Implementing Pre-Qualification Methods for Subcontractors During COVID-19

As a surprise to no one, COVID-19 has had a large impact on subcontractor pre-qualifications. The pandemic has led to low readings on both the Construction Backlog Indicator, which measures the amount of work that will be performed by contractors in the coming months, and the Construction Confidence Index , which measures the expectations for sales, profit margins, and staffing. Low readings on these have led to additional concerns for rising costs as well as credit worthiness of subcontractors. As the pandemic lingers, the current readings have risen some, but the outlook could lead to a decreased or stagnated backlog combined with low profit margins and sales confidence, causing some subcontractors to overextend themselves.

Three main impacts for subcontractors have been noted as a direct result of the COVID-19 pandemic

1. Financial health: With low confidence indexes, increasing material and labor costs and pandemic uncertainties, the financial health of many Companies has fallen since the onset of the pandemic.
2. Supply chain disruptions: As price fluctuations on materials run rampant and delays on delivery are a common theme, estimating total costs and hitting target completion dates become more and more difficult.
3. Labor force: In an already difficult labor market, dealing with COVID-19 restrictions, unexpected quarantines, and finding qualified people to work has become increasing burdensome and costly.

In order to avoid awarding work to subcontractors who are unable to deliver, certain pre-qualification criteria should be implemented. These pre-qualifications follow the 3 Cs – capacity, capital, and character, which help give insight into the capabilities of a subcontractor.

1. Capacity: How big and what types of jobs can a subcontractor handle? Analyzes manpower, location, skills, and experience.
2. Capital: How stable is their financial position? Examines their financial statements, financial history, and revenues.
3. Character: What is their industry reputation? Evaluates their professional history, safety incidents, and reputation.

These pre-qualifications benefit the subcontractors as well, as meeting these qualifications can lead to more work and financial incentives from contractors.

In addition to the 3 Cs, certain pandemic specific considerations should be noted when evaluating a subcontractor.

1. PPP Loans: When considering a subcontractor’s capital, the status and impact of the company’s PPP loan(s) should be reviewed. While financials are being looked at much more forgivingly due to the pandemic, PPP loan forgiveness created bottom line income for some companies where a loss position would have occurred otherwise.
2. Material prices and damages: Not only are material prices fluctuating at great rates, but companies are also heavily scrutinizing contracts with suppliers, specifically the provisions regarding damages, price fluctuations, and material delays.

The main goal of these pre-qualification considerations is to mitigate as much risk to the owner/general contractor as possible. This can best be done by spending time looking for risks and red flags upfront, implementing the 3 Cs, and having an active and ongoing pre-qualification process. Although the pandemic has brought much uncertainty, a contractor needs to be able to adjust and adapt. These processes will help identify those companies that can and those that cannot .

Please take the time to review this process and contact one of our construction accounting specialists.