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Are Contractors Playing with Fire? Construction Projects and 'Uncertified Revenue'

  • Market Insight 22 avril 2020 22 avril 2020
  • Asie Pacifique

  • Infrastructure

Are Contractors Playing with Fire? Construction Projects and 'Uncertified Revenue'

Please see our latest update below. We also invite you to a live webinar on Tuesday 12 May 2020 at 4:00pm (Singapore time) - Public Sector Projects in Singapore: Organising for Success - where we will explore the below issues and much more. Click here to secure your place and receive the webinar access details. 

Uncertified revenue is the value of work as assessed by a contractor which has been completed but not yet certified and paid by an employer. It typically could include the value of measured works, changes to the works and / or other claimed entitlements.

Practices in the industry vary hugely. However, some contractors account for uncertified revenue on a basis which is – at best – optimistic and – at worst – wildly unrealistic. They may assume that the vast majority, or even 100% of uncertified revenue will be realised when reporting internally and externally. This approach can pose serious risks.

Following the collapse of Carillion in the UK in 2017 it was found that £294 million of the £729 million revenue reported in its accounts but which it would not actually receive concerned unapproved variations and other claims submitted to clients (i.e. uncertified revenue). Although there were many other failings, this unrealistic accounting of uncertified revenue was a major factor in masking Carillion's failing health.

While Carillion is a dramatic example, any inaccurate reporting regarding likely recovery of uncertified revenue can have dire consequences. With profit margins on projects so tight it can disguise problems and delay remedial action which can be the difference between financial success and failure.

Why do some contractors fail to account for uncertified revenue realistically?

Large projects are extremely fast paced and involve arduous reporting obligations, both externally to the employer and internally to management. Project teams are often ill-equipped to make accurate, timely assessments of their claims and other risks, and of the financial repercussions.

Both the construction market and the environment during project execution are also extremely competitive. Major projects typically involve high capital spend, neutral cash flow and very narrow profit margins. Individuals and teams at various levels of contractor businesses may feel under great pressure to paint an optimistic picture regarding financial positions and projected outcomes (what psychologists refer to as 'optimism bias').

The key question, however, is not whether uncertified revenue should be accounted for when reporting internally and externally. In many cases it has to be in order to track progress and the likely financial outcome of a project with any degree of accuracy. Doing so is critical for identifying problems, avoiding any sudden deterioration in margin, and informing key business decisions.

Rather, the burning question is how best to account for uncertified revenue?

Unfortunately there is no simple answer. The solution is robust and effective commercial management combined with processes which enable the contractor to make accurate assessments of entitlements and risks in real time, as they arise. In turn, this enables the contractor to make timely, realistic assessments of the uncertified revenue which is likely to be realised and should be accounted for.

While this can be easier said than done, the following steps are particularly important (being in addition to all the normal – but nevertheless important – advice as regards fully understanding and carefully administering the contract).

The construction programme needs to be accurate, to show a clear critical path and to be agreed with the employer from the outset. It must set out the sequence of works and durations of activities. Progress must then be updated periodically (usually monthly) on an as-built basis.

This allows the contractor properly to understand progress and any delays, and promptly to take appropriate action. If the contractor can understand the causes and impacts of delays as and when they occur it will be far better placed to mitigate any delay and to pursue (and make realistic assessments of) any entitlements to time and time related costs.

The costs of indirect, time-related preliminaries should be measured from the outset on a monthly basis. The direct costs of the various major activities and their production rates, and of any claimed entitlements (including changes to the works), should also be measured carefully on a monthly basis. This enables the project team accurately to track costs as against budget, and to identify potential over-spend and other risks at an early stage.

Critically, these steps enable the contractor to have an informed understanding of the financial health of its project at all times, including as regards its measured and claimed entitlements and the recovery of uncertified revenue.

Fin

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