Financial Management
Key Strategies Contractors Can Employ In Periods of Elevated Interest Rates
By PHILLIP ROSS, CPA, CGMA, PARTNER
Interest rate changes directly impact construction companies in a variety of ways, beginning with the affordability of borrowing and availability of financing. To battle these uncontrollable headwinds, planning can save construction companies time and money—especially in the current environment of elevated rates.
The Federal Reserve recently determined that interest rates would remain stagnant, and as of May, the federal funds rate was in a target range of 5.25%–5.50%—the highest level in more than 22 years. Higher interest rates reduce the financial resources available to firms. Higher borrowing costs can significantly constrain a firm’s ability to invest in new projects, expand operations or hire additional staff. This limitation can stifle growth and innovation within the industry, as firms may become hesitant to take on new ventures due to the increased financial burden.
Some strategies construction firms can employ to succeed in these changing market conditions include diversifying services, exploring new markets and adopting more efficient construction practices to remain competitive.
Projections are very important for construction firms to plan for these challenges. To mitigate the risks associated with interest rate fluctuations, construction firms must engage in long-term budgeting. Incorporating interest rate forecasts into strategic planning processes is crucial.
Firms should assess the potential impact of interest rate shifts on project costs, cash flow projections and overall profitability. Engaging with financial advisors, accountants, and risk management professionals can help firms develop tailored strategies to manage interest rate risks effectively. Additionally, implementing flexible budgeting strategies and contingency plans can help mitigate adverse effects and ensure further financial stability and reduce the need for additional financing sources.
We’ve seen the benefits of this planning first-hand with clients. In times of expensive capital, businesses that look to streamline their internal processes–a more efficient billing process that enables the company to send invoices out sooner (three days after month close)–speeds up collections and improves cash flow, reducing the need for additional borrowings. In addition, limiting work on unapproved change orders and then obtaining timely approvals reduces the upfront costs that contractors would otherwise have to fund.
Developers may also experience delays in obtaining financing for a project. Some projects may be let out for bid while the financing is being finalized. This results in longer lead time for the construction companies between bidding the work, being awarded the project and then actually starting the job. Planning ahead is a must.
Exploring alternative funding sources is another effective strategy for mitigating interest rate risks. Diversifying funding sources can enhance financial stability and resilience, particularly during periods of fluctuating interest rates or credit market volatility as well as dealing with longer periods to collect from their clients. Construction firms can consider options such as private equity, venture capital, or public-private partnerships to reduce reliance on traditional bank loans. By diversifying funding sources, firms can better manage financial risks—and maintain the capital necessary to support ongoing and future projects.
By planning and adopting strategic financial practices, construction firms can navigate these obstacles and maintain stability. Long-term planning, incorporating interest rate forecasts, engaging with financial professionals, and diversifying funding sources are essential strategies for avoiding interest rate risks.
About the author: Phillip Ross, CPA, CGMA is an Accounting and Audit Partner and Chair of the Construction Industry Group at Anchin, Block & Anchin, LLP. For more construction industry thought leadership and content, log on to www.anchin.com.