Cash flow in construction industry
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these specific milestones. This procedure leads not only eventually in the efficient operation | these specific milestones. This procedure leads not only eventually in the efficient operation | ||
of the construction works and the on-time deliverable of the project, but also help a | of the construction works and the on-time deliverable of the project, but also help a | ||
| − | company grow its business. In this wiki article, | + | company grow its business. In this wiki article, cash flow and its relation with the project milestones is presented. |
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=Introduction= | =Introduction= | ||
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Until the main contractor has been appointed, cash flow projections are likely to be based only on agreed fee payment schedules for consultants and a simple division of the construction cost over the likely construction period (or perhaps an allocation of construction cost over an s-curve distribution). It is only when the main contractor is appointed, a master programme prepared and some form of payment schedule agreed that cash flow projections become reliable. | Until the main contractor has been appointed, cash flow projections are likely to be based only on agreed fee payment schedules for consultants and a simple division of the construction cost over the likely construction period (or perhaps an allocation of construction cost over an s-curve distribution). It is only when the main contractor is appointed, a master programme prepared and some form of payment schedule agreed that cash flow projections become reliable. | ||
Cash flow projections may be affected by the need for the early purchase of long-lead time items or by items that the client may wish to purchase that are outside of the main contract (such as furniture or equipment). | Cash flow projections may be affected by the need for the early purchase of long-lead time items or by items that the client may wish to purchase that are outside of the main contract (such as furniture or equipment). | ||
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| − | + | Cash flow is an issue of utmost importance for the client. It represents the timeline of the incurred costs for the project not only during its construction, but also during the life cycle of the project. In other terms, it is the inflow of cash to the contractor form the client, which is necessary for funding the project. <ref name="Design"> Cash flow in construction, Designing Buildings Wiki [URL:http://https://www.designingbuildings.co.uk/wiki/Cash_flow_in_construction]Retrieved on 12 June 2017</ref>. | |
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| − | Cash flow is an issue of utmost importance for the client. It represents the timeline of the incurred costs for the project not only during its construction, but also during the life cycle of the project. In other terms, it is the inflow of cash to the contractor form the client, which is necessary for funding the project. | + | |
==Supply chain cash flow== | ==Supply chain cash flow== | ||
| + | Cash flow is also an issue for the construction supply chain, and is a common reason for contractors and sub-contractors becoming insolvent. This can be catastrophic for a project in terms of time and money. It is in the client's interest therefore to ensure that the supply chain is paid promptly. <ref name="Design"> Cash flow in construction, Designing Buildings Wiki [URL:http://https://www.designingbuildings.co.uk/wiki/Cash_flow_in_construction]Retrieved on 12 June 2017</ref>. | ||
| + | https://www.designingbuildings.co.uk/wiki/Cash_flow_in_construction | ||
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| − | =Importance of cash flow= | + | ==Importance of cash flow== |
| + | Cash flow is vital for organizations in the construction industry. Shortfalls in cash flow may result to major problems in all the parties involved in the construction project. These problems affect the relationship and the collaboration atmosphere between the different parties in a project, leading eventually to disputes between them. Consequently, additional risk is included in the overall final cost estimation, which maybe conclude to higher final cost. <ref name="Constructing">Constructing Excellence (2016). \The Payment Minefiled, Constructing Excellence Member Forum". Pat. [URL:http://constructingexcellence.org.uk/wp-content/uploads/2016/03/cemembersforum10022016.pdf]Retrieved on 12 June 2017</ref>. | ||
| − | File:Cashflow.png | + | [[File:Cashflow.png|thumb|right|300px|Figure 1: Problems derived from cash flow (click to zoom)]] |
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In construction projects, the identification of the major milestones of the construction process is often the major tool for managing the schedule <ref name="Winch"></ref>, and consequently the managing of the budget of the project. Finally, the payment between the suppliers and the contractor usually take place after the delivery of the service. <ref name="Winch"></ref> | In construction projects, the identification of the major milestones of the construction process is often the major tool for managing the schedule <ref name="Winch"></ref>, and consequently the managing of the budget of the project. Finally, the payment between the suppliers and the contractor usually take place after the delivery of the service. <ref name="Winch"></ref> | ||
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| + | =Cash flow estimation= | ||
| + | A cash flow projection is a business tool of utmost importance for the construction industry, providing a basis for controlling one or multiple projects. The cash flow projection of the project execution team implies whether the project can be funded throughout its whole construction timeline, avoided undesirable events, such as budget shortfall, which maybe in some extreme cases may lead the contractor to bankruptcy. Cash flow estimation is closely related to construction time, as it is a dynamic procedure where project cost meets the project schedule. <ref name="Chen">Chen, M. T. et al, 2007, ABC of Cash Flow Projections, AACE International Transactions, PM. 02</ref> | ||
| + | A cash flow forecast (also called a 'cash flow budget' or 'cash flow projection') helps identify whether a firm needs to borrow, how much, when, and how it will repay the loan. | ||
| + | Building a cash flow forecast allows an evaluation of cash resources that are required and when they are required by. Business owners can identify likely future gaps in funding and plan for those gaps accordingly. It is a vitally important tool for predicting the continuing financial health of the business. | ||
| + | Additionally, cash flow models enable business owners to assess 'what if' scenarios by changing key variables to see how vulnerable the business is to price changes, staffing levels, exchange or interest rate movements, and other key drivers. | ||
| + | In larger organisations the cash flow projection can be integrated with day to day operations. This can help identify what production is necessary, what resourcing is required and can provide an assessment of the capacity within a business. <ref name="Design2"> Cash flow in construction, Designing Buildings Wiki [URL:https://www.designingbuildings.co.uk/wiki/Cash_flow_forecast]Retrieved on 12 June 2017</ref>. | ||
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==Cash flow estimation with BIM== | ==Cash flow estimation with BIM== | ||
| − | A unique value of this prototype is dramatically | + | A unique value of this prototype through [[Building Information Modeling]] is dramatically |
automating the time required to generate cash flow | automating the time required to generate cash flow | ||
analysis. Traditionally, contractors could spend weeks | analysis. Traditionally, contractors could spend weeks | ||
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has the best possibility to earn the highest profit margins. | has the best possibility to earn the highest profit margins. | ||
The contractor could then focus its resources on preparing | The contractor could then focus its resources on preparing | ||
| − | bids for only the most profitable projects. | + | bids for only the most profitable projects. |
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=Limitations= | =Limitations= | ||
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=Annotated bibliography= | =Annotated bibliography= | ||
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Latest revision as of 22:46, 12 June 2017
Cash Flow in construction industry presents an aspect of utmost importance for the cost planning of the project. It is essential that project managers deal also with the project accounting, in collaboration with the accountant. Cash flow is an ongoing process, in which the project manager must cope with all the payment costs, through cost projections, during the construction lifetime of the project, trying to avoid cash shortfalls. Especially, in construction industry, the cash flow management is critical due to retainage, change orders and delays. Due to a successful cash flow management the project manager, together with the other parties, has to set project milestones and achieve that the project will be cash positive in these specific milestones. This procedure leads not only eventually in the efficient operation of the construction works and the on-time deliverable of the project, but also help a company grow its business. In this wiki article, cash flow and its relation with the project milestones is presented.
Contents |
[edit] Introduction
[edit] Client Cash Flow
The cash flow sets out when costs will be incurred and how much they will amount to during the life of the project. Predicting cash flow is important in order to ensure that an appropriate level of funding is in place and that suitable draw-down facilities are available. Until the main contractor has been appointed, cash flow projections are likely to be based only on agreed fee payment schedules for consultants and a simple division of the construction cost over the likely construction period (or perhaps an allocation of construction cost over an s-curve distribution). It is only when the main contractor is appointed, a master programme prepared and some form of payment schedule agreed that cash flow projections become reliable. Cash flow projections may be affected by the need for the early purchase of long-lead time items or by items that the client may wish to purchase that are outside of the main contract (such as furniture or equipment).
Cash flow is an issue of utmost importance for the client. It represents the timeline of the incurred costs for the project not only during its construction, but also during the life cycle of the project. In other terms, it is the inflow of cash to the contractor form the client, which is necessary for funding the project. [1].
[edit] Supply chain cash flow
Cash flow is also an issue for the construction supply chain, and is a common reason for contractors and sub-contractors becoming insolvent. This can be catastrophic for a project in terms of time and money. It is in the client's interest therefore to ensure that the supply chain is paid promptly. [1]. https://www.designingbuildings.co.uk/wiki/Cash_flow_in_construction
[edit] Importance of cash flow
Cash flow is vital for organizations in the construction industry. Shortfalls in cash flow may result to major problems in all the parties involved in the construction project. These problems affect the relationship and the collaboration atmosphere between the different parties in a project, leading eventually to disputes between them. Consequently, additional risk is included in the overall final cost estimation, which maybe conclude to higher final cost. [2].
[edit] Payment methods and milestones
The project payment methods have to be clearly defined in the contract and describe the exact terms of the transactions between the stakeholders. The contracts, naturally, affect the cash flow of the construction project, as they can describe different payment methods, specifically for one particular project. Especially, if the client pays for the project at the project completion, the contractor have to search funds from the start to the delivery of the project. Some typical payment methods are [3] :
- Payment on completion. However, this type of payment is not usual in construction industry
- Advance payment. This is the opposite when the client pays in advance some amount of the payment
- Milestone payments. Payment is made on the successful achievement of a project milestone. The milestone payment can be an agreed percent of the total value or a percentage according to the phase of the project. With the word milestone, it can be the payment is based upon progress in completing on what it has been agreed between the client and the contractor. These type of payment based upon achieving defined percentages of a contractor’s programme of activities is also called as a ‘planned payment’ scheme.
In construction projects, the identification of the major milestones of the construction process is often the major tool for managing the schedule [4], and consequently the managing of the budget of the project. Finally, the payment between the suppliers and the contractor usually take place after the delivery of the service. [4]
[edit] Cash flow estimation
A cash flow projection is a business tool of utmost importance for the construction industry, providing a basis for controlling one or multiple projects. The cash flow projection of the project execution team implies whether the project can be funded throughout its whole construction timeline, avoided undesirable events, such as budget shortfall, which maybe in some extreme cases may lead the contractor to bankruptcy. Cash flow estimation is closely related to construction time, as it is a dynamic procedure where project cost meets the project schedule. [5] A cash flow forecast (also called a 'cash flow budget' or 'cash flow projection') helps identify whether a firm needs to borrow, how much, when, and how it will repay the loan. Building a cash flow forecast allows an evaluation of cash resources that are required and when they are required by. Business owners can identify likely future gaps in funding and plan for those gaps accordingly. It is a vitally important tool for predicting the continuing financial health of the business. Additionally, cash flow models enable business owners to assess 'what if' scenarios by changing key variables to see how vulnerable the business is to price changes, staffing levels, exchange or interest rate movements, and other key drivers. In larger organisations the cash flow projection can be integrated with day to day operations. This can help identify what production is necessary, what resourcing is required and can provide an assessment of the capacity within a business. [6].
[edit] Cash flow vs expenditure
[edit] Uncertainty in cash flow
The final cost of successful construction projects is usually well estimated and it does not overrun the available budget [5]. However, the actual expenditure during a specified project milestone may vary from the estimated cost at that time of the construction schedule by a large amount. This is due to the fact that the cash flow projections may differ from the accounting calculations due to a number of factors: [5]
- The Project managers are quite optimistic and are more based on the overall cost estimation of the project proposal
- The client delays his payments milestones due to disagreements and, generally, aggressive contract negotiations with the contractor, resulting eventually in decreasing the amount of the inward cash flow.
- Bureaucratic collisions and limited managerial capability of the contractor can result in delays, concerning the assembling of the invoice supporting documents.
- Delays due to the invoice approval cycle by the client
- Delays in the equipment and the materials of the construction project
- Changes in materials and prices due to rapid inflation [4]
- Contingency events and errors in the design process
[edit] Prerequisites of cash flow projection
[edit] Tools for cash flow projection
[edit] Cash flow estimation with BIM
A unique value of this prototype through Building Information Modeling is dramatically automating the time required to generate cash flow analysis. Traditionally, contractors could spend weeks performing the quantity takeoff, scheduling, cost estimating, and cash flow analysis. This prototype offers a method that can produce a cash flow in minutes. Architects will often propose multiple designs, each represented by its own 3D model. With this technology, contractors would be able to quickly compare cash flow scenarios for each model, which would be potentially useful for value engineering decisions and bidding strategies. Contractors who are considering bidding on multiple projects would be able to quickly perform cash flow analysis for each project and determine which one has the best possibility to earn the highest profit margins. The contractor could then focus its resources on preparing bids for only the most profitable projects.
[edit] Limitations
[edit] References
- ↑ 1.0 1.1 Cash flow in construction, Designing Buildings Wiki [URL:http://https://www.designingbuildings.co.uk/wiki/Cash_flow_in_construction]Retrieved on 12 June 2017
- ↑ Constructing Excellence (2016). \The Payment Minefiled, Constructing Excellence Member Forum". Pat. [URL:http://constructingexcellence.org.uk/wp-content/uploads/2016/03/cemembersforum10022016.pdf]Retrieved on 12 June 2017
- ↑ Marks, T., 2012, 20:20 Project Managmement: How to Deliver on Time,on Budget and on Spec , p.cm
- ↑ 4.0 4.1 4.2 Winch, G. M., 2010, Managing Construction projects, second edition
- ↑ 5.0 5.1 5.2 Chen, M. T. et al, 2007, ABC of Cash Flow Projections, AACE International Transactions, PM. 02
- ↑ Cash flow in construction, Designing Buildings Wiki [URL:https://www.designingbuildings.co.uk/wiki/Cash_flow_forecast]Retrieved on 12 June 2017
