More than 22,000 construction businesses across Australia are expected to fail over the next year, new forecasts suggest.

In the August edition of its Business Risk Index report, credit reporting bureau CreditorWatch reported that the construction industry has a current ‘business failure rate’ of 5.3 percent on an annualised basis.

This represents the fifth highest rate of business failure out of the eighteen sectors which are considered in the report.

Over the next twelve months, CreditorWatch forecasts that the rate of construction business failure will ease slightly but remain at elevated levels of 4.9 percent.

At this level, failure rates are well above those that were seen prior to COVID.

With recent ABS data indicating that 452,820 businesses were active as at the end of June, the expected failure rate implies that more than 22,000 construction businesses (22,188 businesses to be precise) are expected to fail over the next twelve months.

The latest data comes as the construction industry has undergone considerable expansion over the past five years.

This has seen the number of businesses which are active in the sector surge to record levels and has also led to record levels of building industry employment.

However, the industry has experienced challenges on account of higher construction costs, a higher borrowing and debt servicing costs and slowing demand.

Patrick Coghlan, CEO of CreditorWatch, says that several factors are driving the high rates of business failure across the sector.

“I think you should break it into a couple of variables,” Coghlan said.

“(First,) You have your macroeconomic impacts. So obviously you have got interest rates and inflation where they are. You have then got the flow-on impact which that has on the consumer and the commercial spend. People and businesses are likely to spend less – whether that’s a rebuild of their premises or their house. They might trade down. Instead of a new house, they might just renovate an existing single level. So you’ve got that impact.

“Then, you’ve got the industry impact – the cost of materials, supply chain disruption, the cost of labour and the labour shortages given the high level of employment.

“Finally, without a doubt, when there is a downturn, construction as a whole is challenged because the margins in the construction industry are really narrow. So there’s not a lot of room for error. When there is an issue on an individual site, an individual project, or, at the company level, that (because of the low margin) can turn a profitable business into a loss -making business very quickly. Then the ability to get funding in that industry is extremely tough.

“So that’s why we do certainly see a higher rate of failure in that (construction) industry.”

To effectively manage risk, Coghlan encourages owners and managers of construction businesses to adopt several strategies.

These include:

• remaining on top of cash flow and credit collection, including by understanding how this works and adopting a policy which can then be put into practice;
• conducting financial due diligence on key clients and suppliers and having strategies to manage any impact which may occur where a key client or supplier goes into bankruptcy or insolvency; and
• obtaining advice from accountants and financial planners to implement strategies to manage their own business and finances in a sustainable manner.

Whilst current market conditions are expected to remain challenging, Coghlan expects conditions to improve toward the second half of next year.

This will occur as a recovery in the housing construction sector is expected to take hold.

“After the next year or so (from now), conditions should become more positive,” he said.

(source: CreditorWatch Business Risk Index, Aug 2024)

Overall Business Conditions to Get Worse Before They Get Better

In its report, CreditorWatch says that business failure rates are expected to contract slightly in some areas but to remain elevated in several others.

It notes that operating conditions are expected to remain difficult across several sectors. As well as construction, these include food and beverage, arts and recreation and retail trades – sectors which are highly sensitive to current interest rate and consumer inflation pressures.

Overall, CreditorWatch chief economist Anneke Thompson said that business conditions are expected to remain difficult over the near term.

“We don’t expect businesses to feel more confident until there have been at least two or three cuts to the cash rate,” Thompson said.

“Unfortunately, this means it is likely things will get worse before they get better.”

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