CAUSES OF INSOLVENCY

CAUSES OF INSOLVENCY

The main reasons for the advent of insolvency, which in turn hinder the successful completion of capital projects, are many and varied depending on the parties and extraneous factors involved in the contract.

Frankly speaking, insolvency is a product of mismanagement in all its ramification. Some of the major causes are listed below as noted by Hall G. (1992):

1. Inadequate financial provision for the project.
2. Inadequate planning of project or faulty feasibility studies and implementation.
3. Inflation in project cost.
4. Lack of executive capacity of the contractor.
5. Variations in project scope.
6. Administration action/regulation.
7. Inability to procure relevant materials and equipment.
8. External forces/foreign exchange market.
9. Abuse of mobilization payment.
10. Faulty design and/or supervision.
11. Inadequate Financial Provision for the Project

This is a very common problem in both the private and public sectors and occurs as a result of any or all of the following circumstances.

1. Inadequate cash-flow forecast: This may occur as a result of wrong projection of eventual cost of project at inception and the client’s inability to fund future cost expended on the project by the contractor.
2. Clients’ over optimistic projection of their revenue expectations during the period of project execution, and the actual revenue generated falling short of original expectations.
3. Reliance on procurement of funds from financial institutions which later fails to materialize.
4. Inadequate Planning of Project of Faulty Feasibility Studies and Implementation

In this country, many public and private organizations do not allow sufficient time for project planning. During the execution of such projects, major issues, which were not adequately analyzed and tackled crop up and may adversely affect the total cost of the project. If the client has no avenue for procuring further funds, this can eventually lead to the insolvency of the client.

A faulty initial feasibility study of a project might lead to insolvency. This is usually as a result of consultants not having adequate date for the exercise.

3. Unsteady Inflation of Project Costs

One major reason responsible for insolvency is the escalating cost of building materials. Most projects have a factor of cost escalation allowed for at inception stage based on historical cost data. The client is able to meet reasonable cost inflation from such provision.

As with the current circumstance, the rate of cost escalation is much more than could have been reasonably envisaged by any budget planner.

4. Lack of Executive Capacity of the Contractor

Insolvency as earlier stated is a product of mismanagement in all its ramifications, obviously if the affairs of the firm will prosper, a competent and experienced estimator would ensure that the estimate for the project was well thought out and the cost to the contractor kept within expected profit margins.

Unfortunately, most indigenous contractors, out of ignorance consider the employment of an estimator or quantity surveyor a waste of money because they cannot physically see the financial reward. After the estimator has prepared for tendering, some indigenous contractors lobby for award of contract from all the people that have a role to play in the award of the contract. They even make false claims as to their technical, financial and executive capacity. After the award of the contract, their inadequacy becomes obvious making it impossible for them to execute the project as planned financially.

5. Variation to Project Scope

Almost all projects are varied in scope, Fisk, E. (1997). A project may be completed at a higher cost than originally planned. Inability of the clients to procure more funds can result to insolvency. Some variations are politically induced. A development plan may call for three new hospitals to be sited in certain areas but political expediency may dictate the inclusion of other areas not favoured in the original scheme. The fund embarked for three projects may then be used for eight instead of four without a corresponding increase in budget allocation. The result would be inadequate finance to complete any of the projects. Our Universities, Polytechnics, Secondary Schools, etc are filled with uncompleted projects arising out of “variation” to development plan programme without adequate financial backing, Fisk, E. (1997).

6. Administration Actions / Regulation

Delays in taking vital decision on project at various levels of the client organization lead to slow-down starting and completion of projects. When final decision are eventually taken, the funds required to implement them are much higher than originally provided for which in turn requires further approvals and search for additional funding. Considering the galloping inflation ravaging the country, coupled with government economic measures, if a project was commissioned in 1987 it would cost about six times initial cost of the project to complete it now. In depressed economy like this, this will lead to unavailability of enough funds to finance project, which in turn results to insolvency Fisk, E. (1997).

7. External Forces / Foreign Exchange Market

Not all the problems are caused by the government programme; events taking place outside the border of Nigeria also have serious impacts in the country.

The economic decision taken by the Western World also affect the ability to raise loan to complete some of the cherished projects in the country, upward revision in the interest rates of the Western Banks would mean increase in the costs of on-going projects which would then affect the payment of loan that have already been made.

8. Local Borrowing Rates

Local rate of borrowing is another factor which must be addressed. Increase in local borrowing rate also affects the financial projection of both the client and the contractor. Thus, the future cash-flow projection based on the previous rate of interest might not materialize in depressed economy like this, increase in rate of borrowing will hinder the procurement of loan for project financing and adversely affect the on-going projects. This will eventually lead to client not having enough funds to meet the project requirements.

9. Abuse of Mobilization Payment

The idea of giving mobilization payment came into being especially to enable our indigenous contractors to compete favourably with their foreign counterparts based in Nigeria, unfortunately, some of the Nigerian contractors who were supported to benefit most from the schemes abused the system. It is pertinent to note that some of these contractors do not have enough financial capital to execute the project. Project embarked upon with the mobilization payment assistance might be stopped halfway due to unavailability of enough funds to execute the project before honoring the certificate.

10. Faulty Design and Supervision

Poor design makes execution of project very difficult for the contractor; it wastes time and resources especially where work executed would have to be totally demolished before the correction can be done. Since this might not be the responsibility of the contractor, the employer has to be responsible for the cost of demolition, cost of materials and labour including associated costs. If the client has no avenue of procuring additional funds this might result in insolvency, Clough, R. and Sears, G. (1994).

A poor supervision of a project may also cause insolvency, proper supervision is essential to impact cost system so as to reduce the advent of excessive increase in completion cost compared with the budget. It is essential to employ a good contractor that can easily detect the faults in the design and make correction to avoid demolition and waste of materials and resources, Clough, R. and Sears, G. (1994).

References

Burnett R.G (1991) Insolvency and the sub-contractor, Occasional Paper 48. Chartered

Clough, R.H. and Sears, G. A. (1994) Construction Contracting. (6th edition) John Wiley & Sons Inc., New York

De Valence (1994.)Douglas, C. (1985).Burnett, R. (1991).

Douglas, C.R. (1985) An Investigation into Some of the Major Problems Facing Small Building Firms, Unpublished B.Sc. Dissertation, University of Cape Town.

Fisk, E. R. (1997) Construction Project Administration. (5th edition) Prentice Hall, New Jersey.

Hall G. (1992) Reasons for Insolvency amongst Small Firms – Reviews and Fresh