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Cash Flow Management in Construction Projects.

Updated on February 1, 2012

BRIEF

Maintaining a consistent healthy Cash Flow in CONSTRUCTION PROJECT is a dream of every CEO, CFO, Project Manager and other stakeholders of all Construction Companies. Delays in CONSTRUCTION PROJECTS largely depend on insufficient CASH FLOW at required time. Mobilisation of 3 main RESOURCES – MANPOWER (Staff and Labour workforce), MATERIAL and MACHINERIES in any PROJECT is totally depended on FUND. Synchorised availability of 3M's (Manpower, Material and Machinery) can only lead to PROGRESS at site. Arranging necessary FUND at requisite time helps PROJECTS to move as per SCHEDULE. If the same fund is arranged or provided after a time lag then entire scenario changes in a PROJECT due to its cascading effect. Several activities are interlinked in a PROJECT. Any deviation in one Activity effects other activity thus affecting entire PROJECT as a whole.

PROJECTS having good consistent CASH FLOW avails following additional benefits than PROJECTS having chocked CASH FLOW.

  • Better credit facility from MATERIAL SUPPLIERS / VENDORS.

  • Most competitive rates from MATERIAL SUPPLIERS / VENDORS.

  • Labour Mobilisation required for the PROJECT shall be easier as payments are made in time. 

  • PROJECT delays can be avoided. Thus loss due to additional OVERHEAD cost due to TIME OVERRUN can be avoided and chances to complete PROJECT within BUDGET remain high.
  • Cost escalation due to inflation can be avoided by completing PROJECT in time.

  • Better STAFF shall be motivated to join such PROJECTs.

  • More chances of getting further PROJECTS from same CLIENT looking into the resource mobilisation and work progress.

Additional COST incurred in PROJECTS for arranging additional FUNDS from Financial Institutions in form of LOANS is much less than possible tangible BENEFITS reaped as detailed above. Thus, PROJECT Success or Failure depends largely on availability of a Consistent Healthy Cash Flow.

In this section we shall be dealing with several aspects of CASH FLOW at various stages of a CONSTRUCTION PROJECT from a CONTRACTOR's point of view and try to understand how to MANAGE CASH FLOW in best possible manner.

CASH FLOW


CASH FLOW deals with CASH INFLOW by which money comes into the PROJECT and CASH OUTFLOW by which money goes out of the PROJECT.

CASH INFLOWs are possible from 3 Main Areas.

§ Receipts from CLIENT as per CONTRACT and WORKS executed.

§ Receipts from SALE of GOOD (mainly SCRAP).

§ Funds raised in form of LOANS from financial institutions or other approved sources as WORKING CAPITAL.

Target shall be to keep Funds raised in form of LOANS at minimum. Let us find out factors which contribute to a CASH INFLOWS and CASH OUTFLOWS in a PROJECT so that all persons concerned can at least attempt to keep the target. At any point of time, a PROJECT should have following condition to consider it as ‘PROJECT with healthy CASHFLOW’.

FUNDS ARRANGED AS LOANS ≥ (CASH OUT FLOWS - RECEIPTS FROM CLIENT).

Receipt from Sale of Goods has not been considered as its contribution towards CASHINFLOW is meagre with respect to Receipts from CLIENT.

To keep 'FUND arranged as LOAN' to minimum, 'RECEIPTS FROM CLIENT' should be on higher side and 'CASH OUTFLOWS' shall be on lower side at all times.

CASHINFLOWS are possible from following avenues in a CONSTRUCTION PROJECT.

1. Mobilisation Advance – In most CONTRACTS, Mobilisation Advance is generally paid by CLIENT to its CONTRACTOR at the commencement of project along with LOI (Letter of Intent) or WO (Work Order) upon submission of BG (Bank Guarantee). This payment is generally paid @ 10% of WO value / LOI value in full upon BG submission. But in some cases, 50% of the advance amount is paid upon BG submission and balance 50% amount upon mobilisation of required RESOURCES (Plant, Machinery, Site Establishments etc.) at site as per WO requirements. This helps CLIENT to ensure advance amount paid to CONTRACTOR have been utilised for that particular PROJECT alone. Thus, PROJECT RISK is minimised from CLIENT’s viewpoint. Most VETERAN CONTRACTORS who are running the business for long time need not to buy any new RESOURCES except few unless all his RESOURCES are engaged in other PROJECTS. But for a new VIRGIN CONTRACTORS, almost all required resources need to be bought. In both the cases, the CONTRACTOR can firm up the PAYMENT TERMS and its CREDIT PERIOD with their SUPPLIERS / VENDORS (for supply of RESOURCES) in same timeline as expected to receive payment from the CLIENT. This shall help to avoid taking LOAN. As most of the required RESOURCES need to be bought by new VIRGIN CONTRACTORS which in most of the cases amounts much more than Mobilisation Advance receivable from CLIENT. In such cases, the CONTRACTOR can restrict his Purchase of RESOURCES (Plants, Machinery etc) to the extent of Mobilisation advance receivable from CLIENT and balance RESOURCES can be planned to use on MONTHLY RENTAL BASIS or RENTAL ON PRODUCTION BASIS. By this process again CASHFLOW can be managed using CLIENT’s fund.

2. Payments against Bills for works executed - Based on PAYMENT TERMS mentioned in LOI or WO, payments can be received from Client on Monthly or Fortnightly basis based on actual works executed at site. In some cases, ADHOC payments are made to CONTRACTOR by CLIENT within 10 days upon Bill submission for 70-80% of Bill Value. Balance amount is received within 7 days upon Bill certification. Approximately 15% - 20% amounts to Labour Cost and 50% to 70% amounts to Material Cost. So adhoc payment paid by CLIENT against Bill Submission helps to meet the Labour and Material payment on monthly basis. Recoveries in each BILL shall lead to get net receivable almost 83% of Bill Values (Refer Table below). Balance 17% amounts to Gross Profit Margin which includes (10% NetProfit + 7% of Overhead / Indirect Cost).

PARAMETERS
VALUE
REMARKS
WO / LOI Value
100
 
Mobilisation Advance Payment
10
 
Bill Value in One Month
20
Assume
Recovery of Advance payment (Max 10%)
2
Total recovery shall be made till completion
Tax deduction - 2% TDS-IT
0.4
 
Retention Amount - 5%
1
 
Net Receivable amount from Bill
16.6
Approx 83% of Bill Value


In some cases, some MATERIAL SUPPLIERS / VENDORS don’t provide any Credit facility and in such cases additional fund need to be raised in form of LOAN to buy such Materials for the PROJECT. Material Procurement Plan need to be done meticulously to avoid excess procurement than required buffer stock. To avoid taking LOAN in such cases, CONTRACTOR can fix up terms during negotiation stage with CLIENT for procurement of such materials by CLIENT on CONTRACTOR’s behalf.

3.Payment against Material Stock - In some Contracts, Clients also pay for Material Costs available in Stock on the bill closing date for Major item like – Cement, Aggregate, Sand, Blocks, Reinforcement Steel, Structural Steel, Diesel, Bitumen etc. Thus again payments to SUPPLIERS / VENDORS are met for STOCK of materials using such payments received from CLIENT.

Above 3 points mentioned above are sources of CASH INFLOW for ‘RECEIPTS from CLIENTS’.

4. Payment received against Sale of Scrap - The amount received against Sale of scrap is also another source of receivables but its contribution is very meagre in terms of total receivables from CLIENT. Moreover, this occurs mostly at the end of the PROJECT.

CASH OUT FLOW is affected by following ways in a CONSTRUCTION PROJECT.

1. RESOURCE PROCUREMENT (Plant, Machinery, Office establishments etc.) - To be paid using Mobilisation advance. If RESOURCE PROCUREMENT COST is expected to be more than Mob. Advance Receipts then RESOURCE RENTAL should be opted for to avoid taking LOANS. Proper judgment should be made in identifying RESOURCES which need to be rented. This is approximately 10%.

2. LABOUR COST - To be met using payments received from Client against work done bills as detailed above. This amounts to approximately 15% - 20%.

3. MATERIAL COST - Materials used in the work done can be paid using payments received from Client against work done. Payments for Materials in Stock can be met to VENDORS / SUPPLIERS from Payment received from Client against Material Stock (dealt above). This amounts to 50% - 70%.

4. OVERHEAD COST / INDIRECT COST - Payments towards this cost is around 7% of PROJECT VALUE which cannot be done using Receipts from CLIENT. Refer Table above which shows net receivable from BILLS is exhausted by paying for LABOUR COST and MATERIAL COST. So, the CONTRACTOR need to arrange LOAN as WORKING CAPITAL on monthly basis to meet this OVERHEAD COST.

5. PLANT DEPRICIATION COST – It’s a book cost and not an actual one. Hence, need not to arrange fund for this.

Upon PROJECT completion the CONTRACTOR receives 10% PROFIT in form of ASSETS (RESOURCES), 5% amount towards Release of Retention Amount. LOAN required to pay-off for monthly OVERHEAD COST ie 7% of Monthly Bill Value shall be effectively 7% of TOTAL PROJECT VALUE / WO value for half PROJECT DURATION. Such amount of LOAN taken from BANK including its Interest amount shall amount to be around 8%. Thus 5% amount out of 8% can be paid back to FI’s using 5% Retention Amount as released by CLIENT upon PROJECT completion. Any deficit 3% if found can be overcome from either of the following ways.

  • Take projects with higher Net Profit Margin instead of 10%.
  • Reduce Cost (Labour, Material Cost) by Cost Control Measures (Wastage Control, Monitoring Labour Productivity, Working in Double shift, developing better work methods etc).
  • Reduce Cost by Optimal Utilisation of Available Resources / Rental Resources.
  • Limit cost using ESCALATION CLAUSE.
  • Finding innovative ways to award SUB-CONTRACTING works and carry our proper MATERIAL PROCUREMENT by way of which statutory taxes can be saved to certain extent and add up to the Profit Margin.
  • Proper negotiation with SUPPLIERS / VENDORS for Supply Rates.

CASH FLOW MANAGEMENT detailed above shall give a brief idea about different aspects of CASH FLOW and its importance applicable for Construction Projects. Detailed idea of CASH FLOW PLAN can be prepared on monthly basis based on

§> CONSTRUCTION SCHEDULE planned for the PROJECT clubbed with SALES RATE (Revenue) and BUDGET COST (Cost) against each items of work.

§> SALES RATE shall provide MONTHLY REVENUE SCHEDULE whereas

§> BUDGET COST shall provide MONTHLY COST SCHDULE.

§> PAYMENT TERMS AND CONDITIONS for CLIENT RECEIVABLES and VENDORS / SUPPLIERS PAYMENTS.

§> MOB. ADVANCE PAYMENT AND RECOVERY CLAUSES.

§> MATERIAL ADVANCE PAYMENT AMOUNT.

§> RETENTION AMOUNT AND ITS RELEASE.

Detailed CASH FLOW PLAN can help in understanding it better and shall give a fair idea to CONTRACTOR about WHEN and HOW MUCH to inject FUNDS in PROJECT to run it smoothly and complete it within stipulated time without TIME AND COST OVERRUN.

Following factors are of utmost importance in managing CASHFLOW at CONSTRUCTION PROJECT.

§ PROPER CONTRACT CLAUSES should be agreed upon to reduce the burden of taking LOANS. Inclusion of following clauses to maximum favourable condition to CONTRACTOR.

1.Mobilisation Advance.

2.Recovery of Mobilisation advance

3.Bill Certification period and its frequency.

4.Adhoc payment clause against Work Done.

5.Payment against Material Stock.

6.Price escalation clause.

7.Materials to be brought by CLIENT on behalf of CONTRACTOR.

8.Retention withheld amount and its release upon PROJECT completion.

9.Delayed payment by CLIENT.

§ CONTRACTOR should be well prepared in arranging BG (Bank Guarantees) against COLLATERALS for obtaining Mobilisation Advance, Performance Guarantee and also to avail LOANS towards Working Capital.

§ Proper Planning, Execution, Monitoring and Control is carried out in the PROJECT till its completion.

§ CLIENT should remain capable of making payment as per CONTRACT terms during the entire tenure of the PROJECT. Client should be financially sound or should have good financial support. Any Payment delay by CLIENT need to be accommodated by CONTRACTOR arranging additional funds in form of LOAN. In case of a VETERAN CONTRACTOR some surplus shall be available from Mobilisation Advance which can be used to meet these contingencies (delay by Client in making payment in time).

§ Proper negotiation with VENDORS / SUPPLIERS for rates and CREDIT PERIOD in similar payment terms as expected to receive from CLIENT.

§ Last but not the least the PROJECT should be a PROFITABLE project with at least (17% + 3% deficit = 20%) Gross Profit Margin. Otherwise extra FUNDs need to be arranged beyond PROJECT receivables.

I am restricting this topic of 'CASH FLOW MANAGEMENT in CONSTRUCTION PROJECTS' up to this extent. Hope this deliberation shall be useful to you in your CONTRACT finalisation and PROJECT EXECUTION.

Thanks to all Readers for your patience. Best of Luck for MANAGING CASH FLOWS.

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    • Steel Engineer profile image

      Steel Engineer 4 years ago from Kiev, Ukraine

      Great article. Planning = success!

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