spring 2008, king saud university cash flow analysis dr. khalid al-gahtani 1 payment schedule...

Spring 2008, King Saud University

Cash Flow AnalysisDr. Khalid Al-Gahtani

• Payment schedule• Materials• Mobilization• Monthly payments• Final Payment

Contract Provision that Impact Cash Flow

Contractor Cash Disbursements

• Labor• Equipment• Materials• Subcontractors• Other

– Insurance,– Permit and mobilization– Overhead items

Factors That Minimize Contractor's Negative Cash Flow

1. Front end rate loading: – earlier items in bill of quantities carry a higher mark-

up than later items early stages.– This reduces negative cash flows in contract early

stages.

2. Reduction of delays in receiving revenue.

3. Adjustment of work schedule to late start timing.

4. Coinciding the timing of delivery of large materials orders with the submittal of the contractor's monthly pay estimate.

Factors That Minimize Contractor's Negative Cash Flow

5. Delay in paying labour, plant hirers, materials suppliers, and subcontractors.– This would reduce negative cash flows but undermine

commercial confidence in the company.

6. Increasing the mark-up and reducing the retentions.

7. Increasing mobilization and advance payment.8. Achievement of maximum production in the

field.9. Quick settlement or claims.

The Cash Flow Analysis

Example 4.1

• The mark-up is 10% of tender value and is assumed to be uniformly distributed over the contract.

• The contractor will receive an advanced payment of 10% of tender value. – This will be deducted from each monthly revenue.

Retention is 5% and is paid on contract completion.• Labour cost is assumed to be 30% of total

contract cost and is paid after one week's delay.• The delay for other submitting is one month.• Revenue is received after 4 weeks from

submitting invoices.

Example 4.1

• Assuming all the activities are scheduled on their early start timings, it is required to derive:– revenue and income curves, – cost and expense curves and– contract cash flow curves.

• Compare contract net cash flows for revenue received after 4 and 6 weeks from submitting invoices.

• Determine the effect on contract cash flow of scheduling the activities on their late start timings while the revenue is received with 4 week’s delay.

Table 4.3 Date for example 4.1

Activity Duration (weeks)

Preceding activity

Overlap Value (LE)

A 5 30000 B 4 A 20000 C 5 A -1 15000 D 5 A 15000 E 5 B 2 25000 F 4 B,C 16000 G 6 D 18000 H 4 E 1 8000 I 3 F,G 2 with G 9000 J 2 H.I 4000

Algorithm Calculations1) calculate the net operating cash flow at the end of

period t for t ≥ 0 is given by:

At = Pt Et

– At is positive for a surplus and negative for a shortfall– Et = the contractor's expenses in period t, and – Pt = owner's payments in period t, for t = 0,1,2,...,n.

2) calculate The cumulative operating cash flow at the end of period t just before receiving payment Pt (for t ≥ 1) is:

Ft = Nt-1 Et

– Nt-1 is the cumulative net cash flows from period 0 to period (t-1).

3) calculate the cumulative net operating cash flow after receiving payment Pt at the end of period t (for t ≥1) is:

Nt = Ft + Pt = Nt-1 + At

4) The gross operating profit G for a n-period project is defined as net operating cash flow at t=n and is given by:

Algorithm Calculations

Example 1: Contractor's gross profit from a project

The contractor's expenses and owner's payments for a multi-year construction project are given in Columns 2 and 3, respectively, of Table 1. Each time period is represented by one year, and the annual interest rate i is for borrowing 11%. The computation has been carried out in Table 1, and the contractor's gross profit G is found to be N5 = $8.025 million in the last column of the table.

TABLE 1 Example of Contractor's Expenses and Owner's Payments ($ Million)

Period t

Contractor's Expenses

Owner's Payments

Net Cash Flow

Cumulative Cash Before Payments

Cumulative Net Cash

0 1 2 3 4 5

$3.782 7.458

10.425 14.736 11.420

5.679 $53.500

$0 6.473 9.334

13.348 16.832

15.538 $61.525

-$3.782 -0.985 -1.091 -1.388 +5.412

+9.859 +$8.025

-$3.782 -11.240 -15.192 -20.594 -18.666 -7.513

-$3.782 -4.767 -5.858 -7.246 -1.834 +8.025

Considering the time value of money

1) Compute the interest per period

- If is negative and i is the borrowing rate for the shortfall,

- If is positive and h is the investment rate for the surplus,

2) calculate the interest accrued in period t, the cumulative cash flow at the end of period t just before receiving payment Pt (for t ≥1) is:

3) calculate the cumulative net cash flow after receiving payment Pt at the end of period t (for t ≥1) is:

4) calculate the gross operating profit at the end of a n-period project including interest charges is:

where is the cumulative net cash flow for t = n.

Example 2: Effects of Construction Financing

The computation of the cumulative cash flows including interest charges at i = 11% for Example 1 is shown in Table 2 with gross profit = = $1.384 million. The results of computation are also shown in Figure 2.

TABLE 2 Example Cumulative Cash Flows Including Interests for a Contractor ($ Million)

Period (year)

Construction Expenses

Owner's Payments

Annual Interest

Cumulative Before Payments

Cumulative Net Cash Flow

0 1 2 3 4 5

$3.782 7.458 10.425 14.736 11.420 5.679

0 $6.473 9.334 13.348 16.832 15.538

0 -$0.826 -1.188 -1.676 -1.831 -1.121

-$3.782 -12.066 -17.206 -24.284 -24.187 -14.154

-$3.782 -5.593 -7.872

-10.936 -7.354 +1.384

Example 2

Example 3: Effects of Inflation Suppose that both expenses and receipts for the construction project in the Example 1 are now expressed in then-current dollars (with annual inflation rate of 4%) in Table 3. The market interest rate reflecting this inflation is now 15%. In considering these expenses and receipts in then-current dollars and using an interest rate of 15% including inflation, we can recompute the cumulative net cash flow (with interest). Thus, the gross profit less financing costs becomes = = $0.4 million. There will be a loss rather than a profit after deducting financing costs and adjusting for the effects of inflation with this project.

TABLE 3 Example of Overdraft Financing Based on Inflated Dollars ($ Million)

Period (year)

Owner's Payments

Annual Interest

Cumulative Before

Payments

Cumulative Net Cash

0 1 2 3 4 5

$3.782 7.756 11.276 16.576 13.360 6.909

0 $6.732 10.096 15.015 16.691 18.904

0 -$1.149 -1.739 -2.574 -2.953 -1.964

-$3.782 -12.687 -18.970 -28.024 -29.322 -18.504

-$3.782 -5.955 -8.874 -13.009 -9.631 +0.400

Example 4: Effects of Work Stoppage at Periods of Inflation

TABLE 4 Example of the Effects of Work Stoppage and Inflation on a Contractor ($ Million)

Period (year)

Owner's Payments

Annual Interest

Cumulative Before

Payments

Cumulative Net Cash

0 1 2 3 4 5 6

$3.782 7.756 11.276

0 17.239 13.894 7.185

0 $6.732 10.096

0 15.015 16.691 18.904

0 -$1.149 -1.739 -1.331 -2.824 -3.330 -2.457

-$3.782 -12.687 -18.970 -10.205 -30.268 -32.477 22.428

-$3.782 -5.955 -8.874 -10.205 -15.253 -12.786 -3.524

spring 2008, king saud university cash flow analysis dr. khalid al-gahtani 1 payment schedule...

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