply Chain Finance initiative to open up access to finance for SMEs.
Last year Carillion also launched its Early Payment Facility under the government’s Supply Chain Finance banner, a move that caused controversy because it meant subcontractors having to accept 120-day terms.
And contractor Kier has confirmed to CM that “we are going to get involved”, although it is not part of the group convened by government.
The pilot began in March and will run to June, when it will be evaluated by Balfour Beatty and the suppliers involved.
Balfour Beatty said it would approve invoices for payment earlier than the dates set out in the contract terms, and the supplier would then access the funds, paying “a lower rate of interest than it would be likely to get in the market”. It has yet to be revealed what the payment terms will be.
It also said that “the pilot is operating on the same payment timeline terms as they currently utilise across the business”.
120-day terms
A feature of the Carillion scheme is that subcontractors have to convert to 120-day terms “on paper”. Carillion has stressed that this simply means it has 120 days in which to pay the face value of the invoices to the bank offering the facility – but this puts it in a better financial position than if it had to settle invoices at Day 30 or Day 60, for example.
Rudi Klein, chief executive of the Specialist Engineering Contractors Group, linked the sudden spread of supply chain finance in construction to the low cash balances of the industry’s top contractors and the increased take up of Project Bank Accounts. One effect of PBAs is to reduce the amount of time project cash is available to main contractors.
Klein said: “It’s driven by under-capitalisation. The cash balances of the largest contractors have fallen so low and that’s what they’re trying to address. Presenting it as ‘something the Prime Minister has asked for’ just gives them an alternative way to describe it.
“What I can’t understand is, if they’re approving the invoice early, why can’t they just pay it? They’re still basically asking the supply chain to be their bankers.”
At business adviser Grant Thornton, partner Ian Corfield anticipated that supply chain finance would take off in construction, “but it wouldn’t be an explosion”.
He agreed that it could create a slight financial advantage for the Tier 1 contractor. “The average construction company is making a net margin of 1-1.5%, so anything they can do to improve their cash flow is worthwhile. With supplier [supply chain] finance, you’re talking small percentage movements, but that can mean a big absolute number. Each organisation runs their cash position differently so it’s hard to predict the effect exactly. But it means that every month Carillion makes one payment to RBS [the bank running the facility], not 1,000s, so it should simplify their business.”
His view was that supply chain finance could benefit SMEs in the supply chain as long as they examine and fully understand the small print. “The money will only be available for drawdown if all the paperwork and governance is fully agreed – you can’t just fire off a payment application. It won’t shorten the payment cycle unless you have good paperwork.
“That said, the interest charges for supplier finance are still relatively expensive, so the small supplier needs to balance the pros and cons of applying for this facility, or managing cash flow conventionally.”
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So we nearly got rid of pay when paid and have replaced it with pay to get paid.
What will the finance whizz kids think up next?
I can only see this adding more cost to construction projects. I find it incredulous that these debates are taking place when in the vast majority of Public Sector contracts there should be clauses that insist MC’s offer the same terms to suppliers as they have, that is back to back. Given that the Public Sector should pay in a maximum of 30 days why does the problem exist? The answer is as per usual, lack of contract management, culture of power and bullying. Changing the process will not address the real issues in the industry. Let’s get real and drive culture change through collaboration, transparency leading to trust and changed behaviours.
re-David Benson – I completely agree with your stance, I can only hope all clients follow your lead, but I would imagine the majority of the clients to these Tier 1 contractors are the public sector, so they will be paying the Tier 1 guys within 30/60 days so that the public accountants can claim they’re doing everything to help the construction industry, when they are in fact endorsing better profits for the Tier 1 contractors. It would be interesting to see which banks will provide this financing (I can only assume they will be the ones the Government has a stake in – therefore they will be indirectly earning more money off the Supply chain). Finally; can you imagine trying to chase a payment – Tier 1 QS ‘we’ve passed it to the financer, chase the bank’ – Financer ‘we’ve received no notifications, chase the Tier 1 contractor’ ad infinitum or maybe until the 120 days have expired.
There can be no justification for any Tier 1 contractor to withold payment to its supply chain once it has been paid by its client under the terms of the contract. The position that Carillion has put forward, is to my mind untenable and unethical and speaking as a client, I would not wish to engage with any contractor who had terms of payment that exploit the life blood of the industry. I would call on all clients/client bodies to outlaw this practice and not engage with those who have or are proposing to take it on board. It is time for change!
It is very important to make a ‘clear water’ distinction between 1) a contractor being offered the option of paying interest, to be paid ahead of already reasonable contract terms, and 2) that contractor being put in the position of having to pay interest simply to get paid in a reasonable time.
Those operating along the lines of option 2) are benefiting from confusion between these two industry scenarios. Even 1) might lead to trouble further down the line, but 2) should be outlawed.