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Dawit WorkyeADDIS ABABA UNIVERSITY
SCHOOL OF GRADUATE STUDIES
ADDIS ABABA INSTITUTE OF TECHNOLOGY
DEPARTMENT OF CIVIL ENGINEERING
Construction Cash Flow Management Practice In Selected
Leading Local Construction Companies
KASSAHUN MEREAWI
Advisor: Prof. Dr.-Ing. Abebe Dinku
A Project Submitted to School of Graduate Studies in Partial Fulfilment
of the Requirements for the Degree of Master of Science in Civil
Engineering (Construction Technology and Management)
April 2016
Addis Ababa
ADDIS ABABA UNIVERSITY
SCHOOL OF GRADUATE STUDIES
ADDIS ABABA INSTITUTE OF TECHNOLOGY
DEPARTMENT OF CIVIL ENGINEERING
Construction Cash Flow Management Practice In Selected
Leading Local Construction Companies
By
KASSAHUN MEREAWI
APPROVED BY DESK OF EXAMINERS:
Prof. Dr.-Ing. Abebe Dinku ____________ ___________
ADVISOR DATE SIGNATURE
__________________ ____________ ___________
INTERENAL EXAMINER DATE SIGNATURE
__________________ ____________ ___________
EXTERENAL EXAMINER DATE SIGNATURE
__________________ ____________ ___________
CHAIR PERSON DATE SIGNATURE
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ACKNOWLEDGMENTS
First of all, I am indebted my special thanks to the almighty GOD for empowering and giving me
internal courage and strength to accomplish my educational career one step further. And more
this project wouldn’t have been possible without support of many people. Many thanks to my
advisor, professor Dr.‐Ing. Abebe Dinku, who helped me make some sense of a paper by
offering guidance and valued supports. I owe my special thanks to Engineer Tsegay Okubu, a
very experienced planning expert, for his meticulous comments on the current practice of cash
flow management and clearly identification of gaps on the practice. I am also grateful to all
those who participated in the questionnaire survey. And finally, thanks to my wife, parents and
work colleagues who endured this time with me, always offering support and love.
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ABSTARCT
Construction industry is a one of the most risky sectors due to high level of uncertainties
included in the nature of the construction projects. Although there are many reasons, the
deficiency of cash is one of the main factors threatening the success of the construction
projects and causing business failures. Therefore, an appropriate cash planning technique is
necessary for adequate cost control and efficient cash management while considering the risks
and uncertainties of the construction projects.
The main objective of this project therefore is, to assess the current practice of construction
cash flow management in the local construction industry. Accordingly, five leading
construction companies are selected who have the largest stake in the building construction
sector. It is tried to see the gaps in the subject matter through detail literature review and
consultation of reputed professionals in the industry.
The paper is organized in to four chapters. The first chapter talks about the introductory part
with sub‐topics; background, statement of the problem, research questions, objective, scope
and methodology. The second chapter discusses about the literatures review which is the
major part of the paper. The third chapter, which is responsible part to show the practice on
the local industry, contains the data collection and the discussion of findings. Finally,
conclusions and recommendations are forwarded after analyzing the literature and
international experience with the local practice. When you go through it, hopefully you find it
valuable and I think it adds a little thing in the industry by serving as a secondary data for
further research works in the area.
Key Words: Cash flow management, Cash in, Cash out, Cash flow prediction, cash deficiency
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TABLE OF CONTENT
ACKNOWLEDGMENTS......................................................................................…......i
ABSTARCT………………………………………………………………………………………….……..……......ii
LIST OF TABLES AND FIGURES………………………………………………………………...…….....iii
1 INTRODUCTION………………………………………….……………….……………….…………....1
1.1 General………………….…………………………………………………………………...………….1
1.2 Statement Of The Problem………………….…………………………………......…………3
1.3 Research Questions…………………….…………………………………………….....………..3
1.4 Objective Of The Project……………………………………………………………………......4
1.5 Scope Of The Project And Limitations……………………………………...……………..4
1.6 Methodology…………………………………………………………….………….………………..5
2 LITRATURE REVIEW………………………………………………………….…………….……….....6
2.1 Overview And The Need For Cash Flow Forecasting By Contractors.……...6
2.2 Cash Flow Management Approach And Forecasting Methods……….….…...9
2.3 Project Contract Cash Flow…………………………………………………….…..…..…...15
2.3.1 Construction Project Costs……………………………………….....……..16
2.3.2 The S‐Curve………………………………………………………….…..………...18
2.3.3 Project Income……………………………………………………..…..….…….19
2.3.4 Calculating Of Cash Flow……………………………….………..…………..21
2.4 Strategies to Minimize Contractors’ Cash Flow Deficit Cash Flow….…..…23
2.5 Factors Affecting Cash Flow Predictions…………………………….…………..….…25
2.6 Literature Summary..................................................................................28
3 DATA COLLECTION AND DISCUSSIONS………………………………………………..…….30
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3.1 Data Collection………………………………………………………………….…….…………...30
3.2 Why Cash Flow Forecasting For Local Construction Industry……..………….31
3.3 Local Practice On Usage Of Forecasting Methods…….…………..……....……..31
3.4 Local Practice On Strategies To Alleviate Of Cash Deficit……..…..…….….…34
4 CONCLUSION AND RECOMMENDATIONS…………………………………..…..….……..39
4.1 Conclusions …………………………………….…………………………….…………….……....39
4.2 Recommendations…………………………………………………………….….…………..….41
REFERENCES………………………………………………………………………….……….………………....43
APPENDIX A: Questionnaire...................................................................................45
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LIST OF TABLES AND FIGURES
List of Figures
Figure 1‐ Construction cash flow concept ………………………………………………………………………………….9
Figure 2 ‐Project cost and expense curve .............................................................................…... 18
Figure 3‐ A sample S curve ...........................................................................................................19
Figure 4 ‐Project revenue and income curve ...............................................................................20
Figure 5‐ Cash flow based on monthly payments ........................................................................21
Figure 6 ‐Effect of advance payment on improving cash flow .....................................................21
List of tables
Table 1‐ Surveyed construction firms’ status ...............................................................................31
Table 2‐ Extent usage of cash flow forecasting method ..............................................................32
Table 3 ‐Cash deficit resolving strategies .....................................................................................34
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1. INTRODUCTION
1.1 GENERAL
During the past five years (first growth and transformation plan of Ethiopia) the Ethiopian
government and private sectors have been investing hugely in the development of
infrastructures. Building construction projects of housing development, educational institutes
expansion projects, different public organizations offices, private multipurpose buildings and
other buildings were among those infrastructures built by grade one contractors.
Experience and various reports indicate that the performances of these projects were recurrent
and serious problems were addressed. That is, most of these projects were not implemented as
per expectations or used to face considerable performance variance on timely completion. The
evidence from many projects revealed that these problems are not being adequately dealt
with. One of the problems addressed is contractor’s cash flow management ineffectiveness [1].
In my experience, inadequately detailed planning practice and abuses on cash utilizations are
major contributors for cash shortages in construction undertakings which this paper has tried to
find finally.
As cash is one of the resources in executing building projects and cash flow forecasting is based
on planned site activities, the chances of inability to meet cash flow requirement, during
construction stage, can cause incapability in financing projects and difficulty in delivering
projects on time [2].
A cash flow forecast shows the anticipated income and expenditure of the business and
resulting surplus or shortfall which will occur each month. While a thorough knowledge of your
business profitability is vital, it is even more important to know the state of the business cash
flow i.e. where your money is, where it is coming from and where it is going to. Many
businesses fail because they fail to control their cash flow. [3]
A cash flow can be used as follows:
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It establishes how much money is needed and when it will be needed
It helps to ensure that capital expenditure is properly controlled (e.g. the 'what if'
situation)
It encourages efficient use of resources through budgeting and the analysis of over and
under spending
It helps with facing facts and decision making.
Generally, cash flow management is all about balancing the cash coming into the business with
the cash going out. The danger is that demands for cash, from the suppliers, employees or the
subcontractors, arrive before cash you are owed is collected. More often, cash inflows seem to
lag behind your cash outflows, leaving your business short. This money shortage is your cash
flow gap.
By understanding cash flow and planning ahead, we can avoid problems and shortages, provide
stability to our organizations, and take advantage of opportunities to purchase capital assets
and build organizational capacity. Managing cash flow is not a one‐time activity. Projections
should be updated and reviewed regularly. The frequency will depend on how closely the
organization’s cash flow needs to be monitored.
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1.2 STATEMENT OF THE PROBLEM
The reputation of construction industry as a high‐risk business is due to the high level of
business failures which is far beyond those in many other industries. While these failures result
from the combination of several factors, the financial‐related causes account for a considerable
proportion of them, manifesting themselves in low returns, losses and, in some cases,
liquidations. Even profitable construction companies can fail due to poor cash flow
management [3].
Construction industry is a one of the most risky sectors due to high level of uncertainties
included in the nature of the construction projects. Although there are many reasons, the
deficiency of cash is one of the main factors threatening the success of the construction
projects and causing business failures [4].
Business failure of the construction companies is the most important result of the fragile
structure of the construction sector. Although there are various reasons of business failure,
according to many construction management researches like Peer and Rosental (1982), Pate
Cornell et al. (1990), Singh and Lakanathan (1992), Kaka and Price (1993), Boussabaine and Kaka
(1998), the main reasons of the bankruptcy of the construction companies is the inefficient
control and management of cash. Therefore, controlling and regulating the movement of the
cash is necessary for the success of the construction projects.
Companies fail because of poor financial management, especially inadequate attention to cash
flow forecasting. It is common consensus that cash flow management and liquidity are key
elements in the survival of contractor [5].
1.3 RESEARCH QUESTIONS
The paper has the following questions that has been tried to address.
1) How do some selected local contractors manage their cash flow?
2) What is the current practice of cash flow management in the local construction
industry?
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3) How do contractors mitigate for cash shortages?
4) What methods and mechanisms shall be deployed as a solution?
1.4 OBJECTIVE OF THE PROJECT
The aims of the project are listed below:
1) To assess the current practice of construction cash flow management of some
selected leading local construction company’s and its impact on project
performance.
2) To identify the international practices.
3) To forward recommendations or methods that improve cash flow forecasting for
better project performance with regard to time and cost and,
4) To serve as a secondary data for those interested to do detail research in the area.
1.5 SCOPE OF THE PROJECT AND LIMITATIONS
This project on cash flow management in the construction industry of Ethiopia is limited in
scope to the following:
1) The study is limited to the cash flow management of selected leading grade 1
contractors working on building construction projects.
2) Only contractors’ perspective is considered in the research, hence from the client’s
organization and consultant’s perspective could be totally different. But clients’ cash
flow will be seen as it affects contractors’ cash flow.
3) The study covers on cash flow practice of selected local contractors participating on
building construction projects.
4) The study focuses on cash flow management without including discounted cash flow
and time value of money.
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One of the limitations of this project is a small number of highest grade contractors
registered in the federal government are being under the study. Those that are registered
on regional basis and lower grade contractors are not part of this paper as time is
inadequate and no budget is allocated. Research made locally in the specific area couldn’t
be found and it makes difficult to really show the negative impact objectively in this short
period of time.
1.6 METHODOLOGY OF THE STUDY
This project paper is started with unstructured preliminary literature review during proposal
preparation: to get an in depth knowledge of the subject area attributed to construction cash
flow management; to assess the level of existing knowledge and identify gaps to select project
title and identify suitable research methods for data collection and analysis.
The primary data is collected with questionnaire desk interview of experienced professionals
from selected leading local contractors. The contractors being selected are those who are
performing well and with highest annual gross revenue. Accordingly, five local construction
companies are selected and two experienced professionals from each companies are requested
to fill the forms with desk interview. Besides, some highly experienced construction
professionals with lots of exposure in building constructions which are not working in the
selected contractors are consulted and their feed backs are being used.
The data collected from questionnaire survey studies is analyzed and discussions made based
on the findings of the analysis. Finally, conclusions is made and recommendations are
forwarded according to the gaps seen between the literature and the local practice.
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2. LITERATURE REVIEW
2.1 OVERVIEW AND THE NEED FOR CASH FLOW FORECASTING BY CONTRACTORS
Execution of construction projects can make substantial demands on a contractor’s cash.
Initially, the contractor faces mobilization of workers and equipment, and setting up costs. The
contractor’s expense on a project typically exceeds its monthly progress payment income over
an appreciable part of the construction period. The cash deficit on the project must be made up
from the contractor’s working capital, or money must be borrowed to provide the necessary
operating funds. ‘Cash flow’ refers to a contractor’s income and outlay of cash. The net cash
flow is the difference between disbursements and income at any point of a time. A negative net
cash flow means disbursements are exceeding income which is a usual situation on even a
highly profitable project during the greater part of its duration [6].
A determination of the future rates of cash disbursements and cash income, together with their
combined effect on the project cash balance, is called a cash flow forecast. It is the intent of the
contractor to accrue income faster than it accrues costs. At the end of the project, this
difference represents the contractor’s profit. The problem is that the cost of the work put into a
project is not directly related to the resulting income. Additionally, the time delays between the
accrued costs and the cash disbursement are not the same as the time delays between the
accrued income and the cash receipts.
To forecast the amount of money the contractor must invest in the project, it is necessary to
estimate the amount and the timing of the cash disbursements and the cash receipts. The cash
flow projection approximates the progress payments for each payment period during the
construction contract. This projection is used by the owner to make financial arrangements,
which makes funds available for the payments and optimizes investment opportunities. The
contractor uses the cash flow projection for anticipating revenue for future periods [6].
Projection of cash flow is directly related to the construction schedule which is a cost estimate
of planned activities and achievements at the site. Many factors influence the actual amount of
interim payments which may produce variances from the projection; i.e. late or early delivery of
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materials; late or early completion of work activities; revisions in sequencing of work activities;
and the unequal completion of work activities as planned.
Studies and investigations have shown that lack of liquidity is a major problem causing
construction project failure. A model for accurately predicting trends in a project’s cash flow
prior to the construction phase has been a prevailing challenge. But, early knowledge of the
factors affecting cash flow and an understanding of the impact is essential to the contractor.
Throughout the construction process, contractors need to be comparing the actual income and
expenses against the forecasted values. If there are discrepancies between these values, the
contractor needs to adjust the schedule and update the project plan to match the estimated
situation as early on as possible. With good knowledge of cash flow forecasting, the contractor
could more efficiently and accurately manage cash flow during the construction process to
prevent extra costs and avoid project failure [7].
According to (Peer, 1982; Singh and Lakanathan, 1992), financial management has long been
recognized as an important management tool and proper cash flow management is crucial to
the survival of a construction company because cash is the most important corporate resource
for its day‐to‐day activities.
A proper cash flow management is also important as a means to obtain loans, as banks and
other money lending institutions are normally much more inclined to lend money to companies
that can present periodic cash flow forecasts (Navon, 1995). However, construction industry
suffers the largest numbers of bankruptcy of any sector of the economy with companies failing
because of poor financial management, especially inadequate attention to cash flow
management (Boussabaine and Kaka, 1998; Calvert, 1986; Harris and McCaffer 2001).
One of the final causes of insolvency is inadequate cash resources and failure to convince
creditors and possible lenders of money that this inadequacy is only temporary. The need to
forecast cash requirements is important in order to make provision for these difficult times
before they arrive (Harris and McCaffer, 2001).
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Cash flow forecasting according to McCaffer (1976) provides a good warning system to predict
possible insolvency. This according to him enables preventive measures to be considered and
taken in good times. In times of high interest rates the need for cash flow forecasting is even
more important and Sandilands, in his in his inflation accounting report to government,
highlighted the need to forecast cash flow in times of inflation and thus avoid an embarrassing
cash deficit when replacing old equipment at new inflated costs.
There is evidence that some smaller companies confuse profit flows with cash flows and make
misleading calculations (Harris and McCaffer, 2001). A cash flow is the transfer of money into or
out of the company. The timing of cash flow is important. There will be a time lag between the
entitlement to receive a cash payment and actually receiving it. There will be a time lag
between being committed to making a payment and actually paying it. These time lags are the
credit arrangement that contractors have with their creditors and debtors. It is these credit
arrangements, stock levels and depreciation that make cash and profit different.
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2.2 CASH FLOW MANAGEMENT APPROACHES AND FORECASTING METHODS
Cooke and Jepson (1986) defined cash flow as the actual movement of money in and out of a
business. Money flowing into a business is termed positive cash flow and is credited as cash
received. Monies paid out are termed negative cash flow and are debited to the business. The
difference between the positive and negative cash flows is termed the net cash flow as shown
in the figure below.
Net cash flow
Positive cash flow Negative cash flow
(Interim payments) (Disbursements)
Variously known as variously known as
Earnings Liability
Income Expenditures
Value Cost
Cash in Cash out
Derived from Expended on
Material Material
Labor Labor
Plant Plant
Sub‐contractor Sub‐contractor
Mobilizations Mobilizations
Overheads
Overheads
Figure 1 Construction cash flow concept (Source: [7]).
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Mawdesley et. al. (1997) emphasized the need for financial plan in cash flow management. This
according to him would normally represent the planned position throughout a project and as
such would be concerned with the income, expenditure and net cash flow. According to him,
this enables the cash flow situation to be monitored using approaches such as pre‐project cash
flow plan or forecast, project phase monitoring/updating and monthly cost/value
reconciliation.
Kaka and Boussabaine (1999) and Mawdesley et. al. (1997) emphasized the need to update
cash flow forecast in the course of a project. The suggested frequency of updating cash flow
forecast from these and other authors include weekly update, monthly and quarterly. Cormican
(1985) is however of the opinion that updates should be done when the deviations from the
existing plan are such that the existing plan is meaningless or when the client requests an
update.
The traditional approach to cash flow prediction usually involves the breakdown of the bill of
quantities in line with the contract program to produce an estimated expenditure profile. This
could be expected to be reasonably precise provided that the bill of quantities is accurate and
the contract program is complied with (Lowe, 1987). Although this traditional approach is
presently being supplemented with the use of computer spreadsheet, it is likely to be slow and
costly to produce; as such, several attempts have been made to devise a ‘short cut’ method of
estimation, which will be both quicker and cheaper to utilize.
Attempts have been made at the mathematical formulae and statistical based modeling of
construction cash flow in both the contractor and client’s organizations. This was demonstrated
by the development of a series of typical S‐curves by many researchers (Kaka and Price, 1993).
The models obtained by these researchers rest on the assumption that reasonably accurate
prediction is possible by means of a single formula utilizing two or more parameters which may
vary according to the type, nature, location, value and duration of the contract.
Kenley (2003) identified other cash flow forecasting methods to include the cost and value
approach and the integrated system e.g. the cost/schedule integration. Kenley, developed a
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‘Logit net cash flow’ model using actual component inward and outward cash flow data in order
to form a residual cash flow model. While developing the model, he had recognized the
stepped nature of cash flows and although it was quite suitable for representing real data, he
felt that it could not be represented for any form of modeling, forecasting or simulation. He
therefore smoothened the steps to remove the jagged nature of the net cash flow. Kenley’s
model was based on empirical project data that used the actual component inward and
outward cash flow data in order to form the residual model. This model had adopted the Logit
gross cash flow model by Kenley and Wilson, to model the component curves. When combined,
the component curves form a net cash flow model reflecting the true net cash position for each
project. The final model is still based on smoothened out ‘S’ curves instead of step curves.
Park, Han & Russell (2005) attempted to estimate cash flows by categorization of different
project activities on the basis of time lags involved between their physical occurrences of
different stages and the related cash flows and identifying the characteristic movement of
cumulative cash flow against time of the activity. Various cost categories were identified for
material, labor, equipment, sub‐contracts and overheads and depreciation since each of these
categories had a different time lag and a cash flow profile. Typical ‘cash flow curves’ were
developed for each of the different categories based on moving weights system and were
converted to mathematical equations for cash inflows and outflows. The overall cash flows
were worked out by consolidating these equations to the project schedule.
Jarrah, Kulkarni & O’Connor (2007) collected actual cash flow data in form of monthly account
summary reports for various projects under Texas Department of Transportation. The sample
consisted of different category of projects such as construction and replacement of bridges,
new non‐freeways, road overlay and rehabilitation of existing roads, landscape scenic
enhancements, widening of freeways etc. Projects were further classified in different cost
ranges. Based on the scatter chart of payments against time for different projects in a given
category, a fourth degree polynomial regression analysis was used to obtain the cash flow
curves that turned out to be characteristic ‘S’ shaped for most of the projects. Although
statistical significance could not be proved due to limited availability of data, a feasible
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approach for cash flow prediction was established. Since the data was related to payments to
the contractor, only the cash inflow curves could be established. Extending the same
methodology to data for contractor’s cash outflows, there appears to be a possibility of working
out net working capital gap.
A model developed by Görög (2009) suggested a set of new measurements and indicators in
line with the ‘earned value’ measurements and indicators, for possible integration of both
systems. Therefore similar to the earned value measurements such as Budgeted Cost of Work
Scheduled (BCWS), Budgeted Cost of Work Performed (BCWP) and the Actual Cost of Work
Performed (ACWP) for working out the Cost Performance and Schedule Performance Indices
(CPI and SPI); the new set of measurements and indicators was based on the ‘Price Value’ and
‘Invoice Value’ of the contracted work. This could therefore forecast the difference between
price to be received by the contractor from client and the cost to be expended by the
contractor for the amount of work carried out at any point of time. Hence the differential
indicated expected margin based on project status. Since the methodology explained in the
model worked out the values on accrual basis and did not recognize the time difference in their
occurrence and therefore could not be found useful to forecast and monitor cash flows in
financial sense.
A software ‘FINCASH for Windows’ developed by CSIRO, Australia, that was specifically
designed for project cash flow management was compared by O’Leary and Tucker , with
present methods for cash flow projections using project management software such as
Primavera P3, Suretrak and Microsoft Project. FINCASH made use of a library of cash flow ‘S’
curve profiles that were characteristic of the particular type of project under consideration.
These cash flow profiles were developed on the basis of past experience and amenable to
modification and refinement as more data becomes available. This eliminates the need for
specifying cash flow profiles for individual activities as is the case with other project
management software and hence was claimed to be easier to use. However the FINCASH
software has the same limitation like other project management software i.e. it gives only the
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cash outflows based on costs and associated time lags in payments, but does not account for
the cash inflows that are very important for the contractor [8].
A computer program CAFFS (CAsh Flow Forecasting System) was developed by Hwee & Tiong
(2002) for predicting cash flow profile of a construction project. The program took into account
contractual factors in a project as well as working practices and trends that affect the project’s
cash flow. Impact of uncertainties and risks such as excess measurement, variation of contract,
cost fluctuation etc. could also be reflected on the cash flow profile. Internal Rate of Return
(IRR) based on monthly cash flows and maximum working capital requirement were the
primary outputs that could be most useful to the contractor and also act as indicators to
project’s performance. The input data such as contract value, duration, defect liability period,
percentage markup, payment delay period, retention limit and estimated proportions of
different cost groups (material, labor, equipment, subcontracts and overheads) were coupled
with typical ‘S’ curve profiles for different cost groups to develop a theoretical ‘S’ curve profile
for the project. Output of the program was cumulative monthly cash outflows and cash inflows.
The program could therefore be used for predicting the cash flows as the project progressed as
well as to understand the impact of risk factors on project cash flows.
The models carried out so far as seen above has always assumed cash flows as continuous
functions and have tried to fit them in different types of curves such as second, third, fourth or
fifth degree polynomials to see the best fit. It was also observed the cash flow curves were
always assumed to follow the sigmoid curves or more commonly known as ‘S’ curves that
generally represent typical expenditure curve or a ‘cost‐flow’ curve for a project. However, cash
flows in reality do not progress continuously, but occur at specific points of time. Therefore
mathematically, cash flows are not continuous functions but are step functions and any
projection made on the assumption of them being continuous functions would be inaccurate
and therefore unreliable in practice. While modeling cash flows as continuous functions may be
a mathematically reasonable approximation, it tends to average out the values occurring at
different times by a smooth curve and may hide the likely cash deficits that may occur between
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the two periods. This difference cannot be ignored since cash flow shortfall, even for an
extremely short duration of a few days, can have acute real consequences on a project [9].
Khosrowshahi (2000) reported the development of the Advanced S‐Curve (TASC), software to
aid cash flow forecasting. Other software includes Cybercube (developed in the UK). Generally,
the following construction cash flow forecasting methods and models are some among others:
Spread sheet ( MS Excel)
The detailed approach ( break down of bill of items into work/schedule )
Value approach (based on project value)
Cost approach (based on cost of input resources)
Short cut approach ( using models/library of S curves based on past similar projects )
Integrated systems ( e.g. cost/schedule integration)
Cybercube ( developed in the UK )
TASC ( the advanced S‐curve)
FINCASH (developed in Australia)
There are many more papers by researchers that try to further refine the process of cash flow
forecasting to bring it nearer to the real life situation, but still have their limitations for
universality in application. These cash flow models assume that only a few variables are
sufficient to derive an ideal construction project cash flow curve. However, each project follows
a unique process cycle that results in individual variation between projects that do not allow it
to be fitted into a standardized model [9].
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2.3 PROJECT CONTRACT CASH FLOW
According to (Harris and McCaffer, 2001), contractors who undertake cash flow forecasting do
so at two levels. One is at the estimating and tendering stage, when the forecast is just for the
single project being estimated. The other level is the calculation of a cash flow forecast for the
company, division area; this involves aggregating cash flows for all active projects and is done
regularly every quarter or every month.
These two types of forecasts require different treatments. The estimator has all the project
details at the estimating stages and, because the forecast applies only to one project, the
estimator can produce a carefully calculated forecast based on these details by allocating bill
items for activities on the pre‐tender bar chart or network. This creates a direct link between
the estimator’s build‐ups for each item with the pre‐tender construction program and follows
the production of value versus time and cost versus time curves from which cash‐in and cash‐
out can be calculated.
At the project level, a project’s cash flow is the difference between the project’s expenses and
income. At the construction company level, the difference between company’s total expense
and its total income over a period of time is the company’s cash flow.
Cash flow = Cash in – Cash out = Income - Expense
Forecasting cash flow is necessary for a construction company for the following reasons:
To ensure that sufficient cash is available to meet the demands.
It shows the contractor the maximum amount of cash required and when it will be
required. Thus, the contractor can made arrangements to secure the required cash.
It provides a reliable indicator to lending institutions that loans made can be repaid
according to an agreed program.
It ensures that cash resources are fully utilized to the benefit of the owner and investors
in the company.
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The three main components in determination of cash flow are:
Expenses (cash out) which represents the aggregate of the payments which the
contractor will make over a period of time for all resources used in the project such as
labor, equipment, material, and subcontractors.
Income (cash in) that represents the receipts a contractor will receive over a period of
time for the work he/she has completed.
Timing of payments: in cash flow analysis, the main interest is the timing of payments
related to the work done by the contractor.
2.3.1 CONSTRUCTION PROJECT COSTS
In preparing the cash flow for a project, it is necessary to compute the costs that must be
expended in executing the works using activities durations and their direct and indirect costs.
The principal components of a contractor's costs and expenses result from the use of labors,
materials, equipment, and subcontractors. Additional general overhead cost components
include taxes, premiums on bonds and insurance, and interest on loans. The sum of a project's
direct costs and its allocated indirect costs is termed the project cost.
The costs that spent on a specific activity or project can be classified as;
Fixed cost: costs that spent once at specific point of time (e.g., the cost of purchasing
equipment, etc.)
Time‐related cost: costs spent along the activity duration (e.g., labor wages, equipment
rental costs, etc.)
Quantity‐proportional cost: costs changes with the quantities (e.g., material cost)
Project direct costs are the costs and expenses that are incurred for a specific activity are
termed direct costs. These costs are estimates based on detailed analysis of contract activities,
the site conditions, resources productivity data, and the method of construction being used for
each activity. A breakdown of direct costs includes labor costs, material costs, equipment costs,
and subcontractor costs.
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Project indirect costs are other costs such as the overhead costs are termed indirect costs. Part
of the company’s indirect costs is allocated to each of the company's projects. The indirect
costs always classified to: project (site) overhead; and General (head‐office) overhead.
Project overhead – Project overhead are site‐related costs and includes the cost of items that
cannot be directly charged to a specific work element and it can be a fixed or time‐related
costs. These include the costs of site utilities, supervisors, housing and feeding of project staff,
parking facilities, offices, workshops, stores, and first aid facility. Also, it includes plants
required to support working crews in different activities.
A detailed analysis of the particular elements of site‐related costs is required to arrive at an
accurate estimate of these costs. However, companies used to develop their own forms and
checklists for estimating these costs. Site overhead costs are estimated to be between 5% ‐ 15%
of project total direct cost.
General overhead ‐The costs that cannot be directly attributed a specific project called general
overhead. These are the costs that used to support the overall company activities. They
represent the cost of the head‐office expenses, mangers, directors, design engineers,
schedulers, etc. Continuous observations of the company expenses will give a good idea of
estimating reasonable values for the general overhead expenses. Generally, the general
overhead for a specific contract can be estimated to be between 2% ‐ 5% of the contract direct
cost. The amount of the general overhead that should be allocated to a specific project equals:
Project direct cost x general overhead of the company in a year
Expected sum of direct costs of all projects during the year
Having identified the direct costs, indirect costs, then the project total cost equals the sum of
both direct and indirect costs. When studying cash flow, it is very important to determine the
actual dates when the expenditures (cost) will take place. At that time, the expenditures will be
renamed as the expenses. Figure 2 illustrates the difference between the costs and the
expenses. As shown in the figure, they are the same except the expenses are shifted (delayed)
than the costs.
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Cost Expense
Cost
Time
Fig. 2 (Project cost and expense curve)
2.3.2 THE S – CURVE
Due to their peculiar execution cycle, projects follow a sigmoid or ‘S’ curve pattern in their
progress from start to completion as compared to a steady level maintained by continuously
running manufacturing or trading activity. As per the standard accounting practice of booking
the cost on accrual basis, incurrence of cost on a project that is directly linked to the physical
progress of project activities is also proportional to the physical progress and therefore follow
the ‘S’ curve [9] .
It has also been established that the cash flows relating to the activities have different timings
than the incurrence of costs. For a contractor working on a project, the cost is incurred on a
continuous and regular basis while the payment for the work completed on a periodic basis is
received from the client after certain time lag as per the terms of the contract. Similarly,
payments for the materials, equipment and sub‐contractor also occur with a time lag except for
the advances given initially. Therefore it is generally assumed that the cash flows – inflows and
outflows – follow a pattern of ‘S’ curve albeit with a time lag from the ‘S’ curve for project
expenditure [9].
The curve represents the cumulative expenditures of a project direct and indirect costs over
time are called the S‐curve as it takes the S‐shape. In many contracts, the owner requires the
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contractor to provide an S‐curve of his estimated progress and costs across the life of the
project. This S‐shaped of the curve results because early in the project, activities are mobilizing
and the expenditure curve is relatively flat. As many other activities come on‐line, the level of
expenditures increases and the curve has a steeper middle section. Toward the end of a
project, activities are winding down and expenditures flatten again. The S‐Curve is one of the
most commonly techniques to control the project costs. Toward the end of a project, activities
are winding down and expenditures flatten again (Figure 3).
Cost
Time
FIG.3 a sample S curve
An S‐curve for a project can be developed using the following steps:
Constructing a simple bar chart for all the tasks of the project.
Assigning costs to each task using task duration.
Plotting the cumulative amounts of expenditures versus time by smoothly connecting
the projected amounts of expenditures over time.
2.3.3 PROJECT INCOME (CASH‐IN)
The flow of money from the owner to the contractor is in the form of progress payments.
Estimates of work completed are made by the contractors periodically (usually monthly), and
are verified by the owner's representative. Depending on the type of contract (e.g., lump sum,
unit price, etc.), these estimates are based on evaluations of the percentage of total contract
completion or actual field measurements of quantities placed. Owners usually retain 5% of all
validated progress payment submitted by contractors (PPA 2006). The accumulated retained
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payments are usually paid to the contractor with the last payment. As opposed the expenses
presented in Figure 3 with smooth profile, the revenue will be a stepped curve. Also, when the
contractor collects his/her money it is named project income (cash in) as shown in the Figure.
Revenue
Income
Time
Fig.4 Project revenue and income curves
The time period shown in Figure 3 represents the time intervals at which changes in Income
occur. When calculating contract income it is necessary to pay attention to the retention and/or
the advanced payment to the contractor if any.
Retention ‐ Retention is the amount of money retained by the owner from every invoice,
before a payment is made to the contractor. This is to ensure that the contractor will continue
the work and that no problems will arise after completion. These retain amount ranges from 5%
to 10% and hold by the owner from every invoice till the end of the contract. The whole
amount will be paid to the contractor at the end of the contract.
Advance payment ‐ This is amount of money paid to the contractor for mobilization purposes.
Then, it is deducted from contract progress payment. Applying this strategy improves the
contractor cash flow and prevents him/her from loading the prices at the beginning of the
contract. This strategy, however, may be used only in projects that require expensive site
preparation, temporary facilities on site, and storage of expensive materials at the beginning of
the project.
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2.3.4 CALCULATING CONTRACT CASH FLOW
Having determined the contract expenses and income as presented in the previous section, it is
possible to calculate the contract cash flow. If we plotted the contract expense and income
curves against each other, then the cash flow is the difference between the points of both
curves. Figure 5 below shows the cash flow of a specific contract. The hatched area represents
the difference between the contractor’s expense and income curves, i.e., the amount that the
contractor will need to finance. The larger this area, the more money to be financed and the
more interest charges are expected to cost the contractor.
Cost
Time
Fig.5 Cash flow based on monthly payments
The contractor may request an advanced or mobilization payment from the owner. This shifts
the position of the income profile so that no overdraft occurs as shown in Figure ‐ below.
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Cost
Income
Expense
Advance payment Time
Fig.6 Effect of advanced payment on improving cash flow
The cash flow calculations are made as described in the following steps:
Perform project schedule and determine project and activities timing.
Draw bar chart based on early or late timings.
Calculate the cost per time period.
Calculate the cumulative cost.
Adjust the cost according the method of paying it to produce the expenses.
Calculate the cumulative revenue (revenue = cost x (1 + markup)).
Adjust the revenue based on the retention and delay of owner payment to determine
the income.
Calculate the cash flow (cash flow = income – expense) at the contract different times.
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2.4 STRATEGIES IN MINIMIZING CONTRACTOR’S DEFICIT CASH FLOW
According to Cooke and Jepson (1986), within a construction organization, positive cash flow is
mainly derived from monies received in the form of monthly payment certificates. Negative
cash flow is related to monies expended on a contract in order to pay wages, materials, plant,
subcontractors' accounts rendered and overheads expended during the progress of the work.
According to them, on a construction project, the net cash flow will require funding by the
contractor when there is a cash deficit and where cash is in surplus the contract is self‐
financing.
Short‐term bank loans or overdraft facilities according to Cormican (1985) often meet the
shortfall that may occur between the supply of funds and the need for cash. According to him,
the credit facilities extended by financial institutions have been subject to more strict controls
and this has often resulted in cash shortages in firms who may not suspect a threat from this
source.
The resulting shortage of cash may often force liquidation of assets and foreclosure by the
company's creditors. A contractor may be forced to avail himself of short‐term borrowing at
very high interest rates (Cormican, 1985). Other approaches utilized in resolving cash deficit
according to Harris and McCaffer (2001) and Kaka and Price (1993) include delayed payment to
subcontractors and suppliers, tender unbalancing, utilizing company’s cash reserves and
overvaluation.
It is very essential to the contractor to minimize his/her negative cash flow because this may
hinder him/her during performing the contract due to lack of financial resources. Among the
procedures the contractor may follow to minimize negative cash flow is:
Loading of rates, in which the contractor increases the prices of the earlier items in the
bill of quantities. This ensures more income at the early stages of the project. However,
this technique might represent a risk to the contractor or the owner.
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Adjustment of work schedule to late start timing in order to delay payments. In this
case, the contractor should be aware that in this case in delay might happen will affect
the project completion time and may subject him/her to liquidated damages.
Reduction of delays in receiving revenues (try to collect interim payments from the
client as fast as possible).The time between interim measurement, issuing the certificate
and receiving payment is an important variable in the calculation of cash flows.
Although monies out goes to many destinations, e.g. labor, suppliers, rentals and
subcontractors; the monies in comes from only one source i.e. the client. Thus any
increase in the delay in receiving this money delays all the income for the contract with
the resulting in the capital lock‐up.
Asking for advance or mobilization payment (In local contracts there is provision).
Achievement of maximum production in the field to increase the monthly payments.
Increasing the mark up and reducing the retention.
Adjust the timing of delivery of large material orders to be with the submittal of the
monthly invoice.
Delay in paying labor wages, equipment rentals, material suppliers and subcontractors.
The following are list of strategies for resolving deficit cash flow in a construction company:
Company’s cash reserve
Tender unbalancing ( it may be a factor for rejection of bids in our country )
Delayed payment to subcontractors
Delayed payment to suppliers
Company’s asset
Borrowed funds…
The earlier you anticipate cash flow issues, the easier it is to address them. The most effective
way to manage cash flow is to develop and maintain cash flow projections that look forward as
much as possible in the life of the project. In order to avoid cash flow problems:
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Develop realistic, well‐considered budgets for each project
Consistently operate with the goal of a surplus of income over expenses
Build internal cash reserves over time
Plan early and regularly
Be aware of cash flow and budget assumptions and react to changes
Maintain good relationships with vendors, contractors, and banker
Once you have a cash flow projection, you are then able to:
Plan the use of cash
Prepare to avoid problems
Respond to changes and revise plans
Above in view, it can be generalized that in order to minimize cash deficit, one has to plan in
detail based on reliable data and information so that it will be possible to be proactive than
reactive before a difficulty happens. Here controlling and monitoring the forecast on regular
basis is crucial to take corrective actions in advance and make revisions timely.
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2.5 FACTORS AFFECTING CASH FLOW PREDICTIONS
Cash flow forecasting is, like any forecasting, the result of calculations based on the information
available at the time and a few assumptions as to what will happen. If as likely, the data
contained in the information changes or the assumptions alter, the forecast will be in error and
a few forecast is required to revise it again and again (Harris and McCaffer, 2001) .
The factors which affect contractor’s cash flows are;
The duration of new projects,
The profit margin on these projects,
The retention condition,
the delay in receiving payment from the client,
The credit arrangements with suppliers and the phasing of the projects in the company’s
work load and
The late settlement of outstanding claims. As many projects last one, two or three years
the cash flow forecasts should also look this far ahead (Harris and McCaffer, 2001).
The expectation of construction participants especially clients has not been met due to non‐
achievement of project success as expected. Client has a role to arrange for finances for the
project and make predictions of the total cost of the project and associated fees and charges.
According to Sambasivan and Soon (2007), construction involves huge sum of money and most
contractors find it very difficult to bear the heavy daily construction expenses when payments
are delayed which will invariably affect the progress of work. Also, one of the main problems
faced by contractors is delay in receiving payment from the client; to prevent this, there is need
for client to predict the cash flow so as to know how to source for the required amount at the
right time to meet up with the contractors’ expectation (Ojo, 2010). However, Onukwube
(2005) revealed that an accurate forecast of construction cash flow has been a difficult issue
due to risks and uncertainties inherent in construction projects.
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High uncertainty and risk among other factors have been identified as factor that makes
construction industry to be vulnerable to bankruptcy (Wang and Hg, 2010). Risk is an important
issue to contractors as well as clients and consultants of the industry. However, the problems of
risk assessment are complex and poorly understood in practice (Laryea, 2008).
The determinants of success of any project are delivery within the appropriate cost limit,
measurable time frame, acceptable quality standard and a high level of client satisfaction.
However, this has not been achieved; research work of NIQS (2003) revealed that projects are
not actualized as budgeted. Construction is often cited as a highly risk‐ prone business because
of the unique nature of the industry and its projects (Laryea, 2008). Risk in relation to
construction is a variable in the process of construction project whose variation results in
uncertainty as to the final cost, duration and quality of the project (Bufaied, 1987; Akintoye and
MacLeod, 1997).
According to Raftery (1994), risks have an upside, where there is possibility of gain, and a
downward, when a loss may be incurred. Therefore, risk management becomes important in
reducing (or possibly eliminating) uncertainty via hedging to protect against unfavorable
outcomes. Odeyinka (2003) and Ojo (2010) emphasized that effect of risk is assessed through
the risk factors, there is usually insufficient objective data to adequately calculate the
occurrence and impact of risk events because of the individual nature of construction projects;
hence some degree of subjective judgment is usually required.
Sidewall and Rumball (1982) identified building type, height, shape and design characteristics,
and external environmental influences, individual contractors pricing characteristics and
weather as causes of low accuracy of predicted cash flow.
Peters (1984), agreed that the overall success of cash flow forecast depends essentially on
mode of payment, quality and reality of project program, method of assessing interim payment,
risk, level of required information, retention, currency of data, delay in honoring architect
instruction and overestimating.
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Other factors identified were seasonal effects on construction works, variability in preliminary
expenses, contract extensions of time for inclement weather and valuations (Calvert, 1986);
estimating error, tendering strategies, cost variances and duration overrun (Kaka and Price,
1993 and Kaka, 1996); delay payment and difficulty in obtaining the right amount of funds at
reasonable interest rates (Khosrowshahi, 2000); retention, claims, tender unbalancing and
delay in receiving payments (Harris and McCaffer, 2001).
Lowe (1987) and Laufer and Coheca (1990) grouped causes of inaccuracy of predicted cash flow
into contractual, programming, pricing, valuation, economic and technological factors while
Okemah (1999) grouped them into external and internal factors.
All of them discovered that accuracy of cash flow forecast was difficult to achieve due to certain
requirements. These requirements were recognized by Odeyinka (2003), Odeyinka and Ojo
(2007), Odeyinka et al. (2008), Babalola and Ojo (2010), Ojo (2010) as risk factors. These
authors assessed the risk factors as they affect cash flow prediction by either clients or
contractors in general.
Some studies on cash flow prediction revealed that the predictive ability of cash flow models
had been hampered by host of factors which include project characteristics. Odeyinka and
Lowe (2000, 2001) found that a more accurate modeling of cash flow forecast that takes risks
and uncertainties into consideration would need to consider differing project groupings.
Skitmore (1992) also found that segregating cash flow data into differing project groupings
significantly improves the predictive power of developed models. These project characteristics
included type of client, type of project, project size; project duration and procurement method.
According to Skitmore, the result of his study established the need for due consideration of
project characteristics during risk management of project at early stage especially cash flow
preparation stage by the clients.
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2.6 LITRATURE SUMMARY
The literature is organized to see the general concept of about construction cash flow
management, its importance to construction projects, how cash flow forecasting is being
practiced in the industry, and what strategies to follow to minimize cash deficit during
construction stage actively and proactively, and finally the major factors to be considered and
which affect cash flow predictions. Many studies are made internationally about construction
cash flow management with different titles and objectives. The researcher has tried to see
some of them which are important for the specific title of this project and the researcher
believes that some knowledge about the subject matter is gained.
The methodology of this project focuses on the above main points to see the gaps in the local
practice. Specifically, the survey identified from literature includes: the need for cash flow
forecasting, and various approaches for resolving deficit cash flows. It also identified factors
affecting cash flow predictions as well as its impact on project performance. The questionnaire
identified further various cash forecasting models if any that are in use of the local practice. The
data collection and discussion of the findings are described on the next chapter of the paper.
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3. DATA COLLECTION AND DISCUSSION OF FINDINGS
3.1 DATA COLLECTION
The data collection approach adopted for conducting this project includes both primary and
secondary sources. Questionnaire and interview provide the primary data for this thesis while
the secondary data sources include civil engineering journals those especially in project and
construction management and internet sources on cash flow issues of various construction
works overseas. These different methods of data collection have been used in order that the
data or information obtained from one can be supplemented by the others whereby the
collected data will give multiple evidences.
Questionnaire provides direct information for the subject matter of a research as it is focused
on issues which further serves as a survey to understand the main concerns and attitudes of
respondents towards the problems. The preliminary data for this project is collected from
questionnaire survey from five selected local grade 1 construction companies. Two experienced
professionals working from each of the five construction companies are requested to fill the
forms with live discussions.
The survey, identified from literature includes: the need for cash flow forecasting, and various
approaches for resolving deficit cash flows. It also identified factors affecting cash flow
predictions as well as its impact on project performance. The questionnaire identified further
various cash forecasting models if any that are in use of the local practice.
The questionnaire produced information regarding the firm’s annual turnover of the past five
years, organizations experience in building construction, number of projects at hand and year
establishment which enables us to estimate in general the firms’ capacity and work volume
(Table 1). The response rate for questionnaires is 100% as the number is small and the survey
was conducted live and forms are filled with interview. It took six days to finalize collecting of
data.
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Interview is one of the primary data collection methods which is flexible and adaptive way of
investigating underlying motives of a subject in a way that self‐administered questionnaires
cannot. The interview undertaken for this thesis was based on semi structured style. This type
of interview has a predetermined set of questions (generalized form of questionnaire) with a
flexible order depending on what the interviewer perceives the subject matter by looking at the
respondent capability and exposure or experience. The interview for this thesis was made with
four reputed professionals of the sector. From these interviewed professionals, two of them are
from consultants’, the two others are from client side (university projects) and the remaining
one is a construction company chief accountant who has direct exposure in administering
different construction companies’ cash flow.
Table 1: Surveyed construction firms’ status
Construction Companies surveyed
Type of information
A B C D E
Average turn over the past five
0.80 0.85 0.74 0.70 0.67
years in birr billion billion billion billion billion
Experience (in years) of the
company in building construction 20 16 12 14 15
projects.
Year of establishment in E.C. 1988 1992 1996 1994 1993
Number of building construction
18 22 12 10 7
projects at hand at this time.
3.2 NEED FOR CASH FLOW FORECASTING
Asper the structured questionnaire assessment, the five construction companies were asked for
the importance of cash flow forecasting for construction projects. All the respondents from the
contractors’ side have the same ground with regard to the need for cash flow management for
construction projects that it is very important.
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3.3 USAGE OF CASH FLOW FORECASTING METHODS
One survey was carried out to investigate the usage of various cash flow forecasting methods
by the companies that are identified from literatures. The result of the survey is shown in table
2 below. The result of the table shows the major methods adopted for cash flow forecasting
seems (not totally the same and impossible to differentiate) the use of computer spread sheet
and the detailed approach (breakdown of bill item into cost/schedule).
Table 2: Extent usage of cash flow forecasting methods
Ser. Companies Surveyed
Forecasting Method Remark
No. A B C D E
1 Spread sheet × × × × ×
The detailed approach ( break × × × × ×
2 down of bill items into
work/schedule )
Value approach ( based on project All the surveyed
3
value ) companies are
Cost approach ( based on cost of not using these
4
input resources ) methods and
Short cut approach (using even don’t have
5 models/library of S curves based any idea.
on past similar projects)
It has been tried to assess to what degree of detail they are using the cash flow forecasting
methods. Almost all the construction companies are preparing the cash flow forecast for
contractual purpose only that is production of S curve for the sole use of the project owner or
client. Even though they are using these types of forecasting methods, it is not detailed enough
and doesn’t consider the actual time in which cash is collected from the client when payment is
made to creditors and subcontractors.
From the surveyed construction companies, one of them is using cash flow management
system which is developed by the company’s IT department for in house use of finance
department only. The system is developed to generate summarized daily, weekly and interim
cash balance reports just for the consumption of the company general manager for very short
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term periods. It uses cash in from a very recent (not more than 15 days) cash collections from
projects. It also produces status of liabilities or payables for creditors. It lacks many inputs as it
is not linked with engineering department plans so it is impossible to take this as practice of
cash flow management.
Theoretically and as evidenced show from literature international practices, mostly 12 months’
time span or planning time should be considered company wise in preparing construction cash
flow forecasts. Here as surveyed to investigate the local practice, construction companies
produce cash flow of S curve by their engineering teams and it is not integrated and
coordinated with other functional departments to reach on a reasonable forecasts. The S curve
shows only either cumulative cost or revenue. Normally, the cash flow diagram incorporates
periodic and cumulative construction revenue (interim payment collections), periodic and
cumulative expenses (expenses should be categorized based on time of pay out the cash i.e. at
the start, prorated or at the end of the period in consideration) and periodic and cumulative
cash balances throughout the time of the project.
However, the ground here is surprisingly different and there is no a single company out of the
five selected ones which we can confidently say they are producing cash flow forecasting
properly for cash flow management. On the contrary, it will be difficult to generalize that the
practice is not well implemented in the local construction industry with this very little number
of sampling.
From the study, 80% of the surveyed companies are almost managed by one man management
(by the owners) and with regard to cash it is found that the owner is the only one who decides
and they don’t want to lay a clear system of managing the company’s cash. During discussions
with some selected expertise in the field, they pointed out that the main reason why the
owners do not want to use a cash flow system is that they are spending advance and interim
payments given by their client to some other investment or personal expenditures rather than
for the specific project under contract. On top of that, they decide on purchasing machineries
without knowing the actual cash flow of the project which in turn drains the working fund
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 33
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
necessary to run the project and as a result the project will be in danger. Due to these and
others reasons it will be reckless to expect proper cash flow management implementation in
short period of time in the local construction industry.
It is found out that one of the construction companies out of the fives is working to implement
an integrated approach of resource planning practice named ERP (enterprise resource planning)
which can improve planning practice and cash flow forecasting to manage construction cash
flow properly. And this may be taken as an exemplary and a good start for the local
construction industry if implementation is realized.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 34
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
3.4 ALLEVIATION OF CASH FLOW DEFECIT
Another survey was carried out to evaluate the extent of usage of various strategies for
resolving deficit cash flow. These mitigation methods are just taken from the reviewed
literatures. Table 3 summarizes the result of the survey. The companies were also requested to
give rank on what method they are using for resolving deficit cash flow and responded as
tabulated below.
Table 3: Cash flow deficit resolving strategies
Companies Surveyed and rank given
Ser. by them on the extent usage of the
Mitigation Method Remark
No. methods
A B C D E
1 Company’s cash reserve 6 6 6 6 6
2 Tender unbalancing 1 3 1 2 1
Delayed payment to
3 5 4 4 4 4
subcontractors
4 Delayed payment to suppliers 4 5 5 5 5
Reduce delay of interim
5 2 1 2 1 2
payments from client
6 Borrowed funds 3 2 3 3 3
Develop realistic, well‐
7 considered budgets for each 7 7 7 7 7
project
Key for the ranks given
1. Very highly preferred
2. Highly preferred
3. Preferred
4. Moderately preferred
5. Less preferred
6. Very less preferred
7. Not preferred at all
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 35
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
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As shown from the result of the survey on the mitigation method, all the companies are not
using their cash reserve in solving their cash deficit. They all ranked it 6th .It is assumed that the
reason why they are not using their cash reserve can be the diversification of their company in
to other related business firms. Unfortunately more than half of the companies surveyed have
found to establish sister companies which seems have direct relations to the prime company. It
is also argued that may be they are investing on these companies which as a result couldn’t
allow them to use their cash reserve.
Most of the surveyed companies rely on as much as possible on early collection of money from
the approved payment by the client. This strategy is ranked 1st and 2nd by all of them. It is found
during survey that some of the companies have established on department level for collection
of interim payments from clients. The department is responsible for following payment from its
initiation at project up to the collection from the client.
The other finding of the survey is that all companies are not using the 7th method which is
proactively action taking mechanism based on developed realistic cash flow forecasting for
their projects. They usually face cash deficit without their prior or in advance knowledge of the
problem as it clearly shown on their practice. It is clear that if they work hard on the detailed
planning for forecasting cash flow, they can be prepared for the deficit and as a result they will
act carefully on unwanted expenditures and will look for fund in advance. The gap on this
strategy is one of the main finding of this project and it is believed that it is very crucial for the
local industry.
66% of the respondents ranked tender unbalancing (front loading) 1st for possible cash deficit
resolving at the early stages the project. Tender unbalancing involves the contractor’s marking
up prices on quantities that are scheduled for early completion trading off quantities for late
completion (Arditi and Chotibhongs, 2009; Skitmore and Catelli, 2011). From an efficiency
perspective, the problem with front loaded tender is that the client will make the payment to
the contractor earlier than in a situation with full information about the cost. This strategy has a
dimension of risk to it, which has to do with price manipulation at the tendering stage [9].From
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 36
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
tender unbalancing (front loaded) the contractor may benefit positive cash flows at the earlier
months, but if the money is not properly allocated on the project, the project may suffer at the
finishing stage and may bring unwanted consequence and delays.
From the study, 80% of the respondents give rank for payment delay to subcontractors at stage
4. This is a good strategy as one of the objective of subcontracting is to finance the project next
to need for specialization. During discussions on the survey this strategy could have been
ranked 2nd or 3rd but some special subcontractors do not give enough time and want to be paid
as early as possible since they have bargaining power. That is why delaying subcontract
payment is ranked 4th by most of the respondents.
Like delaying payment of subcontractors, delaying of suppliers payment is ranked 5th by most of
the respondents. Here one of the argument is most suppliers are not patient not cooperative to
wait until the contractors get payments.
Other findings of the study in regard to mitigation of cash deficit is the relationship of
contractors with suppliers and subcontractors. The issue of cash flow raises questions about
how a company could deal with it. If company survival is to do with cash flow, a contractor
should be able to manipulate the payouts, in order to hold more money for longer. However, it
is clear that this way of raising working capital only passes bigger problems down the supply
chain.
It was mentioned on previous part of the questionnaire that some construction companies are
establishing sister companies which has direct relation with their prime company. The other
reason here why they establish is that most suppliers and subcontractors are working with the
contractor’s money and this is exposing them for cash shortages. Basically, one of the aim of
subcontracting is to finance the project. But, the situation here is totally different and
contradictory. As an example most of suppliers and special subcontractors are paid 50% of their
contract amount up on signing of the contract without doing anything.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 37
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
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So, the construction companies here are forced to manage the import issue to their project by
their money and also engage on special works. For that they will establish a sister company
doing this additional business. This has both negative and positive effect on their cash flow
management. The negative effect is that, when the prime company is diversified this is an
investment and it will affect working capital of the prime company. The positive part is that the
owner of the construction company will retain the money by not subletting the work to other
company and if the established sister company is fit enough it can be source of cash by doing
other works to other clients. This serves in some way as a strategy to minimize cash deficit of
the construction company in the future as one of the construction company owner
underscored during the survey.
Construction companies should have clear strategies to create a very good relationships with
suppliers and partnership approach with their special subcontractors so that their projects will
be financed and cash deficits can be minimized.
During discussions between some selected reputed professionals in the field, they have pointed
out major causes or reasons for cash shortages during execution of a project. Improper
utilization of advance payment (disbursing it somewhere that is not specific to the project use),
Poor practice of forecasting or planning, delay of client payment and price escalations are
among the major ones exposing a project to cash shortages.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 38
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
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4. CONCLUSIONS AND RECOMMENDATIONS
4.1 CONCLUSIONS
Construction industry takes a big share of the country’s budget. It also presents high levels of
insolvency and failure for this sector is a serious problem for the development of the country.
As it is presented on the literature review part, one of the major causes of failure for the sector
is bad cash flow management emanating from poor planning practice.
Based on this, the researcher looked into cash flow management practice in the leading local
construction companies participating hugely on building projects. Essentially, the paper has
investigated issues like: the need for cash flow forecasting, the methods deployed in
forecasting cash flows and extent usage of cash flow deficit minimizing strategies in the
selected construction companies’ custom.
Finally, the following concluding remarks are forwarded based on the result of the survey:
1) Cash flow forecasting and management are perfect tools to avoid risk of incompletion of
construction projects due to shortage of fund as all the surveyed companies stamped
their five fingers for agreement on the issue.
2) Even though there are plenty of cash flow forecasting methods and models in use
abroad, the methods found in practice here locally are using spread sheets and the
detailed approach (break down of bill items into work/schedule) incompletely i.e. they
are using these methods to generate S curves which shows either cumulative cost or
cumulative revenue . The S curve uses solely to the client for budgeting and it doesn’t
show the cash out, cash in and cash balance with proper timings.
3) Improper utilization of advance payment (disbursing it somewhere that is not specific to
the project use), Poor practice of forecasting or planning, delay of client payment and
price escalations are among the major ones exposing a project to cash shortages.
4) With regard to proper usage of cash flow forecasting method for construction cash flow
management, the paper generally concludes that the local practice is very poor.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 39
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
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5) Most of the constructing companies are not using their cash reserve in solving cash
deficit problems rather they rely on borrowing funds from banks or other financial
institutions. Besides, tender unbalancing (front loading) is also found to be their favorite
approach or strategy to solve cash flow problems even if it has some risks on them.
6) It is found that delaying payments of suppliers as a strategy for solving cash deficit in
construction creates a problem on supply chain as there are no potential capable
suppliers who can wait for contractor’s payment for so long. Some suppliers are also
found using their high bargaining power to influence the contractors not to delay their
payments.
7) Some construction companies are found to be forced to establish sister companies
doing imports and specialized works to assist the construction company and to serve as
a strategy in minimizing cash flow deficit during construction.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 40
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
4.2 RECOMMENDATIONS
As mentioned earlier, one of the main objective of this paper is producing
recommendations to minimize the gaps identified during the study time. Accordingly, the
following recommendations are forwarded that can contribute a lot on the construction
industry practice.
1. As deficiency of cash is one of the main factors threatening the success of
construction projects and causing business failure, an appropriate cash planning
technique is necessary for adequate cost control and efficient cash management to
reduce the risks and uncertainties of the construction project. Contractors need to
work hard on laying clear guideline on cash flow management practice and should
closely follow up the implementation by establishing planning and monitoring team
responsible for the work. The planning team should also properly prepare plans to
identify future shortages and regularly revise it for any deviations during execution
by monitoring expenditures.
2. A construction company should ensure the proper usage of the project advance
payment and interim payments for the sole purpose of project progress and should
avoid spending the money elsewhere so that the project will not suffer on cash
shortage in forthcoming.
3. Continuous training on application soft wares which can assist cash flow forecasting
is mandatory to properly implement cash flow management in construction
projects. Construction schedules and plans for a construction project should be
prepared with actual quantities of work volume by preparing take off sheets before
commencing the work so that cash forecasts will base accurate expenses of
construction inputs.
4. Contractor’s cash flow forecast and cash flow diagram should be included in the
special condition of contract then the client will be aware of which time the project
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 41
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
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will be in short of cash and develops confidence on its timely completion. This helps
to take joint actions with the contractor so that any projected problems can get
solution in advance. The consultant should also work hard on timely submittal of the
forecast by the contractor and communicate this to the client.
5. The researcher has tried to assess cash flow management practice associated with
the local construction industry. It is believed a further work on the area is vital in
order to guide the construction industry with efficient implementation of
construction cash flow management. Accordingly, the following topics are selected
for further investigation :
Assessment of construction cash flow management and its impact on
project completion.
Assessment of cash utilization of some selected contractors’ and its impact
on cash flow management.
Construction cash flow management and contractual relationships between
client and contractor, focusing on public building projects like educational
facilities.
Construction cash flow management and relationship between suppliers
and subcontractors , focusing on complex building construction projects
Impact of inflation and price escalation on construction cash flow
management of building projects.
Assessment of construction cash flow practice of local construction
companies and foreign construction companies participating in the local
industry.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 42
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
8. REFERENCES
1. Kaka, A. P., and Price, A. D. F. (1993) Modelling Standard Cost Commitment Curves for
Contractors’ Cash Flow forecasting, Construction Management and Economics, 11, 271–
283, E&FN Spon Ltd,, UK.
2. Al‐Issa, A. and Zayed, T. 2007. Projects cash flow factors‐contractor perspective,
Construction Research Congress (CRC) conference, ASCE, Bahamas, May 5‐8.
3. Sears S. K., Sears, G. A., and Clough, R. H., (2008). “Construction Project Management ‐A
Practical Guide to Field Construction Management”, 5th Ed., John Willey, 272‐274
4. Harris, F. and McCaffer, R. (2001) Modern Construction Management, 5th Edition,
Oxford: Blackwell Science.
5. Grace Kehinde Ojo, Project characteristics influence on risk associated with
construction clients’ cash flow prediction Journal of Research in International Business
and Management (ISSN: 2251‐0028) Vol. 2(5) pp. 142‐150, May, 2012. Available online
@http://www.interesjournals.org/JRIBM
6. Mohamed Abd El razek1, Hosam El Din Hosny2 and Ahmed El Beheri, RISK FACTORS IN
CONSTRUCTION PROJECTS CASH‐FLOW ANALYSIS, IJCSI International Journal of
Computer Science Issues, Vol. 11, Issue 1, No 2, January 2014 ISSN (Print): 1694‐0814 |
ISSN (Online): 1694‐0784.
7. Vivek Datey, 2015, Step Function Model for Forecasting Project Cash Flow, Ph.D research
paper at the Global Business School, International journal of scientific research and
management, Volume||\ 3||Issue||5||Pages|| 2812‐2815||2015||.
8. Kenley R. (2003) Financing Construction: Cash Flows and Cash Farming. Spon Press
9. Kenley, R. and Wilson, O. (1986). A construction project cash flow model – An
ideographic approach. Construction Management and Economics, 4, 213‐32.
10. Kaka, A.P. and Boussabaine, A.H. (1999) Updating techniques for cumulative cost
forecasting on construction projects. Journal of Construction Procurement. University of
Glamorgan. 5(2), November, 141‐158.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 43
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
11. Khosrowshahi, F. (2000) a radical approach to risk in project financial management.
th
Proceedings of the 16 Annual ARCOM Conference, Glasgow Caledonian University,
September 6‐8, 547‐556.
12. Odeyinka, H.A. & Lowe J.G. (2001) an evaluation of methodological issues for assessing
risk impacts on construction cash flow forecast. In: Akintoye, a (ed.) Proceedings of 17th
Annual ARCOM Conference, University of Sanford, and September 5‐7. Pp. 381‐389.
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 44
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
APPENDIX – A
Questionnaire !!!
Dear Madam / Sir,
I am undertaking a research entitled ‘’Construction Cash Flow Management Practice In
selected Leading Local Construction Companies’’ for the partial fulfilment of the requirement
of master degree in civil engineering stream of construction technology and management.
This survey is part of academic research that aim to assess the Current practice of construction
cash flow management in the local construction industry. The primary objective is to identify
the gaps in the local practice from the international accepted rehearses and propose
recommendations that help progress the local practice for better project performances.
You are chosen as one of the best construction company or candidate to participate in my
research by answering the closed and semi‐closed questionnaires related to the title. I
appreciate your valuable contribution from your experiences in the field of construction
engineering by completing all questions by taking your valuable times. All the information you
provide will be kept in strict confidentiality and it will be only used for academic purpose only.
Sincerely,
Kassahun Mereawi
Post graduate candidate, Construction Technology and Management
School of Civil and Environmental Engineering Addis Ababa Institute of Technology (AAiT)
Addis Ababa University
Tel: +251911601001
Email: kassabay@gmail.com
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 45
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
Part I: General Information and Experience
1. Name: (optional) ________________________________
2. Company name _________________________________
3. Email _________________________________
4. Gender _________________________________
5. Which organization do you represent
Client
Consultant
Contractor
Others
6. Please mark you Designation in the company below
Owner
Project manager
Engineering Department manager
Deputy General Manager
Finance manger
7. Year of establishment in E.C. of the company you have been working
(Please specify the establishment year in EC here)
8. Total experience in years of the company you have been working in building
construction projects.
(Please specify the total years of experience here)
9. Average annual turnover of the company you have been working for the past five years.
(Please specify the amount in Ethiopian birr here)
10. Number of building projects at hand currently
(Please specify the number of projects here)
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 46
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
Part II: Need For Cash Flow Forecasting
Cash flow forecasting according to McCaffer (1976) provides a good warning system to
predict possible insolvency.
1. Please rank the need for cash flow forecasting for a construction company
1.1 Not important
1.2 Less Important
1.3 Moderately important
1.4 Important
1.5 Extremely important
2. Please foreword any other additional point or opinion for the subject matter; like how it
is important for the industry…
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________ .
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 47
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
Part III: Extent Usage Of Cash Flow Forecasting Method
1) Please give rank to the degree usage of construction cash flow forecasting method your
company uses for managing building construction projects undertaken.
1. = Usually
2. = Sometimes
3. = Once
4. = Don’t use any more
Ser.
Type of cash flow forecasting method 1 2 3 4
No.
1.1 Spread sheet
The detailed approach ( break down of bill of items into
1.2
work/schedule )
1.3 Value approach (based on project value)
1.4 Cost approach (based on cost of input resources)
Short cut approach ( using models/library of S curves based on past
1.5
similar projects )
1.6 Integrated systems ( e.g. cost/schedule integration)
1.7 Cybercube ( developed in the UK )
1.8 TASC ( the advanced S‐curve)
1.9 FINCASH (developed in Australia)
1.10 Others , please specify
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 48
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
2) What is your perception towards the use of detailed cash flow forecasting method
practice in the local construction industry?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
______________.
3) What is your general comment regarding cash flow forecasting method and what do you
expect in the future?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
____________________ .
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 49
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
Companies April, 2016
Part IV: Extent Usage Of Cash Flow Deficit Mitigation Strategy
According to Cooke and Jepson (1986), on a construction project, the net cash flow will
require funding by the contractor when there is a cash deficit and where cash is in surplus
the contract is self‐financing.
1) Please give rank to the degree of usage of cash flow deficit minimizing strategy.
1. = Usually
2. = Sometimes
3. = Once
4. = Don’t use any more
Ser.
Cash Deficit mitigation strategy 1 2 3 4
No.
1.1 Company’s cash reserve
1.2 Tender unbalancing
1.3 Delayed payment to subcontractors
1.4 Delayed payment to suppliers
1.5 Reduce delay of interim payments from client
1.6 Borrowed funds
1.7 Develop realistic, well‐considered budgets for each project
1.8 Other methods you use if any _______________
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 50
M.eng. Project: Construction Cash flow management Practice In Selected Leading Local Construction
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2) If you have any comments regarding cash flow deficit minimizing strategy , please
specify here:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
__________________________________________________.
3) What is your general comment or opinion in regard to relationships of your company (a
company you are working with) with suppliers, subcontractors and equipment rental for
solving cash deficit?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________ .
Thank you for your cooperation!!!!
AAU, AAiT, School of Civil and Environmental Engineering, COTM: Kassahun Mereawi Page 51
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