What financial risk does ABC Builder face if payouts are required in month 2 without possession until months 5 and 6?

If ABC Builder is required to make payouts in the second month while not receiving possession or income until months five and six, it creates a significant cash flow challenge. The timing issue between the outflow of funds for payouts and the inflow from project revenues can lead to two primary risks.

Firstly, the company could face insolvency if it does not have sufficient liquidity to cover the payouts. Insolvency occurs when a company cannot meet its financial obligations as they come due, which can happen if there is a delay in cash inflows while expenses still need to be paid.

Secondly, the company will need to secure short-term financing to bridge this gap. This might involve taking out loans or other forms of credit to ensure that there is enough cash on hand to meet the payout obligations. Short-term financing typically incurs interest and other costs, which could further strain the company’s finances if the situation persists.

Thus, the correct answer encompasses both risks: the potential for insolvency if cash flow issues are not managed effectively and the necessity for short-term financing to maintain operations during the gap in cash inflow. This multifaceted risk situation illustrates the importance of cash flow management in construction and other project-based businesses.