CASH FLOW FORECASTING. Each year the construction industry experiences a proportionally greater number of bankruptcies than do other industries. One of the final causes of bankruptcy is inadequate cash resources and the failure to convince banks, creditors and other lenders of money that this inadequacy is only temporary. Its essential that a construction company forecasts cash requirements in order to make provision for difficult times in advance. Some companies confuse profit lows with cashflows and make misleading calculations. A cash ; flow is the transfer of money into or out ofa company. ‘The timing of the cashflow is important There will be atime lag between the entitlement to feceive a cash payment and actually receiving it These time lags are the credit arrangements that contractors have with their creditors, Cash flow forecasts should cover not only the next few months. As many projects last one, two or three years, the cash flow forecast should look this far ahead to fully understand the company's likely future financial position, The following factors all affect cash flows: the duration of new projects; the profit margin on these Projects the retention conditions; the delay in receiving payment from the client; credit arrangements with material suppliers, plant hirers, sub-contractors; the phasing of the projects in the company's work load; and the late settlements of outstanding claims Cash tlow forecasting may take place: (i) at the tender stage and (ii) on a corporate basis (monthly or quarterly) Cash tlow forecasting may take place at a project, company or divisional level ‘THE REQUIREMENTS OF A FORECASTING SYSTEM In construction companies the normal approach is to calculate cash flow on a project basis and aggegate the cash flows from all projects and head office to form an overall company cash flow. > THEDATANEEDED (1. The following data are needed to produce the cash flow for a project L A graph of value v time. (Value being the monies actually received by the contractor for doing the work), 2. The measurement and certification interval, 3. The payment delay between certification and the contractor receiving the cash. 4 The retention conditions and retention repayment arrangements. A graph of cost v time showing the contractor's cost liability arising from payment to labour, plant companies, materials and sub-contractors 6, The project costs divided into the above items The delay between incurring a cost liability under the above headings and the meeting, of this liability. 22 19/8/96‘The data required for items 2, 3 and 4 are readily available. Item 6 can be calculated or by studying, several contracts of the same type, appropriate cost breakdowns can be derived. Item 7 should be known by the buying department. Items 1 and S are a little more difficult to abtain Value versus time, (Item 1) ‘A graph of value v is needed to derive the ‘cash in’ for the project. This is produced by reviewing the project plan, calculating the value of each activity and summing the value in each appropriate time period. (This may be weeks or months). Figure 1 shows a simple example of the value v time calculated from the project plan. The calculations are usually done on a cumulative basis and so the ‘cumulative value v time figures are produced by a running total over each time period. Cost versus time, (Item 5) | ‘The graph of cost v time is needed to derive the ‘cash out’. The contribution margin, (ie the margin for profit and overheads added to the direct cost) may be spread uniformly throughout the project. In other words each bill item carries the same percentage for profits and overheads. In this, a instance the cumulative cost v time is a simple proportion of the value v time figures. If the contribution has not been spread uniformly throughout the project plan then the cumulative cost can be produced in the same way as the value v time from the project plan by cashing each activity. A simplification ‘The production of the cumulative value v time and cost v time figures based upon project plans is very time consuming. However itis possible to use ‘standard’ cumulative value v time curves to aciequately represent each project type. When the contribution is spread throughout the project the cumulative cost v time is easily derived from the standard cumulative value curve. Figure 2 shows a typical standard curve. ‘THE CALCULATIONS The calculations to produce the cash flow are shown in Figure 3. A time period of one month has been used but weekly time periods could be used if necessary. The value in each row is as follows: Row 1 is the cumulative value derived as previously discussed Row 2 is the cumulative value less retention. Row 3 is the cumulative value less retention shifted by an amount equal to the payment delay between valuation and the contractor receiving his money. ‘Row 4 is the cumulative retention payments inserted at the time they are received from the client. Row 5 shows the cumulative costs for the project. These costs are then treated individually The proportion of costs due to labour is calculated and shown cumulatively in Row 6. Similarly the cumulative costs for materials, plant and sub-contractors are shown in Rows 8, 10 and 12 Rows 7, 9, 1] and 13 shilt the cost habilities shown in Rows 6, 8, 10 and 12 by an amount equal to the average delay between the cost liability and making the payment Row 14 is the cumulative cash out. This is the sum of Rows 7,9, 11 and 13 Row 15 is the cumulative cash flow from Row 3 plus Row 4 less Row 14 Much of the calculating effort goes into calculating the cash out due to each individual cost heading, This can be particularly tedious if the exercise is based upon tine periods of one week, A 23 1/8/96 a | ee> suggested simplification is to calculate a weighted average payment delay for all the cost headings. This weighted average based upon the cost categories as a percentage of the total cost will give cash out figures that are accurate except for the first few weeks and last few weeks of the project. CAPITAL LOCK-UP : The negative cash flows experienced in the early stages of a project represent locked-up capital that must be supplied from the company’s reserves or borrowed. If the company borrows cash to finance the project during this period it will have to pay interest charged to the project. If the company uses its own cash reserves, it is deprived of the interest earning capability and there should be a charge to the company for the lost earning capability. A measure of the interest may be calculated by considering the area between the cash-out and cash-in curves. This measure is given the name ‘captim’, (meaning capital x time). A simple calculation can convert captim into an. interest charge. The use of ‘captim’ enables the effect of interest charges to be evaluated. Factors that affect Capital Lock-up ‘The following factors all affect capital lock-up for an individual project: ~ the margin; - retention; ~ claims; Front End Rate Loading: - Over Measurement; = Back End Rate Loading and Under Measurement = delay in receiving payment froin the client; = delays in paying labous, plant hirers, material suppliers and sub-contractors; and company cash flow CONCLUSIONS: Cash flow forecasting provides a valuable early warning system to predict possible insolvency. This enables preventative measures to be considered and taken into good time. Examples of the actions available are: (1) Not taking on a new contract if, when the contract is included within the cash flow forecast, the company’s projected cash requirements are more than the overdraft limit (ii) Re-negotiation of overdraft limits supported by reliable forecasts (ii) The adjustment of work schedules on existing contracts. (iv) ‘The negotiation of extended credit with some suppliers. (v) Accepting suppliers’ full credit facilities even if it means temporarily losing some discounts. 19/8/96| WEEK Mme LETS Tes [9 eine Tone ST TT lexcavare Sst | | TTT (TTT Ty cone. Foes | SLE! | I T FL00R 1 ! r r k i : 775] fel 2ie}e aleilele | alefele) Stal a ESTT a) | Hig. 1 Bar Chart programme with contract values Fig.2 An example of a value v. time curveeee . 2 » [a Ts « fa [ow of Po Ja To oe is Te 7 a] Gamumanve ¥ no aso | wo | wo | ase [sso [usu | ras [nes live |fr200 |ra7s0 [rae 1490 ay Cumuianve vavur ers] time [2325 | ane [ano [ears ]snas [errs | omar [rear foes [rree [i202 |1asa7 [rso.o [sa so | nnn chains | cununative GOS e2s[ sor | an95 | aur0| sono | ovis [eres | ones | exer |ru97 | nr fore [vieee [razr [raeaa hizoso agua) eyraaine canon | oer] 247s] «as | saa] aoe | 70] oar [usar | szer [reas] sore | a0me] anor | aaze | ance] 200 | aero camanarive ane ve] os erro [aavafisee fron [azar fae 2020] «126 | ares | cose] su [oa snare es snmanvnverous | on2{ aurel eas [ s2af wee [peal ose [rae [iver [rere | tore [aon] an00 | gaze | asec] ase cwmunanv 7¢ on | airs] eas] saa | coe] x05 | osr | ura: [saer| ve2s | sore] ane | area | aero] ase | 2000 womans cas ovr | onr| sus | ise | gana] ane | o5e7 [yoor | oosy | ores | our? | russ feral sats laid less commaneconow [soaloo | ariel] [soe [i229 [ein [ere | 200 1m [oroe) se [sto Lose ais 73 ip Fig. 3 Calculation of a contract cas: Now A sascha ang ag iene macnn