international Symposium In Developing Economie.~: Cornrrroniilities Afnong Divcrsilies

THE CONTRACTING FIRM'S FAILTJRE AND FINANCIAL RELATED FACTORS : MALAYSIA CONTRUCTION INDUSTRY.

Mohd Suberi Ab.Halim School of Housing Building and Planning,

University Sains Malaysia, Pulau Pinang, Malaysia. E-mail:qwatulwafi@yahoo.my

Mastura Jaafar School of Housing Building and Planning,

University Sains Malaysia, Pulau Pinang, Malaysia. E-mail:masturaj@usm.my

Omar Osman, School of Housing Building and Planning,

University Sains Malaysia, Pulau Pinang, Malaysia. E-mai1:Omar-o@usm.my

ABSTRACT

This paper pertains to the role offinancial management in influencing the success or failure of the constructingfirms. Based on previous studies on the impact of financial factors as the failure of the construction projects, bad financial management and lack of capital are identiied to be the main determinants of construction failure. Failures in the construction industry not only faced by developing countries, but world wide. The failure scenario also happens to construction industry in Malaysia. The failure rate of the consiruction companies in Malaysia is also high. According to the Construction Industry Development Board, ~a iays ia (CZDB), from January 2006 to August 2008 a total of 11,321 construction companies was classified under dormant and non-active. There are very few listed successjil contractors in Malaysia and most of the construction projects cannot not be completed within the original schedule. The failure sources are directly related to financial factors. In this case study, seventeen financial ratios has been used as measurement tools to measure the company's Jinancial performance. Sir Bumiputera contractors from medium and large category were selected as case studies. It was found that most of Bumiputera construction companies did not have sufficient cash capital to finance their construction works, enjoyed low profit margin from the construction project and were highly dependent on debt capital to finance their construction costs. There was lack of monitoring system for the cash flow andproject costs. Without effective financial practices, construction companies are putting their self up to failure.

Keywords: Construction Industry, Financial Management, financialfailure.

1.0 INTRODUCTION

The construction industry plays an important role to enhance the economic performance of a country. It plays a central role in the national welfare by transforming various resources to construct economic and social facilities (Tahir Basir12000). It contributes on average between 5 and 9% of gross domestic product (GDP) in developing countries (Kirmani 1988). The importance of the construction sector is not related to its size, but to its role in economic development. It produces all the facilities needed by others producers and ultimate consumers (Fadhlin, 2004). The construction industry in Malaysia like in others countries, can serve as a barometer indicating the nation's economic conditions. Unfortunately, every year thousands of contractors whether in business for two years or 20 years, face bankruptcy and business failure. These firms leave behind unfinished private and public construction projects - and still worse, billions of dollars in losses to project owners and taxpayers (Dev and Maria/ 2008). Previous studies on the impact of financial factors on the failure of construction firms identified that bad financial management and lack of capital are the main determinants of the construction failure (Kangari,l998 and Noven, 1996 ). According to Peterson (2005), it has been proven by the Surety Information Office (SIO) - an office that collects data on surety bonds in United State, the main failure factors are directly related to the financial management of the company. Yin (2006), found that, most of the contractors do not have sufficient capital to finance their undertakings. Contractors generally do not have fixed asset l i e most of the manufactures. They usually do not have land or building but instead, they have construction equipment. Unfortunately, banks do not accept these moving assets as collateral for a loan. Without bank financing, contractors obviously find it more difficult to undertake their project. Financial problems faced by the contractor are also due to the low profit margin fiom project. Through the open tender system, the contractors always have to produce good work at the cheapest price. Previous researchers used financial ratio analysis as a measurement tools to measure the performance of construction companies. In the present study, seventeen financial ratios for constmction company proposed by Peterson (2005) was used for relative performance evaluation.

2.0 PROBLEM STATEMENT

a. High Number of Business Failure in Construction Industry World Wide.

The below examples show the high number of business failure in the construction industry world wide. In 1997, a total of 10,867 construction companies in the United State failed, bringing the total for the eight year period beginning in 1990 to more than 80,000 construction companies (Peterson, 2005). Probability of failure is not only faced by small and new firms but it also large contracting firms. For example, in 2002, two of the Japan's - largest construction companies - Sato Kogy Company and Nissan Construction filed for bankruptcy (The New York Times, ,2002).Also in the same year, Germany's second largest construction company, i.e, Philipp Holzmann , which had been in business for longer than 150 years, also filed for bankruptcy ( The New York Times, 2002). The same scenario also happens in Malaysia. The failure rate of the construction lirms in Malaysia is high. According to Construction Industry Development Board Malaysia (CIDB), from January 2006 to August 2008 a total of 11,321 construction firms has been classified as dormant and non- active.

Internutio11nl Sjwnposium In D e v ~ ~ f l ~ i t t g Econonties: C0tnrnontilitie.s Among Diversities

b. High Non-Performing Loan ( NPL) in Construction Industry.

Many loans to the construction firms become non-performing, which is commonly referred to as un-collectable (Lin,2007). Figure 1.2 shows the amount of loans and non-performing loans (NF'Ls) by contractors for the year 2004 and 2005.

c. Highly Dependent on Debt Capital.

The construction industry is highly dependent on the banks in order to survive (Lin, 2007). Figure 1.3 shows total amount of financing to construction industry (2001-2005). In 2005, the total amount of loans to the construction industry was RM 25.26 billion compared to RM 23.29 billion and RM 21.71 billion in 2004 and 2003 respectively. The total loan given to the construction sector decreased for the first 3 years from 2001 to 2003. But this trend reversed towards the end of 2005.

Figure 1.3: Total amount of financing to construction industry (2001-2005) by 14 commercial banks

Year I I Source: Project Financing for Small and Medium Contracting Firms. (Lin,ZW7)

3.0 RESEARCH OBJECTWT

To look at the significance of financial management in construction industry, the objective of this paper is to review the importance of financial management practice for construction firms.

Data were collected through case studies. Six Bumiputera's construction companies (Large and medium size) were selected as case studies Three years financial annual reports of the selected construction companies were studied thoroughly, and to be more meaningful for a relative performance evaluation, a three years company's average ratios were used as a comparison to the industry average. Seventeen financial ratios were selected as a measurement performance tools. The ratios are based on the data from financial statements for over 62,000 companies for the years I996 through 2000 as reported by Dun & Bradstreet Inc and proposed by Peterson (2005).

Inrernariofzal Syrnposium in Urvelo~iifrg Econonries: Commonoiities Among Dii,er.sities

5.0 J?INANCIAL RATIO ANALYSIS

The table below shows the results of three years average ratios for the six selected construction companies.

SUMMARY OF FINANCIAL RATIO ANALYSIS

~ntcrnutionalS~~ni~o.nrposiurr~ 6 1 Develi~piny Eaonomia': C111llrntirr11lities.4nro1~~) Diversities

ASSESSMENT 6.0

Table 1.5 below shows an assessment of the findings from case study.

Table 1.5 Assessments of Ratios

to maintain a steady stream of work to pay for their

Internatioitol Syrnposiurn I I I Uevelopir~g Econontics: Carnmoncilitie A n o n Dii,ersities

7.0 CONCLUSION

The overall findings from the case study show that most of the Bumiputera construction companies do not have sufficient cash capital to finance their construction works, low profit margin &om the construction project and highly dependent on debt capital to finance their construction costs. Lack of monitoring system for the company's cash flow and project costs were the main caused for failure.

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