cash flow forecasting 29th october 2015f

8/19/2019 Cash Flow Forecasting 29th October 2015f

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Cash flow forecasting in construction projects

Cash Flow Forecasting

Dr. V. Thiruvengadam


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Concepts of cash flow forecasting

• Project Cash Flow• Project Cash Flow refers to the cash inflow due to income and cash outflow due to

disbursements (expenses) over the project period.

• Net cash flow is the difference between the income and disbursements duringthe project period.

• A positive cash flow means the income exceeding the disbursements during theproject period.

• A negative cash flow indicate that the disbursements exceeding the income duringthe project period.

• For a construction contractor, the progressive payments (monthly) from the clientconstitute the income component. The typical cash disbursements are; projectstart up costs, payments to labour, material suppliers, equipment hire charges,subcontractors costs etc.



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Concepts of Cash Flow Forecasting

• Cash Flow Forecasting

• The estimation of the quantum and the timing of the cash incomes and cashdisbursements over the project period is termed as Cash Flow Forecasting.

• The Cash deficits determined in the cash flow forecasting forms the basis for theworking capital requirements of the contractor.



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Concepts of Cash Flow Forecasting

• Project Cost (Cost of Work)

• The cost incurred to carry out the construction is termed as cost of work. The costof work has two components;

• Direct costs on account of material, labour, equipment usage, subcontractorpayments, etc. directly inbuilt in the construction activities.

• Indirect costs on account of overheads and operational costs like officeexpenses, salary, taxes, etc. associated with the project.

Project Cost Curve

A graph showing monthly cumulative costs vs. the project period is called project

cost curve.

The cumulative cost component could be worked out for the individual cost

components like labour, material etc. to plan the cash requirements for these

components over project period.

The project cost curve is developed based on the activity costs, durations and

their occurrences in the project schedule



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Concepts in Cash Flow Forecasting

.Value of Work

• Value of work is obtained by adding the desired profit margin (markup) to the costof work. Profit margin expressed as a percentage of cost of work.

• If 10% is the profit margin

Value of work = (1+0.01) cost of work

= 1.10 times cost of work

Cost of work = (1/1.10) Value of work

= 0.91 times the Value of work

• Profit margin could be uniform on all items of contract or varying for different items.

• In a front loading strategy, profit margins are kept more on early items like foundations

and structural works to improve positive cash flow.



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Cumulative cost and cumulative value

• Profit margin could be uniform on all items of contract or could be kept varyingfor different items.

• In a front loading strategy, profit margins are kept more on early items likefoundations, structural works to improve positive cash flow.

Cumulative value with uniform profit

C o s

t

CumulativeValue

P r o f i t

Period

Cumulative

Cost



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Cumulative cost and cumulative value

Cumulative value with front loading strategy

C o s t

Value

Period

Cost



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Cost histogram and cumulative cost profile

• Cost histogram represents the cost incurred during specified intervals (weeklyor monthly) over the project period.

• The cumulative costs at specified intervals are obtained as sum of the previouscosts and the cumulative cost profile is developed. The end point of cumulativecost profile is the project total cost.

0

50

100

Project Period (Months)

C o s t s

Cost Histogram

Cumulative Cost Profile

C o s

t s

Monthly Costs 50 60 70 80 60 50 40 20

Cumulative Costs 50 110 180 260 320 370 410 430

0

100

500

400

300

200

0 M1 M2 M3 M4 M5

Months M1 M2 M3 M4 M5 M6 M7 M8

M6 M7 M8

M1M8

M2 M3

M4

M4M5 M6

M7



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Project S curve

• Project S-curve represents the cumulative cost profile of a construction project.The profile follows a lazy S-curve pattern indicating less cost incurrence in theearly and end part and more cost incurrence in the middle part of the project.

• The S-curve cumulative cost profile is obtained through 1/4th-1/3rdrule

meaning;• 1/4th cost (25%) incurred in the first 1/3rd time

• 1/2 cost (50%) incurred in the middle 1/3rd time

• 1/4th cost (25%) incurred in the last 1/3rd time

%

C u m u l a t i v e C o s t s

0

20

100

80

60

40

1/3

T

2/3T T

120

Time Period



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Project S curve

• The shape of S-curve could vary depending upon the project characteristics.

• Construction types using prefabrication technology involve more costs in the

initial fabrication period compared to installation costs in the later period.

%


0

20

100

80

60

40

120

1/3T 2/3T T

Time Period



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Project S curve

• Example problem on S-curve

• A project costing 80 lakhs is planned to be completed in 6 months period. Determine themonthly and cumulative cost requirements using standard S-curve principle.

• Note: With linear cost variation assumed between the periods

Months 1 2 3 4 5 6

Monthly Costs 10 10 20 20 10 10

Cumulative Costs 20 60 80

%


2 0

4 0

2 0

8 0

20

10

30

40

50

60

70

80

90

20

80

60

Period



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Project S curve• Use of S-Curve

• Standard S-curves are used for obtaining approximate the cash forecasts duringthe early stages of the project like feasibility studies, tendering stage.

•Cash flow forecasting of different types of projects like offices, residences,factories, roads and bridges developed from the cost data of past projects forusage in the early stages of similar new projects.

%

C u m

u l a t i v e C o s t s

0

20

100

80

60

40

1/3

T

2/3T T

120

Period



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Need for Cash Flow Forecasting

•Cash flow forecasting is necessary to establish the financial viability of the investmentproposal during pre-project phase of the project.

• Economical analysis of projects using methods like Net Present Value (NPV), InternalRate of Return (IRR) require reasonable estimation of cash outflows (expenditurestreams) and cash inflows (revenue streams) over the project life period.

• Adverse situations (risks) that may occur on cash flows needs to be evaluated topredict the impact of these risks on the financial outcome of the project.

• As lenders of money, financial institutions carry out detailed appraisal on theprojected cash flow of the project to evaluate and decide on financing

• Financial viability

• Ability to pay the interest and repay loan

• Adequacy of equity contribution by borrower (debt-equity ratio)



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Need for Cash Flow Forecasting in PPP projects

• For PPP projects implemented through BOT basis (or itsvariants), cash flow forecasting during concession period ofthe contract is of utmost importance for evaluating thefinancial viability of these projects with the consideration of

risks that would impact on the cash flow streams.• BOT projects have long concession periods with uncertainties

in revenue stream and inflationary effects.



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Need for Cash Flow Forecasting for Contractors

•Cash flow forecasting is essential for construction contractors in the following stages:

• Tendering (bidding) stage

1. To plan the bidding strategy with desired profit margin, cash flowforecasting is necessary taking into consideration the financial conditionsgiven in bid document that would have bearing on cash flow like advances,retentions, intervals of valuation of works and progressive payments andlikely payment delays that would increase negative cash flow.

2. To decide on the capital requirements for the project under bidding.

3. Cash flow positions and commitments of projects already in hand.

4. Finally to decide on participation or otherwise in the bidding process.

• On successful bidding and contract award

1. To workout the quantum and timing of cash requirements and plan theanticipated expenditure on various resources (workforce, material,

equipment, subcontractors etc)



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Need for Cash Flow Forecasting for Contractors

• On successful bidding and contract award

1. To workout the quantum and timing of cash requirements andplan the anticipated expenditure on various resources (workforce,material, equipment)

2. To plan the material procurement strategy (cash or credit)

3. To plan the equipment resource (ownership or hire purchase).

4. To plan direct employment of labour force or through outputbased labour contracts.

5. To decide on subcontractors and payment terms.6. To plan for the modes of providing securities/ warranties through

cash recovery from bills or through bank guarantees.

7. To workout the quantum of overall investment and plan theworking capital requirements for meeting the cash deficits.

8. To plan for the short term financing options from the banks for the

working capital requirements taking into considerations therepayment terms and interest payable (cost of capital).

9. Ultimately to predict the desired profits on project completion.



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Typical project risks affecting the project cash flow

1. Payment related risks:a) Payment delays by the client.

b) Disputes/ conflicts in the interpretation of contract conditions causingpayment delays (ambiguous contract conditions)

c) Change orders not promptly processed causing days in payments

2. Materials and equipment related risks

a) Scarcity of materialsb) Abnormal increase in cost of materials

c) Non-availability of workforce

d) Problems related to equipment

3. Large changes in project scope/ client requirements

4. Delays in project approvals by statutory bodies (works awarded in anticipation of

approvals)

5. Delays in the issues of designs/ drawings by the client

6. Site not clear for taking up of the construction (work awarded in anticipation ofclear site availability)

7. Large scale changes in quantities of items



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Steps involved in cash flow forecasting

1. Collection of project details

a) Project time plan (project schedule)

b) Bill of quantities with contract rates of items (value of items)c) Financial conditions of the contract related to advances, payment terms,

reimbursement for escalations, penalties, etc.

d) Other relevant details having bearing on project cash flow.

2. Prepare the project schedule in the form of bar chart with activity listings anddurations. Schedules prepared using network techniques are consolidated in bar chartformats.

3. Determine activity costs from the itemized costs available in the bill of quantities. Oneor more item costs may constitute an activity cost. A raft foundation activity will involveitems of reinforcement, shuttering and concreting items.

4. Determine the proportional costs that are expended per unit duration (per month) ofan activity. For some activities the expenses may not be in a linear proportion over theactivity duration. Such breakup of activity cost within its duration is important for

activities which consume more resources/ cost in the early part and less cost in thelater part of the activity duration. For example activities involving procurement andinstallation of electrical/ mechanical works involve more cost for procurement and lesscost for installation. In such cases it may be better to keep procurement and installationas separate activities.



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5. For expenses towards overhead charges, the total cost under this subhead may bedistributed equally over the project periods.

6. Calculate the monthly (or any other unit period) cost expenditure of the project bysumming up the cost expenditure of different activities during the month underconsideration. This means sum the portions of activity costs of different activitiesincurred during each monthly interval of the project. These monthly costs areshown in the first row of the table at the bottom of the bar chart. Calculate the

cumulative monthly costs and show in the second row of the table. (See Fig).Thesecalculations could also arranged in excel format.

7. If the value of the activities (which is based on item wise contract cost whichincludes profit margin) is used for the generation of cumulative value of works in asimilar manner described above, then cumulative cost of work is obtained by usingthe relation:

Cumulative cost = cumulative value/(1 + percentage profit in decimal)



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8. Having calculated the period wise (monthly) cumulative value and cumulative costof the work over the project period, the remaining calculations for determiningthe monthly cash inflows due to receipts, outflows due to disbursements andcumulative net cash flow could be worked out in a excel sheet formatincorporating the following details;

• Recovery of retention money (outflow) and its subsequent release (inflow)

• Breakup of the costs into its components (labour, material, equipment,

subcontractors) and their cash outflows based on the timings of theirdisbursements.

9. The above steps completes the procedure of developing the cash flow forecastingof a construction project for a contractor. The above procedure enablesdetermination of working capital requirements, profitability, assessment of impactof risks like delayed payments from the client.

10. The procedure is illustrated through a numerical example.



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Calculation procedure for cash flow forecasting in excel format

Rows related to cumulative values, retention money recovery and retention moneyrelease:

Row 1—Enter month wise cumulative values of work.

Row 2—Enter cumulative values of work less retention money

Row 3—Enter receipts of monthly payments less retention money with respect to billingcycle usually one month after the value of work executed.

Row 4—

Enter cumulative values of retention money received back, 50% one month afterend of project execution and balance 50%, 6 months after project execution (defect liabilityperiod)

Row 5 – Cumulative cash inflow (3+4)



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Rows related to cumulative costs, breakup of costs into components

Row 6—Enter cumulative costs (direct costs)

(Derive from cumulative value with assumption on profit percentage)

Row 7—

Enter cumulative labour costs.Make suitable assessment of the labour cost as fraction of total cost (say 25%) paid at theend of each month right from project starting month.

Row 8 – Enter cumulative labour payment made

Row 9—Enter cumulative material costs

Row 10 – Enter cumulative material payment made

Make suitable assessment on the material cost component (say 50%) and decide on thepayment to material supplier (say one month after the receipt of the payments from theclient)

Row 11—Enter cumulative equipment component (say 15%) and payment cycle similar tomaterial supplies

Row 12 –Enter cumulative equipment component payment made

Row 13—Enter cumulative subcontractor cost (say 15%)

Row 14 – Enter cumulative subcontractor payment made

Payment cycle similar to equipment material supplies

Row 15 – Cumulative cash out flow (8+10+12+14)

Row 16 – Cumulative net cash flow

Note: The payment cycle to material supplier, equipment charges and subcontractor could be changed as per projects ecific arran ements


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Rows related to cumulative cash inflows, cash outflows and net cash flowRow 10—Addition of rows 3 and 4 gives total cumulative cash inflows

Row 11—Addition of rows 6,7, 8 and 9 provide total cumulative cash outflow

Row 12—The difference between row 10 (cash inflow) and row 11 (cash outflow) providesthe net cash flow.

Net cash flow diagram

C a s h F l o w

Negative cash

flow period

Positive cash

flow period

Peaks due to

release of

retention

money P r o f i t

Project Period



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1 : CASH FLOW STATEMENT WITH OUT DELAY IN PAYMENT (WITH 15% PROFIT )

Time (months) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

1 Cumulative Value 1.15 2.88 5.75 8.63 11.50 14.38 17.25 23.00 28.75 30.48 31.05 31.63 31.63 31.63 31.63 31.63 31.63 31.63

2

Cumulative Value less retention money

recovered 1.035 2.587 5.175 7.762 10.35 12.937 15.525 20.7 25.87 27.427 27.945 28.462 28.462 28.462 28.4625 28.4625 28.4625 28.4625

3Cumulative payment received after 1 month

of Billing cycle1.035

2.587

55.175

7.762

510.35 12.9375

15.52

520.7 25.875 27.4275 27.945 28.4625 28.463 28.463 28.463 28.463 28.463

4 Cumulative retention money received back 0 0 0 0 0 0 0 0 0 0 0 0 1.581 0 0 0 0 3.162

5 Cumulative Cash Inflow (Receipt) (3 + 4) 0 1.035 2.587 5.175 7.762 10.35 12.937 15.52 20.7 25.875 27.427 27.945 30.043 28.463 28.463 28.463 28.463 31.625

6 Cumulative C ost 1.00 2.50 5.00 7.50 10.00 12.50 15.00 20.00 25.00 26.50 27.00 27.50 27.50 27.50 27.50 27.50 27.50 27.50

7 Cumulative Labor Cost (25%) 0.250 0.625 1.250 1.875 2.500 3.125 3.750 5.000 6.250 6.625 6.750 6.875 6.875 6.875 6.875 6.875 6.875 6.875

8 Cumulative Labor payment 0.250 0.625 1.250 1.875 2.500 3.125 3.750 5.000 6.250 6.625 6.750 6.875 6.875 6.875 6.875 6.875 6.875 6.875

9 Cumulative Material cost(40%) 0.400 1.000 2.000 3.000 4.000 5.000 6.000 8.000 10.00 10.600 10.800 11.000 11.000 11.000 11.000 11.000 11.000 11.000

10 Cumulative Material payment made 0 0.400 1.000 2.000 3.000 4.000 5.000 6.000 8.000 10.000 10.600 10.800 11.000 11.000 11.000 11.000 11.000 11.000

11 Cumulative equipment cost(20%) 0.200 0.500 1.000 1.500 2.000 2.500 3.000 4.000 5.000 5.300 5.400 5.500 5.500 5.500 5.500 5.500 5.500 5.500

12 Cumulative Equipment payment made 0 0.200 0.500 1.000 1.500 2.000 2.500 3.000 4.000 5.000 5.300 5.400 5.500 5.500 5.500 5.500 5.500 5.500

13 Cumulative Sub contractor cost(15%) 0.150 0.375 0.750 1.125 1.500 1.875 2.250 3.000 3.750 3.975 4.050 4.125 4.125 4.125 4.125 4.125 4.125 4.125

14 Cumulative subcontractor payment made 0 0.150 0.375 0.750 1.125 1.500 1.875 2.250 3.000 3.750 3.975 4.050 4.125 4.125 4.125 4.125 4.125 4.125

15 Cumulative cash out flow(8+10+12+14) 0.250 1.375 3.125 5.625 8.125 10.625 13.125 16.25 21.25 25.375 26.625 27.125 27.500 27.500 27.500 27.500 27.500 27.500

16 Cumulative Net Cash flow(5-15) -0.250 -0.340 -0.538 -0.450 -0.363 -0.275 -0.188 -0.725 -0.550 0.500 0.803 0.820 2.544 0.963 0.963 0.963 0.963 4.125

Example on cash flow forecasting


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-5.00

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Cumulative Value Inf low after 1 month of Billing cycleCumulative Cost Cumulative cash out f low (7+9+11+13)Cumulative Cash (Net) f low (3+4-14)

Fund Requirementbased on Negative

Cash flow

= area of graph of

negative cash flow

region

= average vertical

coordinate x base

= .409 X 8 =

Rs.3.27lakhs

Hence the contractor

has to mobilize of Rs.3.27 lakhs during the

period of negative

cash flow

example

cash flow forecasting 29th october 2015f

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