Financing within the Construction Industry

Construction finance is one of the major concerns of any firm hoping to succeed in the industry. The problem is not just of the quantity but also the quality. Things are made more complex by the laws of the land, the state of the economy, but most importantly by the imperative of minimizing cost.

There all types of construction enterprises- from sole proprietorships to large multi-nationals. Funds are available from various sources and quite naturally large corporations mange to raise the most and of the best quality as well. Construction Loans are of two types:

1. Short Term

2. Long Term

Very often firms have requirements of short term funding to overcome immediate cash shortfalls. These pertain to the hiring of plant, purchase of material, and labour wages to be paid to workers. This is where short term finance is necessary
Long term finance comes into play when capital is required for a period ranging between 5 to 10 years. This may pertain to starting a business or carrying out expansion. In the main the capital is deployed in setting up plant, buildings and equipment. Because of the long term implications the lender has to exercise due caution as the risk is greater.

There are various sources of finance available to the construction industry. These are as follows:

1. Shares- Shares are held by individuals or entities as the legal right of their ownership of the firm to the extent of the value of the shares. This is the best type of funding, as both the profits and losses are shared in proportionate measure by all the shareholders, and there is no pressure of repayment as in the case of loans. A new or a fresh issue of sales infuses fresh capital into the firm.2. Debentures- These are loans taken by the firm from different individuals or entities. These vary from conventional loans as the rate of interest is fixed and the repayment date too is decided in advance.

3. Bank Loans- They are rather difficult to obtain, particularly by construction firms. They will invariably ask the borrowing firm to meet part of the requirement from their own resources, and the rates of interest too are high.

4. Internal Accruals- Sometimes profits are ploughed back into the business to fund expansion and other activities.

5. Bank Overdrafts- This is a facility provided by commercial banks to firms of good standing to overdraw on their account to a certain extent upon the payment of a rate of interest. As soon the money is returned, the interest stops being levied and the account operates normally like before.

6. Creditors- Funds flow can be substantially augmented if the firm can get easy repayment terms from their creditors, and if at the same time their debtors pay up on time. The construction industry is particularly suited to this time of arrangement, since receipts from clients are linked to stages in completion of work. Most construction firms have started using Cash Flow Forecasting software to get a fix on their exact funding requirements.

7. Short Term Loans- These can be obtained from individuals, banks, and other financial institutions. Since they are needed as working capital, they carry a fixed rate of interest on the total sum and cannot be recalled prior to the due date.

8. Corporate Tax Provision- Tax is usually paid one year down the line. This frees up the money for that period of time.

9. Depreciation- This is a bookkeeping exercise by which the initial value of an asset is written off over its life cycle. This too can be regarded as a source of capital. That is because if no depreciation were to be written off greater profits would be available to the shareholders. This is a reserve created by depreciating fixed assets, and is similar in nature to retaining earnings. Of course this will require the preparation of two sets of accounts. One for taxation purposes, and the other for internal consumption.

These days more and more construction firms are resorting to investment appraisal techniques to gauge their requirement of finance. This assumes great significance in light of the fact that they are able to bid more effectively for projects, buy using this kind of calibrated costing. Typically in such an analysis only the incremental expenditure and receipts directly emanating from this project being eyed should be considered.

We can see that construction finance is perhaps one of the most important factors, if not the number one factor in deciding the viability of a project. The present times are particularly challenging because of the paucity of funding available, and also the far greater scrutiny funding of any type is subject to these days. It is therefore contingent upon the firm seeking finance to do its homework right, and present a watertight case for itself, in order to be able to secure the requisite amount of funding.