Cash Flow Forecasting

Cash flow forecasting in construction projects

Dr. V. Thiruvengadam

Concepts of cash flow forecasting

Project Cash Flow
Project Cash Flow refers to the cash inflow due to income and cash outflow due to
disbursements (expenses) over the project period.
Net cash flow is the difference between the income and disbursements during
the project period.
A positive cash flow means the income exceeding the disbursements during the
project period.
A negative cash flow indicate that the disbursements exceeding the income during
the project period.
For a construction contractor, the progressive payments (monthly) from the client
constitute the income component. The typical cash disbursements are; project
start up costs, payments to labour, material suppliers, equipment hire charges,
subcontractors costs etc.

Dr. V. Thiruvengadam

Concepts of Cash Flow Forecasting

Cash Flow Forecasting
The estimation of the quantum and the timing of the cash incomes and cash
disbursements over the project period is termed as Cash Flow Forecasting.
The Cash deficits determined in the cash flow forecasting forms the basis for the
working capital requirements of the contractor.

Dr. V. Thiruvengadam

Concepts of Cash Flow Forecasting

Project Cost (Cost of Work)
The cost incurred to carry out the construction is termed as cost of work. The cost
of work has two components;
Direct costs on account of material, labour, equipment usage, subcontractor
payments, etc. directly inbuilt in the construction activities.
Indirect costs on account of overheads and operational costs like office
expenses, salary, taxes, etc. associated with the project.
Project Cost Curve
A graph showing monthly cumulative costs vs. the project period is called project
cost curve.
The cumulative cost component could be worked out for the individual cost
components like labour, material etc. to plan the cash requirements for these
components over project period.
The project cost curve is developed based on the activity costs, durations and
their occurrences in the project schedule

Dr. V. Thiruvengadam

Concepts in Cash Flow Forecasting

.Value of Work
Value of work is obtained by adding the desired profit margin (markup) to the cost
of work. Profit margin expressed as a percentage of cost of work.
If 10% is the profit margin
Value of work = (1+0.01) cost of work
= 1.10 times cost of work
Cost of work
= (1/1.10) Value of work
= 0.91 times the Value of work

Profit margin could be uniform on all items of contract or varying for different items.

In a front loading strategy, profit margins are kept more on early items like foundations
and structural works to improve positive cash flow.

Dr. V. Thiruvengadam

Cumulative cost and cumulative value

Profit margin could be uniform on all items of contract or could be kept varying
for different items.
In a front loading strategy, profit margins are kept more on early items like
foundations, structural works to improve positive cash flow.
Cumulative
Value

Profit

Cost

Cumulative
Cost

Cumulative value with uniform profit

Period

Dr. V. Thiruvengadam

Cumulative cost and cumulative value

Value

Cost

Cost

Period

Cumulative value with front loading strategy

Dr. V. Thiruvengadam

Cumulative direct cost components

Total Cost

Material

Cumulative Costs

Labor
Equipment

Subcontractor

Project Period

Cumulative cost profile for individual direct cost components

Enables planning of cash requirement for individual components.
Planning for material procurements
Working capital requirements for timely labor payments

Dr. V. Thiruvengadam

Cost histogram and cumulative cost profile

Costs

Cost histogram represents the cost incurred during specified intervals (weekly
or monthly) over the project period.
The cumulative costs at specified intervals are obtained as sum of the previous
costs and the cumulative cost profile is developed. The end point of cumulative
cost profile is the project total cost.

Costs

100

500
400
300
200

50
0

M1

M2 M3 M4

M5

M6

M7

100
0
0 M1 M2 M3 M4 M5 M6 M7 M8

M8

Project Period (Months)

Cumulative Cost Profile

Cost Histogram

Months

M1

M2

M3

M4

M5

M6

M7

M8

Monthly Costs

50

60

70

80

60

50

40

20

Cumulative Costs

50

110

180

260

320

370

410

430

Dr. V. Thiruvengadam

Project S-curve
% Cumulative Costs

120
100
80
60
40
20
0
2/3T
1/3
T Time Period

Project S-curve represents the cumulative cost profile of a construction project.

The profile follows a lazy S-curve pattern indicating less cost incurrence in the
early and end part and more cost incurrence in the middle part of the project.
The S-curve cumulative cost profile is obtained through 1/4th-1/3rdrule
meaning;
1/4th cost (25%) incurred in the first 1/3rd time
1/2 cost (50%) incurred in the middle 1/3rd time
1/4th cost (25%) incurred in the last 1/3rd time

Dr. V. Thiruvengadam

% Cumulative Costs

Project S-curve
120
100
80
60
40
20
0

1/3T

2/3T

Time Period

The shape of S-curve could vary depending upon the project characteristics.
Construction types using prefabrication technology involve more costs in the
initial fabrication period compared to installation costs in the later period.

Dr. V. Thiruvengadam

Project S curve
Example problem on S-curve

A project costing 80 lakhs is planned to be completed in 6 months period. Determine the

monthly and cumulative cost requirements using standard S-curve principle.

90

80
20

70

60

60
50
40
30

80

40

% Cumulative Costs

80

20
20

20
10

Period

Note: With linear cost variation assumed between the periods

Months

Monthly Costs

10

10

20

20

10

10

Cumulative Costs

Dr. V. Thiruvengadam

20

60

80

Project S curve
% Cumulative Costs

Use of S-Curve

120
100
80
60
40
20
0
2/3T
1/3
T Period

Standard S-curves are used for obtaining approximate the cash forecasts during
the early stages of the project like feasibility studies, tendering stage.
Cash flow forecasting of different types of projects like offices, residences,
factories, roads and bridges developed from the cost data of past projects for
usage in the early stages of similar new projects.

Dr. V. Thiruvengadam

Need for Cash Flow Forecasting

Cash flow forecasting is necessary to establish the financial viability of the investment
proposal during pre-project phase of the project.
Economical analysis of projects using methods like Net Present Value (NPV), Internal
Rate of Return (IRR) require reasonable estimation of cash outflows (expenditure
streams) and cash inflows (revenue streams) over the project life period.

Adverse situations (risks) that may occur on cash flows needs to be evaluated to
predict the impact of these risks on the financial outcome of the project.
As lenders of money, financial institutions carry out detailed appraisal on the
projected cash flow of the project to evaluate and decide on financing
Financial viability
Ability to pay the interest and repay loan
Adequacy of equity contribution by borrower (debt-equity ratio)

Dr. V. Thiruvengadam

Need for Cash Flow Forecasting in PPP projects

For PPP projects implemented through BOT basis (or its
variants), cash flow forecasting during concession period of
the contract is of utmost importance for evaluating the
financial viability of these projects with the consideration of
risks that would impact on the cash flow streams.
BOT projects have long concession periods with uncertainties
in revenue stream and inflationary effects.

Dr. V. Thiruvengadam

Need for Cash Flow Forecasting for Contractors

Cash flow forecasting is essential for construction contractors in the following stages:
Tendering (bidding) stage
1. To plan the bidding strategy with desired profit margin, cash flow
forecasting is necessary taking into consideration the financial conditions
given in bid document that would have bearing on cash flow like advances,
retentions, intervals of valuation of works and progressive payments and
likely payment delays that would increase negative cash flow.
2. To decide on the capital requirements for the project under bidding.
3. Cash flow positions and commitments of projects already in hand.
4. Finally to decide on participation or otherwise in the bidding process.
On successful bidding and contract award
1. To workout the quantum and timing of cash requirements and plan the
anticipated expenditure on various resources (workforce, material,
equipment, subcontractors etc)

Dr. V. Thiruvengadam

Need for Cash Flow Forecasting for Contractors

On successful bidding and contract award
1. To workout the quantum and timing of cash requirements and
plan the anticipated expenditure on various resources (workforce,
material, equipment)
2. To plan the material procurement strategy (cash or credit)
3. To plan the equipment resource (ownership or hire purchase).
4. To plan direct employment of labour force or through output
based labour contracts.
5. To decide on subcontractors and payment terms.
6. To plan for the modes of providing securities/ warranties through
cash recovery from bills or through bank guarantees.
7. To workout the quantum of overall investment and plan the
working capital requirements for meeting the cash deficits.
8. To plan for the short term financing options from the banks for the
working capital requirements taking into considerations the
repayment terms and interest payable (cost of capital).
9. Ultimately to predict the desired profits on project completion.

Dr. V. Thiruvengadam

Typical project risks affecting the project cash flow

1.

Payment related risks:

a) Payment delays by the client.
b) Disputes/ conflicts in the interpretation of contract conditions causing
payment delays (ambiguous contract conditions)
c)
Change orders not promptly processed causing days in payments

2.

Materials and equipment related risks

a) Scarcity of materials
b) Abnormal increase in cost of materials
c)
Non-availability of workforce
d) Problems related to equipment

3.

Large changes in project scope/ client requirements

4.

Delays in project approvals by statutory bodies (works awarded in anticipation of

approvals)

5.

Delays in the issues of designs/ drawings by the client

6.

Site not clear for taking up of the construction (work awarded in anticipation of
clear site availability)

7.

Large scale changes in quantities of items

Dr. V. Thiruvengadam

Steps involved in cash flow forecasting

1.

Collection of project details

a) Project time plan (project schedule)
b) Bill of quantities with contract rates of items (value of items)
c)
Financial conditions of the contract related to advances, payment terms,
reimbursement for escalations, penalties, etc.
d) Other relevant details having bearing on project cash flow.

2.

Prepare the project schedule in the form of bar chart with activity listings and
durations. Schedules prepared using network techniques are consolidated in bar chart
formats.

3.

Determine activity costs from the itemized costs available in the bill of quantities. One
or more item costs may constitute an activity cost. A raft foundation activity will involve
items of reinforcement, shuttering and concreting items.

4.

Determine the proportional costs that are expended per unit duration (per month) of
an activity. For some activities the expenses may not be in a linear proportion over the
activity duration. Such breakup of activity cost within its duration is important for
activities which consume more resources/ cost in the early part and less cost in the
later part of the activity duration. For example activities involving procurement and
installation of electrical/ mechanical works involve more cost for procurement and less
cost for installation. In such cases it may be better to keep procurement and installation
as separate activities.

Dr. V. Thiruvengadam

Steps involved in cash flow forecasting

5.

For expenses towards overhead charges, the total cost under this subhead may be
distributed equally over the project periods.

6.

Calculate the monthly (or any other unit period) cost expenditure of the project by
summing up the cost expenditure of different activities during the month under
consideration. This means sum the portions of activity costs of different activities
incurred during each monthly interval of the project. These monthly costs are
shown in the first row of the table at the bottom of the bar chart. Calculate the
cumulative monthly costs and show in the second row of the table. (See Fig).These
calculations could also arranged in excel format.

7.

If the value of the activities (which is based on item wise contract cost which
includes profit margin) is used for the generation of cumulative value of works in a
similar manner described above, then cumulative cost of work is obtained by using
the relation:
Cumulative cost = cumulative value/(1 + percentage profit in decimal)

Dr. V. Thiruvengadam

Steps involved in cash flow forecasting

8.

Having calculated the period wise (monthly) cumulative value and cumulative cost
of the work over the project period, the remaining calculations for determining
the monthly cash inflows due to receipts, outflows due to disbursements and
cumulative net cash flow could be worked out in a excel sheet format
incorporating the following details;

Recovery of retention money (outflow) and its subsequent release (inflow)

Breakup of the costs into its components (labour, material, equipment,

subcontractors) and their cash outflows based on the timings of their
disbursements.

9.

The above steps completes the procedure of developing the cash flow forecasting
of a construction project for a contractor. The above procedure enables
determination of working capital requirements, profitability, assessment of impact
of risks like delayed payments from the client.

10. The procedure is illustrated through a numerical example.

Dr. V. Thiruvengadam

Calculation procedure for cash flow forecasting in excel format

Rows related to cumulative values, retention money recovery and retention money
release:
Row 1Enter month wise cumulative values of work.
Row 2Enter cumulative values of work less retention money

Row 3Enter receipts of monthly payments less retention money with respect to billing
cycle usually one month after the value of work executed.
Row 4Enter cumulative values of retention money received back, 50% one month after
end of project execution and balance 50%, 6 months after project execution (defect liability
period)

Row 5 Cumulative cash inflow (3+4)

Dr. V. Thiruvengadam

Calculation procedure for cash flow forecasting in excel format

Rows related to cumulative costs, breakup of costs into components
Row 6Enter cumulative costs (direct costs)
(Derive from cumulative value with assumption on profit percentage)
Row 7Enter cumulative labour costs.

Make suitable assessment of the labour cost as fraction of total cost (say 25%) paid at the
end of each month right from project starting month.
Row 8 Enter cumulative labour payment made
Row 9Enter cumulative material costs
Row 10 Enter cumulative material payment made
Make suitable assessment on the material cost component (say 50%) and decide on the
payment to material supplier (say one month after the receipt of the payments from the
client)
Row 11Enter cumulative equipment component (say 15%) and payment cycle similar to
material supplies
Row 12 Enter cumulative equipment component payment made
Row 13Enter cumulative subcontractor cost (say 15%)
Row 14 Enter cumulative subcontractor payment made

Payment cycle similar to equipment material supplies

Row 15 Cumulative cash out flow (8+10+12+14)
Row 16 Cumulative net cash flow
Note: The payment cycle to material supplier, equipment charges and subcontractor could be changed as per project
specific arrangements

Calculation procedure for cash flow forecasting in excel format

Rows related to cumulative cash inflows, cash outflows and net cash flow
Row 10Addition of rows 3 and 4 gives total cumulative cash inflows
Row 11Addition of rows 6,7, 8 and 9 provide total cumulative cash outflow

Cash Flow

Peaks due to
release of
retention
money

Negative cash
flow period

Net cash flow diagram

Dr. V. Thiruvengadam

Positive cash
flow period

Project Period

Profit

Row 12The difference between row 10 (cash inflow) and row 11 (cash outflow) provides
the net cash flow.

Example on cash flow forecasting

1 : CASH FLOW STATEMENT WITH OUT DELAY IN PAYMENT (WITH 15% PROFIT )
Time (months)

Cumulative Value

Cumulative Value less retention money

recovered

1.15

2.88

5.75

8.63

11.50

14.38

17.25

1.035

2.587

5.175

7.762

10.35

12.937

1.035

2.587
5

5.175

7.762
5

10

11

12

13

14

15

16

17

18

23.00

28.75

30.48

31.05

31.63

31.63

31.63

31.63

31.63

31.63

31.63

15.525

20.7

25.87

27.427

27.945

28.462

28.462

28.462

28.4625

28.4625

28.4625

28.4625

12.9375

15.52
5

20.7

25.875

27.4275

27.945

28.4625

28.463

28.463

28.463

28.463

28.463

Cumulative payment received after 1 month

of Billing cycle

Cumulative retention money received back

1.581

3.162

Cumulative Cash Inflow (Receipt) (3 + 4)

1.035

2.587

5.175

7.762

10.35

12.937

15.52

20.7

25.875

27.427

27.945

30.043

28.463

28.463

28.463

28.463

31.625

Cumulative Cost

1.00

2.50

5.00

7.50

10.00

12.50

15.00

20.00

25.00

26.50

27.00

27.50

27.50

27.50

27.50

27.50

27.50

27.50

Cumulative Labor Cost (25%)

0.250

0.625

1.250

1.875

2.500

3.125

3.750

5.000

6.250

6.625

6.750

6.875

6.875

6.875

6.875

6.875

6.875

6.875

Cumulative Labor payment

0.250

0.625

1.250

1.875

2.500

3.125

3.750

5.000

6.250

6.625

6.750

6.875

6.875

6.875

6.875

6.875

6.875

6.875

Cumulative Material cost(40%)

0.400

1.000

2.000

3.000

4.000

5.000

6.000

8.000

10.00

10.600

10.800

11.000

11.000

11.000

11.000

11.000

11.000

11.000

10

Cumulative Material payment made

11

Cumulative equipment cost(20%)

12

Cumulative Equipment payment made

13

Cumulative Sub contractor cost(15%)

14

Cumulative subcontractor payment made

15

Cumulative cash out flow(8+10+12+14)

16

Cumulative Net Cash flow(5-15)

10.35

0.400

1.000

2.000

3.000

4.000

5.000

6.000

8.000

10.000

10.600

10.800

11.000

11.000

11.000

11.000

11.000

11.000

0.200

0.500

1.000

1.500

2.000

2.500

3.000

4.000

5.000

5.300

5.400

5.500

5.500

5.500

5.500

5.500

5.500

5.500

0.200

0.500

1.000

1.500

2.000

2.500

3.000

4.000

5.000

5.300

5.400

5.500

5.500

5.500

5.500

5.500

5.500

0.150

0.375

0.750

1.125

1.500

1.875

2.250

3.000

3.750

3.975

4.050

4.125

4.125

4.125

4.125

4.125

4.125

4.125

0.150

0.375

0.750

1.125

1.500

1.875

2.250

3.000

3.750

3.975

4.050

4.125

4.125

4.125

4.125

4.125

4.125

0.250

1.375

3.125

5.625

8.125

10.625

13.125

16.25

21.25

25.375

26.625

27.125

27.500

27.500

27.500

27.500

27.500

27.500

-0.250

-0.340

-0.538

-0.450

-0.363

-0.275

-0.188

-0.725

-0.550

0.500

0.803

0.820

2.544

0.963

0.963

0.963

0.963

4.125

example
35.00

Fund Requirement
based on Negative
Cash flow

30.00

= area of graph of
negative cash flow
region

25.00
20.00

= average vertical
coordinate x base

15.00

= .409 X 8 =
Rs.3.27lakhs

10.00
5.00
0.00
1

10

11

12

13

14

15

16

17

-5.00
Cumulative Value
Cumulative Cost
Cumulative Cash (Net) flow (3+4-14)

Inflow after 1 month of Billing cycle

Cumulative cash out flow (7+9+11+13)

18

Hence the contractor

has to mobilize of Rs.
3.27 lakhs during the
period of negative
cash flow