Chapter 1

WHAT IS FINANCIAL MANAGEMENT?

Financial management is the use of a company’s financial resources. This includes the use of cash
and other assets—such as equipment. Many everyday decisions affect a company’s financial
future. For example, the decision to bid on a large project can have great impact on the finances of
a company. When deciding whether to bid on a project, a manager may need to address the
following questions:
 Does the company have enough cash resources to perform this work or will the company need
outside financing?
 Can the company get bonded for this work?
 If not, what changes need to be made in the company’s financial structure so the company can
get a bond for the project?
 Should the company hire employees to perform the work or should the company subcontract
out this labor?
 Should the company lease or purchase the additional equipment needed for this project?
 If the company purchases the equipment, how should it be financed?
 Will this project require the company to increase its main office overhead?
 And, finally, what profit and overhead markup should be added to the bid?
 The answers to all of these questions will affect the company’s finances.
The answer to one of the questions may change the available options to other questions. For
example, if the manager decides to hire employees to perform the work on the project, the project
will require more financial resources than if the company had hired subcontractors to perform the
labor and may leave the company with insufficient resources to purchase the additional equipment,
leaving leasing the equipment as the only option.
WHY IS CONSTRUCTION FINANCIAL MANAGEMENT DIFFERENT?

1. Project Oriented
The insulation manufacturer is process oriented, whereas the construction company is project
oriented.
For many construction companies, each product is unique but often the products are very different.
It is not uncommon for a construction company to be working on a tenant finish in a high-rise
tower, a fire station, and an apartment complex at the same time. Even when a construction
company is working on similar products—such as a homebuilder or a company building a number
of convenience stores—the projects are often different due to site conditions and locations, which
affects the availability of labor and materials.
No other industry is as project based as is the construction industry. Almost everything a
construction company does is a project. Because of this, a construction company must keep
accurate construction costs for each and every project that it constructs. Not only must the cost be
kept for each project, but also the cost must be kept for each group of components on a project.
PREPARED BY- YETNAYET BIHON (MSC. P.ENG) 1
This data is necessary to control the costs of the current project and also so the cost of the
components may be used in the bidding of future projects. With each project requiring a different
mix of labor, materials, and equipment, knowing the cost of the components of a project is
necessary to bid future projects.
2. Decentralized Production
Construction Company performs its work at a number of decentralized locations. In the
construction industry the equipment and employees are seldom dedicated to a single project year
after year.
Equipment and employees may move from job to job on a regular basis. As a result, the location
of each employee and piece of equipment must be tracked to ensure that their costs are charged to
the correct job. Additionally, each crew and piece of equipment must be managed as a project
center.
3. Payment Terms
For many construction companies, their work consists of long-term contracts for individual
projects with monthly progress payments being made by the owner as the project is being built.
Additionally, the owners often withhold retention—funds used to ensure the contractor completes
the construction project—thus deferring payment of a portion of the progress payment.
As a result, construction companies have unusual cash flows and require modification to
accounting and other financial procedures to handle retention.
4. Heavy Use of Subcontractors
Many construction companies rely heavily on subcontractors’ work. The use of subcontractors
allows a construction company to tap into a subcontractor’s financial assets during the construction
process. The use of subcontractors has a great impact on the finances of a construction company.
Because of these unique characteristics it is important for the manager of a construction company
to have a sound understanding not only of financial management but also of how financial
management principles are applied to the construction industry. The tools that financial managers
are taught in business schools must be modified to take into account the unique characteristics of
the construction industry if they are to be useful to construction managers.
WHAT DOES A FINANCIAL MANAGER DO?

The financial manager is responsible for seeing that the company uses its financial resources
wisely. A financial manager’s responsibilities may be broken down into four broad areas that
include accounting for financial resources, managing costs and profits, managing cash flows, and
making financial decisions.
1. Accounting for Financial Resources
Financial managers are responsible for accounting or tracking how the company’s financial
resources are used, including the following:
o Making sure that project and general overhead costs are accurately tracked through the
accounting system.
o Ensuring that a proper construction accounting system has been set up and is functioning
properly.
PREPARED BY- YETNAYET BIHON (MSC. P.ENG) 2
 o Projecting the costs at completion for the individual projects and ensuring that unbilled
committed costs—costs that the company has committed to pay but have not received a
bill for—are included in these projections.
o Determining whether the individual projects are over- or under billed.
o Making sure that the needed financial statements have been prepared.
o Reviewing the financial statements to ensure that the company’s financial structure is in
line with the rest of the industry and trying to identify potential financial problems before
they become a crisis.
2. Managing Costs and Profits
Financial managers are responsible for managing the company’s costs and earning a profit for the
company’s owners. Financial managers rely heavily on the reports from the accounting system in
their management of costs. Managing the company’s costs and profits includes the following
duties:
o Controlling project costs.
o Monitoring project and company profitability.
o Setting labor burden markups.
o Developing and tracking general overhead budgets.
o Setting the minimum profit margin for use in bidding.
o Analyzing the profitability of different parts of the company and making the necessary
changes to improve profitability.
o Monitoring the profitability of different customers and making the necessary marketing
changes to improve profitability.
3. Managing Cash Flows
Financial managers are responsible for managing the cash flows for the company. Many profitable
companies fail because they simply run out of cash and are unable to pay their bills. The duties of
a financial manager include the following:
o Matching the use of in-house labor and subcontractors to the cash available for use on
a project.
o Ensuring that the company has sufficient cash to take on an additional project.
o Preparing an income tax projection for the company.
o Preparing and updating annual cash flow projections for the company.
o Arranging for financing to cover the needs of the construction company.
4. Choosing among Financial Alternatives
Financial managers are responsible for selecting among financial alternatives.
These decisions include the following:
o Selecting which equipment to purchase.
o Deciding to invest the company’s limited resources in which area of the business.

PREPARED BY- YETNAYET BIHON (MSC. P.ENG) 3

CONCLUSION
A construction company is a risky venture. Each year, many construction companies go out of
business. Operating a successful construction company requires a specialized set of financial
management skills, because of the unique nature of the construction industry. Unlike other
industries, the construction industry faces a number of challenges:
(1) constantly building unique, one-of-a-kind projects,
(2) building a project at a different location each time,
(3) dealing with retention and progress payments, and
(4) Relying heavily on the use of subcontractors to complete the projects.
PROBLEMS
1. According to the Surety Information Office, what are the six warning signs that a construction
company is in financial trouble?
2. Who is responsible for financial management in a construction company?
3. Why is construction financial management different from the financial management of other
companies?
4. What activities are involved in accounting for the company’s financial resources?
5. What activities are involved in managing the company’s costs and profits?
6. What activities are involved in managing the company’s cash flows?
7. List some examples of financial decisions that construction managers must make.

PREPARED BY- YETNAYET BIHON (MSC. P.ENG) 4