Module five: Session Two M5S21

Training objective To review the various financing options available to road contractors M5S22

Training outcome By the end of the session trainees should be able to:  Identify requirements needed for road construction firms to access bank services  Explain the procedures for accessing bank credit  Interpret bank terms and conditions before accessing credit  Appreciate banks and other financial institutions as sources of business capital for road construction. M5S23

Common finance needs for contractors Equipment finance Vehicles, heavy construction equipment Specialised equipment Working capital finance Materials, Labour and Overheads before certification and payment Guarantees and bonds Bidding Performance Retention M5S24

Sources of financing for contractors Supplier credit for working capital items, equipment hire and equipment purchase most common. Short term and not suitable for financing fixed assets purchase. Finance institutions including banks, finance houses and insurance companies Contracting agency (Govt) financing M5S25

Guiding principles to support contractor finance : The contracting agency could:  Pre-finance a job or equipment  Stand guarantee to suppliers or lenders  Set up a leasing scheme  Have a pool of equipment The decision to opt for any of these mechanisms should be based on the following three principles. M5S26

Guiding principles for contractor support: Market rates-This means the contractors should be charged full market rates Reimbursement capacity- the investment by the contractor should be justifiable from the income expected Simplicity – the scheme should be easy to set up and manage M5S27

Options available for long term financing Lease financing schemes Pre-payment of equipment by the project Equipment pools Bridge financing Guarantees on work, on payments or on credit Term Loans Conditional sales contract M5S28

Lease financing Leasing is a contractual arrangement that allows one party to use an asset owned by another in exchange for specified periodic payments. Types of lease financing:  Finance lease  Hire-purchase  Operating lease M5S29

Pre-payment of equipment or works The employer/agency pays the contractor an advance or pays the supplier of equipment. The advance or financing is recovered from the work payments in suitable installments. Administration of the scheme may be entrusted to a financial institution. M5S210

Equipment pools Ownership of the equipment is retained by a government agency that sets up an equipment pool. Disadvantages of the option:  The equipment is usually not properly maintained  The rental rates are often too low to cover the costs of maintenance.  Such rates do not prepare contractors to compete in real market situations.  Contracting agency itself may be blamed for delays in the execution of work M5S2 11

Bridge financing and guarantees Bridge financing: In bridge financing loans for short terms are given out, using future income as guarantee. Contractors of public work can use the construction contract as guarantee to obtain bridge financing. The supplier of the funds may require assurance that payments will be channeled through it. M5S212

Challenges of financing small contractors Commercial banks in developing countries are reluctant to lend to small contractors usually operating in rural areas for a set of reasons:  The contractors are often first-time borrowers without any track records or credit reference;  They are unable to fulfill the collateral requirements of the bank;  They can not present their previous years’ financial statements and their financial management skills wanting; M5S213

Challenges of financing small contractors continued..  They are unable to finance % of the investment as usually required by the banks  Costs of monitoring are high  If equipment is involved, its safety and maintenance is difficult  Securing government commitment to payment is difficult and where obtained payment is irregular  A track record of good work performance is lacking  Continuity of works is not certain M5S214

Guaranteeing work The contracting agency could agree to make payments to the contractors through the bank, The bank could withhold parts of the payments in case of bad loan repayment. The risk is that when payments are withheld, contractors are not able meet operating obligations such as wages. M5S215

Guaranteeing loans Another way is to guarantee contractors’ loans to finance their equipment by setting up a guarantee fund to issue to contractors letters of guarantee. It is an option in countries where efforts to set up a leasing scheme or to facilitate finance through other types of guarantees have not succeeded.  The programme agrees to share the loan risk with banks.  The fund could also cover bid, performance and retention bonds. M5S216

Working capital financing Trade credit Accounts receivable financing or factoring Purchase order financing Bank stand by credit - overdraft Business Improvement Loan(BIL) M5S217

Group discussions 1 Describe the common finance needs of road contractors and the various ways they may obtain finance. 2 Explain how lease financing operates and why it may be suitable for road contractors 3 State the key components one would expect to find in a typical finance application assessment system. 4 Explain why it may be difficult for banks to provide working capital finance in road construction. 5 Identify the key challenges in raising road construction finance and suggest how they can be addressed. M5S218

Q&A M5S219