Engineering firms face inherent risks, but these too can be managed
Dan Thompson is the soft-spoken Chief Financial Officer (CFO) of a successful family-owned engineering firm employing upwards of 2,500 staff.
Thompson is no stranger to the world of engineering. In fact, he knows all too well the potential pitfalls that can beset a company that isn't prepared to manage the inherent challenges.
Chief among these obstacles is the length of time it takes to receive payment from the project sponsor. It may take over a year before a project bid becomes an actual project. During this period, the company must invest its time and resources to produce project bid documents and project bonds. If the bid is successful, the next phase involves negotiating the contract terms, which can take between 60 to 90 days.
"This is a lengthy process that may not guarantee any cash flow for up to 18 months. During this period, we are carrying a lot of debt which makes careful planning a necessity," explains the CFO.
With operations in East Africa, the company's client profile presents another challenge.
"95% of our clients are governments or government agencies. This brings a built-in risk that payment may be delayed or not forthcoming. This tends to make our financiers nervous," offers Thompson.
To counter these obstacles, Thompson notes that the firm has chosen a unique solution.
"Over the past four years we've opted to take out political risk insurance. Although the local market doesn't always require it, we've found benefits in terms of freeing up our capital."
Their insurance partner, the African Trade Insurance Agency's (ATI) political risk insurance promises an end date for payment, particularly when the client is a government agency. ATI relies on its strong relationships with its African member governments, who as shareholders in the Agency have a vested interest to ensure that no claims are brought against ATI.
Thompson offers another reason for opting to go with ATI. "If ATI didn't exist we would go to the private insurance market through a broker. This is a more costly option because the private market has a perception of African risk built into its pricing model."
For engineering firms, insurance protection helps to free up much needed capital for bonding facilities. Lack of these facilities may mean the difference between securing a project and losing out to someone else. Firms can free up their capital by using insurance to cover their financing rather than exposing their own balance sheets.
"Increasingly," adds Thompson, "lenders and funders are financing projects on condition that this type of insurance is in place."
One example he cites is a recent government-backed project in Kenya in which payment is not guaranteed for another three months. In the past, there would be a real possibility that they would have to lay off staff. But with insurance in place, the bank and investors are less jittery because they know payment will be forthcoming.
"In this business your profit margin is everything. We normally retain between 5 to 10% of the contract value for each project. We receive half after the project is completed. The other half we get a year later. This other half represents our profit margin so it's crucial that this margin lands in our bank account."
Names in this article have been altered for purposes of confidentiality.