BUSM 1273 - Project Management Techniques
Cash Flow Management
Dr. Frank Boukamp
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Outline
- Introduction
- Cash Flow Projection/Forecasting
- Requirements for Forecasting
- Cash Flow to the Contractor
- Capital Lock-up
- Overdraft Requirements
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Introduction to cash flow
Cash flow is transfer of money into and out of the company
Profit flows ≠ cash flows
Relatively high numbers of bankruptcies annually due to inadequate cash
resources (even before the economic crisis)
Must make provisions for these scenarios
• esp. when interest rates are high
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Introduction to cash flow
Timing is important!
• Time-lags between
• entitlement and receipt of cash
• commitment to payment and making payment
• Credit arrangement determine timing and associated cost
• Credit arrangements, stock levels and depreciation = difference in cash and
profit
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Cash Flow Example
Credit arrangements cause very different cash flows
Company buys goods at $6 and sells for $8 each
Credit ($)
Profit Flow ($) Cash Flow
Cash Flow ($)
($)
arrangement Out
Out In
In
Buy ten for cash
Sell ten for cash 20 20
20
Buy ten on credit
Sell ten for cash 20 80
Buy ten for cash
Sell ten for credit 20 60
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Factors affecting cash flow on projects
Duration of new projects
Profit margin on projects
Retention conditions
Delays in receiving payment from clients
Credit arrangements with suppliers, plant hirers, sub-contractors
Phasing of projects in portfolio
Late settlement of outstanding claims
Therefore need to look 2-3 years ahead!
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Cash Flow Forecasts
• Forecast based on best information available
• Changes with conditions over time
• Quarterly or monthly
• Two-level cash flow forecast for contractors
• Single-project level
• Aggregate cash flow for the company, division or area
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Where is cash flow forecasting
important?
Two Cash Flow Forecasting Levels
First level is at the estimate stage:
• Forecast is just for the single project being estimated
• Estimator can develop this cash flow by allocating bill items to activities on the CPM network;
• must be done regularly
• need to simplify
Second level is the company cash flow:
• Aggregating cash flows for all active projects
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Cash Flow Projection/Forecasting
Halpin (2006)
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Requirements for forecasting (Harris et al, 2006)
• Graph of value vs time (value = money eventually received for work done)
• Measurement and certificate interval
• Payment delay between certification and contractor’s receipt of cash
• Retention conditions and retention payment arrangements
• Graph of cost vs time – cost liability from labour, plant, materials, etc. (direct
costs)
• Project costs broken down into above categories
• Delay between incurring cost liability under each cost heading and meeting
liability
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Capital Lock-Up
Negative cash flows =
locked-up capital
Supplied by cash reserves
or borrowed
• Borrow = payment of interest
• Reserves = opportunity cost /
interest lost
Harris, McCaffer & Edum-Fotwe (2006)
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Capital Lock-Up (2)
Negative cash flow experienced in the early stages of project
Supplied from the company’s cash reserves or borrowed
• What about interest?
• Borrowed - interest charged to the project
• Own cash - deprived of interest-earning capability - charged to the project
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13
Capital
Lock-Up and Captim
Negative Captim = Finance Area
Capital
Lockup
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Capital Lock-Up and Captim (2)
A measure of interest payable can be obtained by
calculating the area between the cumulative cash flow
curve and the time axis.
Finance Area is in units of $ * weeks (or months). This
measurement has been given the name “captim” (capital *
time)
• Example:
• Captim of 25000 $*month over a year with yearly effective interest
of i=15%
• What’s the payable interest?
• Effective interest rate per month: 15%/year / 12 months/year =
1.25%/month
• Interest payable = 25000$*month * 1.25%/month = $312.50
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Capital Lock-Up and Captim (3)
This calculation can be done on the negative captim alone (assuming that the
cash released by the project does not earn interest)
…or with interest earned by the positive captim being subtracted from the
interest paid on the negative captim
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Capital lock-up
Factors affecting capital lock-up
• Margin
• Higher margin = lower capital lock-up
• Retentions
• Claims
• Front-end loading
• Over-measurement
• Back-end loading and under-measurement
• Delay in paying labour, plant, material, sub-contractor
• Company cash-flow
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Factors that Affect Capital Lock-Up
Margin (Markup)
• Determines the excess over costs and the excess that controls the capital lock-up
Retentions
• Simply reduce the effective margin during the execution of the contract.
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Factors that Affect Capital Lock-Up (2)
Claims…
…can return a project to its intended level of profit. However, the
delay to the actual settlement worsens a contract cash flow: If a
contractor recuperates with claims the difference in a project that has a
margin of 9% and a 4% costs increase, the cash flow margin used must
be 5%. The claim may result in a payment occurring after the project.
Using the original 9% would result in an optimistic forecast.
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Factors that Affect Capital Lock-Up (3)
Front end rate loading
• Earlier items in the “bill” carry a higher margin than the later items. Depends on client’s
awareness.
Overmeasurement
• Work certified in the early months of a contract is greater than the amount of work
done. Compensated for in later measurements.
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Factors that Affect Capital Lock-Up (4)
Back end rate loading and undermeasurement
• Have the effect of increasing the capital lock-up and are usually not
sought by contractors; but in inflation environment with index-linked
prices the contractor may get a better return by funding a larger
capital lock-up and gaining on price fluctuations
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Factors that Affect Capital Lock-Up (5)
Delay in receiving payment from client
• Cash outflow goes to many destinations (labor, plant hires, materials
suppliers and subcontractors)
• Cash inflow usually comes from only one source - the client. Any increase in
the delay in receiving this money delays all the income for the contract with a
resulting increased capital lock-up
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Factors that Affect Capital Lock-Up (6)
Company cash flow
• Timing of contract starts. If several new contracts start within a few weeks of
each other the company capital lock-up can be considered a big problem to
the company
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This course material by Dr. Frank Boukamp is licensed under a
Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International Harris,
License. McCaffer & Edum-Fotwe (2006)
Page 23
This course material by Dr. Frank Boukamp is licensed under a
Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International Harris,
License. McCaffer & Edum-Fotwe (2006)
Page 24
Cash flow to the contractor
Halpin (2006)
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Cash flow to the contractor
Halpin (2006)
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Cash flow to the contractor
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Overdraft requirements
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Overdraft requirements
Total Billed
Subtotal
Direct Cost
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Overdraft requirements
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Halpin (2006)
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Questions?
Dr. Frank Boukamp
e-mail: [Link]@[Link]
Office hours: [Link]
This course material by Dr. Frank Boukamp is licensed under a
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