CHAPTER 2: LITERATURE REVIEW

Topic:

Retention Money's Impact on SME Contractor Cash Flow and Project Performance

in PAM Construction Contracts

2.0 INTRODUCTION

In this chapter, the definitions and theories related to the topic of this research

will be discussed with the information collected from research papers, journals,

conference paper and e-books. The purpose of the chapter of literature review is to

provide an in-depth review of the existing knowledge and academic discussion

regarding the impact of retention money practices in the Malaysian construction

industry, specifically in relation to PAM contracts. This chapter will comprise of 3

sections. The first section of literature review will be discussing about the definition

of retention money, SME contractor, cash flow, project performance and PAM

Construction Contracts. The following section will be presenting the literature review

on impact of retention money practice under PAM contracts on the cash flow of SME

contractor. Meanwhile, the last section of this chapter is about the impacts on project

performance subsequent to the retention money practice of PAM.

2.1 DEFINITIONS

2.1.1 Retention Money

In the 1840s, railway construction during the time of Queen Victoria was the

first time where “retention money” is being utilized. It started because construction

companies often went broke. This caused delays and money loss for clients. The goal

was to give money protection by keeping funds aside to pay for finishing costs if the

contractor runs out of cash. This habit grew popular in building businesses and is still

an important part of papers used for agreements, guaranteeing money safety and
(Raina & Tookey, 2012)
project finish .

Retention money is the sum kept from paying a contractor or subcontractor

until later in the agreement. This is a common way in making deals where the money

held back are only given out after checking carefully to confirm that the project was
(Raina & Tookey, 2012)
finished well. .

Retention money is also referred to an amount owed to the contractor that a

client withheld as a guarantee; if there are problems with the building during its

defect liability period, then, these saved funds must be used to fix the problems
(Muhammed et al., 2019) Cui et al. (2010),
. According to “Retention Money” is also

defined as the sum withheld from early payments to ensure a project is finished

within the time frame given.

Table 1 below presents the compilation of the definition of construction

workers. In conclusion, retention money is a held back part of payments given to

contractors or subcontractors until later in the contract. It acts like a promise given by

the customer, meant to handle problems during the time when they can report
defects. This way makes sure the project is done in the right time and it protects

money, making sure projects are good and finished on time.

Table 1: Definition of Retention Money

Authors Definition
(Raina & Retention money is the sum kept from paying a contractor or

Tookey, 2012) subcontractor until later in the agreement.

(Muhammed et Retention money is referred to an amount owed to the

al., 2019) contractor that a client withheld as a guarantee; if there are

problems with the building during its defect liability period,

then, these saved funds must be used to fix the problems

(Cui et al., Retention money is the sum withheld from early payments to

2010) ensure a project is finished within the time frame given.

In the Nigerian construction industry, as told by the local standard form of

contract “JCT 98”, 5% of the contract sum, is kept back as security during work on

the project. Also, there is a set top limit for holding onto money. This means that the

most you can keep from payments in a project is 10% of the contract sum which was
(Muhammed et al., 2019)
decided during tender . In Malaysia construction industry,

the amount of retention money withheld by the client has been depicted in the

standard form of contract PAM 2018 in clause 30.5 “The Employer may retain the

percentage of the total value of the work, materials and goods referred to in clause

30.2, which is stated in the Appendix as Percentage of Certified Value Retained” (if
(PAM 2018 (With Quantities), n.d.).
none stated is 5% of the contract sum )
 When it come to the release of retention money, only half of the retention

money (5% of the contract sum OR 50% of the retention money) will be released

after the issuance of Certificate of Practical Completion of the project. Meanwhile,

the remaining half of the retention money (the remaining 5% of the contract sum OR

the remaining 50% of the retention money) will be released after the issuance of
(PAM 2018 (With Quantities), n.d.)
Certificate of Making Good Defects .

2.1.2 SME Contractor

Recognising the global importance of the SME sector and the informal

economy, defining SMEs proves to be a tough challenge due to the various criteria

used by different countries. The different criteria that could be considered when

defining a SME result in a plethora of definitions. Particular variables, however, such

as the number of employees, turnover, and overall balance sheet, are frequently
(Aluko, 2016)
emphasised in the classification of SMEs .

Several definitions of SME contractor have been established in other

countries. However, due to the research is carried out in Malaysia construction

industry, the definition of SME contractor will be provided in the context of

Malaysia. In Malaysia construction industry, SME (Small Medium Enterprise) is

defined a company with fewer than 50 full-time workers or making RM5 million or
(Bank Negara Malaysia, 2005)
less annually .

According to Mohamed et al. (2018), in Malaysia construction industry, the

contractors who are graded within the range of G1 to G3 is classified as small

contractors while the contractors who are graded within the range of G4 to G5 is

classified as medium-sized contractors. The grading system of the grade of contractor

is in accordance with the grading scale provided by Construction Industry

Development Board (CIDB). Therefore, SME contractor can also be defined as the

contractors who are graded within the grade of G1 to G5 in the context of Malaysia

construction industry. The Contractor Registration Grades will be shown in the Table

2 below:

(Table 2: Contractor Registration Grades,

Source Mohamed et al., 2018)

SME contractors often face problems that slow down their growth, like

insufficient money, limited financial accessibility and insufficient management

efficiency. They also face regulatory restrictions, limited buying power and trouble
(Hisham & Ruddock, 2017)
getting into global markets . Table 3 below presents the

compilation of the definitions of SME Contractor.

 Table 3: Definition of SME Contractor

Authors Definition
(Bank Negara SME (Small Medium Enterprise) is defined a company with

Malaysia, 2005) fewer than 50 full-time workers or making RM5 million or less

annually in Malaysia construction industry.

(Mohamed et SME contractor can also be defined as the contractors who are

al., 2018) graded within the grade of G1 to G5 in the context of Malaysia

construction industry.

In this study, small and medium-sized construction businesses can be defined

in many ways. In this research, the definition of SME contractor will be limited to

those contractors who are graded within Grade 1 to Grade 5 according to the CIDB’s

Contractor Registration Grades and able to handle projects worth up to RM5 million

but have less than 50 permanent workers.

2.1.3 Cash Flow

Cash flow is the total amount of money that comes in and goes out on a
(Zayed & Liu, 2014)
project during a certain time . Cash flows is also defined as the

amount of money a business has and makes sure it runs well, stays safe with its
(Pavlovi et al., n.d.)
finances, can pay off debts easily and keep up good reputation .

Tarawneh et al. (2023) once said that cash flow is the backbone of the

construction industry, which is generally regarded as the most important resource at a

company. In the context of construction, cash flow has been further categorized into
2 different types namely “positive cash flow” and “negative cash flow”. Positive cash

flow mainly comes from cash received every month through payment certificates. On

the other hand, negative cash flow is linked to spending on a contract. It includes

costs like salaries, materials, equipment, payments for subcontractors or extra

(Odeyinka et al., 2003)
expenses during the contract's period .

The inconsistent pattern of payments in the construction industry causes cash

flow to fluctuate, with large outflows for labour and materials during the early stages
(Glowacki, 2015)
of the project and inflows once it is completed . The factors leading

to the variation of cash flow of a construction firm have been grouped under 5

categories namely contractual, programming, pricing, economic factors and valuation

(Glowacki, 2015)
.

Cash flow is important for the contractors to maintain the day-to-day

activities of the construction industry such as paying the wages of the workers,

suppliers, and subcontractors for costs they spend during a certain construction

period. The contractors then add these costs up and the leftover amount makes a
(Koopman & Cumberlege, 2021)
fresh bill that will eventually lead to cash inflow .

Table 4 below presents the compilation of the definition of cash flow. In

conclusion, cash flow refers to the comprehensive financial movement of funds

within a project or business during a specified period. It represents both the incoming

and outgoing monetary transactions, playing a crucial role in maintaining the

financial health, security, debt management, and overall reputation of the enterprise.

Positive cash flow is primarily derived from the consistent inflow of funds received

monthly through payment certificates. Conversely, negative cash flow is associated

with expenditures related to a contract, encompassing items such as salaries,

materials, equipment, payments to subcontractors, and additional expenses incurred

over the duration of the contract.

Table 4: Definition of Cash Flow

Authors Definition
(Zayed & Liu, Cash flow is the total amount of money that comes in and goes

2014) out on a project during a certain time.

(Pavlović et al., Cash flows is defined as the amount of money a business has

n.d.) and makes sure it runs well, stays safe with its finances, can pay

off debts easily and keep up good reputation.

(Odeyinka et al., -Positive cash flow mainly comes from cash received every

2003) month through payment certificates.

-Negative cash flow is linked to spending on a contract

including costs like salaries, materials, equipment, payments for

subcontractors or extra expenses during the contract's period.

2.1.4 Project Performance

Project performance is the refers to the overall success and effectiveness of a

construction project throughout its life cycle. It is a team effort of different

stakeholders involved, such as the client, consultant, contractor, supplier, end-user

(A. Akintoye, 2002)
and the community . Project performance is also defined as the

assessment of success in the construction industry. It's a very complex idea that is

looked at based on many criteria, like client satisfaction, the quality, safety, cost, and
(Unegbu et al., 2023) A. S. Akintoye & MacLeod (1997
time consumed . Besides, according to
 the ability of construction project to meet the expectations and

needs of the stakeholders while reaching its objectives and giving the end results is

called project performance.

Both experts and people working in the construction industry agree that

measuring construction project performance is very important. It affects the project's

health, the reputation of the construction firm, and the eventual success of the project
(A. S. Akintoye & MacLeod, 1997)
. Key Performance Indicators (KPIs) is

commonly used to measure how well a project is going, the effectiveness and the

stakeholders’ satisfaction. These indicators are important tools for looking at project

performance. These indicators measure different parts of a project performance

including time, cost, quality, safety and environmental related aspects

(Unegbu et al., 2023)
.

A majority of the project performance indicators, encompassing construction

cost, construction time, defects, client satisfaction with both the product and service,

profitability, and productivity, tend to encourage result-oriented considerations. In

contrast, indicators like the predictability of design cost and time, predictability of

construction cost and time, and safety are often categorized as aspects of process-

oriented thinking. These criteria collectively form the common benchmarks

(A. Akintoye, 2002)
employed for the evaluation of project performance .

Table 3 below presents the compilation of the definition of project

performance. In conclusion, project performance is comprehensive measure of the

overall success and effectiveness of a construction project across its entire life cycle.

It encompasses the thorough assessment of a construction project's overall efficacy

and success over the project's whole life cycle.

 Table 3: Definition of Project Performance

Authors Definition
(A. Akintoye, Project performance is the refers to the overall success and

2002) effectiveness of a construction project throughout its life cycle.

(Unegbu et al., Project performance is defined as the assessment of success in

2023) the construction industry.

(A. S. Akintoye The ability of construction project to meet the expectations and

& MacLeod, needs of the stakeholders while reaching its objectives and

1997) giving the end results is called project performance.

2.1.5 PAM Construction Contracts

Construction contracts are formal written agreements signed by the parties

involved to articulate and establish their relationships and responsibilities

(Chong & Zin, 2010)
.

In historical context, the PAM/ISM 1969 Form was developed in 1969,

following the endorsement of both Pertubuhan Akitek Malaysia ('PAM') and

(Rajoo, 2010)
Institution of Surveyors of Malaysia ('ISM') . Its creation aimed to

serve a particular purpose within its historical context. Taking inspiration from the

Joint Contracts Tribunal Form's ("JCT 1963 form") structure and design, it came into
(Rajoo, 2010)
being as an organized document suited for specific applications .
 The PAM standard form of building contract is a widely used template in

Malaysia, making up about 90% of private sector building contracts. It falls under the
(Harisudin et al., 2022)
category of contracts created by professional institutions .

Originally influenced by UK forms, it has evolved over time to suit Malaysia's

unique conditions. In essence, it's a crucial and widely accepted framework for
(Rajoo, 2010)
contractual agreements in the Malaysian construction industry . A

standard form of construction contract would be beneficial in clearly defining the

obligations of the parties involved and outlining, with reasonable clarity, the scope of
(Zakaria et al., 2022)
the project . The PAM contract is commonly employed to

oversee the contractual relationship between the employer and the contractor
(Chia, 2012)
.

2.2 IMPACT OF RETENTION MONEY PRACTICE ON CASH FLOW OF

SME CONTRACTOR

Retentions can cause cash flow issues for both contractors and

subcontractors, requiring large borrowing during times when interest rates are high.
(Raina & Tookey, n.d.)
As a result, owners or clients face higher building costs .

2.2.1 Bankruptcy (Chadee et al., 2023)

Insufficient cash can result in project failure and the bankruptcy of a business
(Al-Joburi, Al-Aomar, et al., 2012)
. Financial difficulties are more likely to impact

construction companies, given the inherent characteristics of the industry

(Aluko, 2016)
. Construction projects often pose challenges due to their intricate nature and a

common lack of precise control, which amplifies the risk factor owing to the
(Marzouq AL-NASSAFI, 2022)
significant expenses involved in execution . The

uniqueness of each project, coupled with intense competition and market volatility
related to construction activities, increases the susceptibility of construction firms to
(Aluko, 2016)
financial distress .

Besides, it has been proven that the construction industry has suffered from a

high percentage of bankruptcies in comparison to other industries, for a considerable

(De-graft Owusu, 2011)
duration . Insufficient availability of cash flow remains one of
(De-graft Owusu, 2011)
the primary factors leading to bankruptcy in this industry .
Wong et al. (2010)
Moreover, also examined that construction companies with cash

flow difficulties drove the company to bankruptcy. As noted by research done by

(Nor Azhari Azman et al., 2012)
in Malaysia construction industry has identified the

late release of retention money by client can affect the contractors’ cash flow which

will eventually leads to bankruptcy and liquidation of the contractors’ firm.

However, the is also critical factor that cause the contractor to encounter cash

flow problem. The delay in the payment of retention money emerges as a significant

contributor to cash flow challenges for construction contractor firms

(Chadee et al., 2023)
Namaiwa (2022),
. According to clients withholding payments such as

retention money in an unnecessary manner can also cause bankruptcy in the SME

contractor. Small and medium-sized company (SME) contractors are particularly

vulnerable to client-induced payment delays due to two key issues. For instance,

their weak bargaining power during negotiations frequently leads them to accept
(Bilotta, 2013)
unreasonable payment delays . Then, the limited liquidity of SMEs

renders them more vulnerable to the negative implications of late payments than
(Bilotta, 2013)
larger rivals .

The delayed release of retention funds, which are vital working capital for
(Namaiwa, 2022)
contractors in the construction industry, directly harms their cash flow
 . Consequently, disruptions in this crucial process can seriously jeopardize a

contractor's financial stability, impeding their ability to handle financial demands and

hindering the successful execution of projects. Ultimately, these challenges can

escalate, potentially leading to the bankruptcy of the SME contractor

(Paul & Boden, 2011)
.

Another research by Odeyinka (2005) has also identified that the practice of

retention money has negatively impacted the SME contractor's cash flow. The

negative impact of retention money on contractor’s cash flow has been further

reinforced by the Latham Report which strongly highlighted the negative impact of
(Latham, 1994a)
retention on contractors' cash flow .

Al-Joburi et al. (2012) argue that a company can endure a transitional phase

without demonstrating profitability or even experiencing losses; however, its ultimate

bankrupt will result from insufficient cash flow. Numerous researchers have explored

the reasons behind failures in the construction sector, as indicated by studies

Argenti (1976) Wong et al. (2010).
conducted by and Their results show that cash

flow problems are one of the main causes that lead to bankruptcy of the contractor’s

firm. In short, upon studying these papers, it has shown that the withholding and late

release of retention money will cause the SME contractors to face cash flow

problems which will eventually lead to bankruptcy.

2.2.2 Increased in Contractor’s Debt (Chadee et al., 2023)

Client representative such as architects and project managers used to

emphasize that they promptly issue retention payments upon the project's

completion. However, contractors argue that this is not the case

(Amoa-Abban, 2017)
. To examine the truth of the issue, an assessment of the duration of payment
have been carried out. Most of the respondents (22 out of 47 respondents) has rated

that the “Delayed of Retention Payment” as “almost always’, which indicates that the

occurrence of delayed in payment of retention money is happening almost all the

(Amoa-Abban, 2017).
time The research also further mentions that the retention

money practice did further exacerbates the financial strain by adding to the already
(Amoa-Abban, 2017)
challenging burden on cash flow .

According to Omopariola et al. (2020), most of the respondents of the

research are from small and medium sized construction companies in Nigeria has

ranked the delays in payment to the contractors as the highest ranking of the causes

of cash flow problems. Besides, given that contractors work with a slim profit

margin, it becomes challenging to anticipate them having excess cash reserves.

Consequently, contractors may find themselves compelled to manage operations with

(Okereke, 2020)
negative cash flows .

Okereke (2020) also argued that the delayed payments such as late delayed

payment of retention money will cause cash flow problem, especially for small and

medium contractor’s firm. This can be explained that large contractor firms have

specific commercial department with experts in managing cash flow. Additionally,

they might have developed methods to address any shortage in cash flow by using
(Okereke, 2020)
alternative funding sources . Conversely, small and medium

contractor firms will have to deal with the shortage of skilled staff in managing their

cash flow and they could not foresee the delayed payments, leading to extra financial

pressure. To cope, these contractors end up using borrowed money to cover the cash

flow gap which will eventually lead to increase in contractors’ debt.

 Based on Adjei et al. (2018) and Omopariola et al. (2017) , it is evident that

poor cash flow can result in capital lock-up for contractors. In situations where

contractors face financial constraints, they may need to borrow money or utilize

company reserves to meet their obligations. This capital lock-up not only hinders the

cash from its interest-earning capabilities but can also lead to an increase in debt for

the contractor. The need to borrow money or tap into reserves indicates a strained

financial situation, emphasizing the detrimental impact of poor cash flow on the

financial health of contractors and their ability to manage debt effectively.

Lastly, according to Chadee et al. (2023), increasing in contractors’ debt is

also ranked as the top leading effects of delayed payments to contractors’ cash flow

with a Relative Importance Index (RII) value of 0.855.

2.2.3 Difficulties in Procuring Materials and Equipment (Chadee et al., 2023)

As per mentioned in the above section that the retention money practice can

cause cash flow problem on contractors. The cash flow problem will eventually

cause the contractors to face difficulties in procuring materials and equipment.

(Chadee et al., 2023) Amoako (2011)
. A research carried out by has identified that

difficulties in procuring materials and equipment as one of the effects cash flow

problem arise from delayed payments with a RII value of 0.811.

According to Chadee et al. (2023) , the absence of effective laws addressing

delayed payments in Trinidad has led to a casual cultural attitude, fostering higher

tolerance levels for late or non-payments and a disregard for agreed-upon contract

terms which will consequently lead to cash flow problem on contractors. Therefore,

suppliers are reluctant to provide materials or engage in business with contractors

(Chadee et al., 2023).
facing cash flow problem
 As noted by Laryea (2010), all of the contractors complained that cash flow

problems is the main problem that caused difficulties for them in procuring materials

and equipment. The contractors claimed that lack of monetary resource will obstruct

them from having the complete set of necessary equipment. Besides, they also

claimed that because of not having enough funds, contractors find it hard to get

important materials like rocks, sand, tar, along with water and fuel oil for their jobs.

They borrow money until they get a point where they can't get more credit. The main

reason for this cash flow problem, according to the contractors, is the excessive delay
(Laryea, 2010)
in getting payment from the government .

2.2.4 Working Capital Constraint (Omopariola et al., 2020)

Working capital are the financial resources that businesses require to continue
(Afrifa, 2016)
their day-to-day (short-term) operations . Working capital is often
(Makori & Jagongo, 2013)
called the life force of any business . A company's

financial resource that it can use in ensuring a company's liquidity, resilience,

financial stability, and profitability is known as working capital. It is the important

(Makori & Jagongo, 2013)
component that keeps a business running .

(Afrifa, 2016) said that investing more money in working capital helps

companies work better. It makes sure operations run smoothly, prevent interruptions

of production, builds strong connections with customers over time and provide

financial flexibility. Although it has been proven that higher working capital can

enhance the overall performance of the firm, unfortunately, a company that facing

financial difficulty such as cash flow problem may not perform such action
(Wasiuzzaman, 2015)
.
 Another research carried out in India had depicted that larger firms tend to

have higher working capital than small and medium firms (SME)
(Chauhan & Banerjee, 2018)
. This is due to large firms have extensive diversity, have greater

access to finance markets and can use this advantage to secure more trade credits.

Conversely, small and medium firms are subjected to more financial constraints
(Chauhan & Banerjee, 2018)
. Therefore, small and medium firms tend to face

working capital constraints compared to large firms.

Lastly, the data findings of a previous research done by Bao et al. (2012) has

shown that financially constrained firms are usually smaller firms with low cash

flow. Expectedly, this small firms will tend to face working capital constraints as
(Bao et al., 2012)
well . To cope with immediate financial needs, these firms often

resort to higher short-term debt. This situation hampers their ability to invest in long-
(Bao et al., 2012)
term assets, leading to reduced growth opportunities . In essence,

financial constraints create a cycle where smaller firms find it difficult to obtain good

working capital.

2.3 IMPACTS ON PROJECT PERFORMANCE SUBSEQUENT TO THE

RETENTION MONEY PRACTICE

The previous research has identified that the retention money practice has
(Odeyinka, 2005)
impacted the SME contractors’ cash flow negatively .
Latham (1994)
has further reinforced this issue by strongly emphasizing the negative impact

of retention on contractors’ cash flow in the Latham Report.

The influence of cash flow permeates every facet of the construction project

implementation process. Insufficient funds can culminate in both project and

business failure. Scholars have investigated the role of cash flow concerning
scheduling, project delays, business setbacks, and predictive forecasting
(Al-Joburi, AlAomar, et al., 2012)
.

Research of Kuwait’s contractors’ perceptions on the effects of cash flow

variation on project performance has examined that cash flow problem will have
(Marzouq AL-NASSAFI, 2022)
negative impacts on project performance . Another

research in Ghana also stated that weak cash flow will impact the construction firm’s
(Adjei et al., 2018)
profitability which eventually affects project delivery . In essence,

it has been proven that the retention money will impact the contractors’ cash flow
(Odeyinka, 2005; Latham, 1994;
which further affects the project performance
Al-Joburi et al., 2012;
Marzouq AL-NASSAFI, 2022; Adjei et al., 2018).

2.3.1 Project Delay

The occurrence of project delay is very common in the construction industry

(Marzouq AL-NASSAFI, 2022)
. The construction industry worldwide has

encountered criticisms for its ongoing challenges with delays.

Sambasivan & Soon (2007)
Agyekum Mensah et al. (2012)
and highlighted delays observed in the

literature, revealing that over 40% of projects globally encounter delays.

In simple terms, a delay in a project is like running late—it's when things take

more time than initially planned, surpassing the agreed-upon date in the contract or
(Abdul-Rahman et al., 2009)
the one decided upon by everyone involved . According
(Abdul-Rahman et al., 2009)
to financial problem has contributed significantly to the
Sweis et al. (2008)
delay in construction project. has supported the statement by

stating that many of the delay in construction projects in Jordan was due to the

financial difficulties encountered by the contractors. Another analysis of construction

delays in Malaysian projects found that contractor cash flow issues has contributed to
(Hoque et al., 2023).
the project delay as well

According to
Construction Industry Working Group on Payment (WG10). (2007)
, if there are issues with payments, it will create a domino effect, causing

serious cash flow problems down the chain of contracts. Cash flow problem will

cause shortage of financial resources which will then lead to project delay
(Kaming et al., 1997)
Al Mohsin et al. (2014)
. further support the statement of retention

money will cause delay in construction project by saying that the retention money

payment will affect the contractors for not able to achieve minimum cash needed for

cash outflow which further cause some activities to be delayed at the site.

For instance, delay in payment such as retention money as aforementioned by

Amoa-Abban (2017)
will subsequently threaten the contractor’s cash flow. This, in

turn, slows down the work on the construction site because many sub-contractors and

suppliers face difficulties with money. As a result, materials don't get delivered to the
(Abdul-Rahman et al., 2009)
site on time and the project progress will be delayed . In
(Abdul-Rahman et al., 2009)
the context of Malaysia construction industry, also

mentioned that financial problem faced by contractors has led to the delay in
Tarawneh et al. (2023)
construction project. also mentioned that the contractors

reflected that poor cash flow affect every phase of construction projects. For

example, buying equipment and raw materials as well as the timely disbursement of

wages. These financial discrepancies contribute to delays in the overall completion

(Tarawneh et al., 2023)
timeline of projects .

In conclusion, the extensive body of research conducted by scholars such as

Abdul-Rahman et al., 2009, Amoa-Abban, 2017 Al Mohsin et al., 2014
and , among
others, consistently demonstrates a compelling connection between the retention

money practice, cash flow problems, and subsequent project delays in the

construction industry.

2.3.2 Quality Challenges and Limitation

In construction industry, quality refers to the criteria that a product or service

must achieve in order to meet the demand and purpose as intended

(Tarawneh et al., 2023)
. Poor quality in construction projects is a prevalent issue globally
(Shah Ali, 2011)
Kazaz & Birgonul (2005)
. Additionally, asserted that meeting the desired

quality standards in construction projects remains unfulfilled, posing a significant

and serious challenge. Yet, in the construction sector, quality is characterized by

fulfilling the criteria set by the designer, constructor, regulatory bodies, and the
(Mallawaarachchi & Senaratne, 2015)
owner .

According to (Adjei et al., 2018) , an unfavourable cash flow situation can

Shash & Qarra (2018)
harm the overall quality of project delivery. also argued that

the payment amount released to contractors is reduced by the withholding of

retention money. This has also caused negative cash flow on contractors for a long
(Shash & Qarra, 2018) Shash & Qarra (2018)
period of time . In the same research,

also identified that insufficient of cash of contractors will eventually impact the
Abas et al. (2015)
project quality negatively. had also mentioned that cash flow

problem can impact the construction project quality negatively as agreed by some of

the respondents.

Research by Sambasivan & Soon (2007) has also gathered the perspective of

client saying that poor cash flow of contractors can lead to low quality of works.

When contractors face cash flow problems, they might use lower-quality materials to
save costs (Chadee et al., 2023) . This choice, driven by contractors’ cash flow

problem, can harm the overall quality of the construction project. Using sub-standard

materials may lead to structural problems, less durability, and more maintenance

issues in the future. So, resolving financial issues is not just about money but also

about ensuring the quality and durability of the construction work

(Othman & Othuman, 2014)
Oke et al. (2017)
. This statement is further supported by by stating

that poor material is one of the factors which contributed significantly to low quality

of construction projects, and it is agreed by some of the respondents with the mean

value above 3.00.

In conclusion, the collective evidence from various studies highlights a clear

connection between poor cash flow in the construction industry and compromised

project quality. The research consistently emphasizes that insufficient cash flow

negatively impacts the procurement of quality materials and hinders the ability to

meet desired standards, ultimately leading to lower-quality construction projects. The

findings underscore the importance of addressing cash flow challenges in the

construction sector to safeguard project quality and overall success.

2.3.3 Cost Overrun

In Malaysia construction industry, cost overrun is a significant problem. As

Omran et al. (2023)
noted by , it can be seen that 89% of Malaysia construction

projects have suffered from cost overruns of within 5 to 10% of the total contract

value. Cost overrun is defined as the difference between total cost incurred by a

construction project once it was completed, and contract cost as per agreed by the
(Raykar, 2016)
client and the contractor . Cost overrun will happen when the incurred
(Raykar, 2016) Raykar (2016)
expenses exceed the initial amount budgeted . Moreover,
 also state that cost overruns in construction projects can impact the

performance of construction projects negatively.

According to the data collected by El-Kholy (2015), cash flow of contractor

was ranked number 2 among the factors that will impact cost in construction

projects. This implies that the contractor might find it difficult to finance the current

project if they encounter negative cash flow on most or all of their previous projects.

As a result, there could be project extensions, which would eventually result in cost
(El-Kholy, 2015) Raykar (2016)
overruns . had highlighted that cash flow of

contractor form one of the major factors contributing to cost overrun and he

emphasized that having sufficient cash flow is very crucial for a contractor to operate

his business.

Apart from that, (El-Kholy, 2015) also emphasized that the client’s financial

situation was the most significant factor contributing to cost overruns in construction
Hasmori, Said, et al. (2012)
projects. This statement has been supported by by stating

that client’s financial problem will cause the delay in payment such as retention

money payment which can further lead to cash flow problems in contractors. Another

researcher also argues that the client’s financial limitations has contributed to the cost
(Raykar, 2016)
overrun of construction projects . He also emphasized that the

occurrence of cost overruns of construction projects can be mitigated by having

sufficient cash flow and allocation of adequate money and time during design stage
(Raykar, 2016)
.

In conclusion, the literature reviewed consistently emphasizes the critical link

(Raykar, 2016)
between poor cash flow and construction project cost overruns. has

examined the significant impact of cash flow on cost overruns. El-Kholy (2015)
further supports this notion, ranking cash flow of contractors as a major factor

influencing project costs. The client's financial situation, identified by El-Kholy

(2015) and supported by Hasmori, Said, et al. (2012) and Raykar (2016), is identified

as a primary contributor to cost overruns. Importantly, this client-related financial

problem may lead to delays in payments, such as late in retention money payment,

thereby exacerbating the contractor's cash flow issues.

2.3.4 Decreased Productivity in Construction Workers

The importance of productivity in construction is vital, and labour

productivity accounts for a significant portion of the production input for building

projects. The unpredictability of numerous external and internal factors contributes to

a continuous uncertainty in labour productivity in the construction industry

(Gundecha, 2012) Adjei et al. (2018)
. reported that cash flow problem can harm the

pleasant atmosphere among stakeholders of project management team and impact the

site productivity negatively.

As aforementioned by Amoa-Abban (2017), contractors who faced

difficulties in procuring materials and equipment are due to cash flow problems arise

from delayed payments such as delayed in retention money payment. Contractors

who encountered cash flow problems will not have adequate cash to pay the
Laryea (2010)
suppliers for the construction materials required. ,
Abdul Kadir et al. (2005)
Muhammad et al. (2015)
and has supported the statement by identifying cash

flow problems were the main challenge that hindered the contractors’ capacity to

purchase materials and equipment as well as access required resources for

construction projects. Eventually, this will lead to the non-delivery of construction

materials by the suppliers which further impact the labour productivity negatively
(Abdul Kadir et al., 2005)
.
 As per mentioned by Omopariola et al. (2020), the source of cash outflow for

contractors entails the payment of wages to the labour. The contractors who

encountered cash flow problem will lead to timely payment of wages to the labour.
Ellis et al. (2014) Shinde & Hedaoo (2008)
The previous research by and have

identified that timely payment in wages to the labour will lead to decreased in labour
Mj & Suman (2021)
productivity. The statement is further reinforced by by saying

that late in payments will cause the labour productivity to be impacted negatively.

According to (Irfan et al., 2020) low wages of payment is also identified as

one of the factors which will lead to decreased in labour productivity. Most of the

employers tend to reduce the wages paid to the labour if they were facing cash flow
(Turnea et al., 2020)
problem . For instance, a survey carried out by ILO Score

Programme in Roman has shown that some of the companies with its cash flow

problem have decreased the wages by 20% during COVID-19 pandemic

(Turnea et al., 2020)
. Another research has shown that the rate of wages is directly proportional

to labour productivity by showing that countries with higher wages result in higher
(Nikulin, 2015) Ellis et al. (2014)
labour productivity and vice versa . However, have

suggested that prompt payment of wages can motivate the labour and hence increase

the labour productivity. This has shown that rate of wages is intricately linked to

labour productivity.

In conclusion, the reviewed literature underscores the pivotal role of cash

flow in influencing labour productivity in the construction industry. Cash flow

problems, arising from delays in payments and challenges in material procurement,

are consistently identified as impediments to accessing necessary resources,

(Amoa-Abban, 2017; Abdul Kadir et al., 2005;
including materials and equipment
Muhammad et al., 2015)
. The inability to meet timely wage payments, often linked
to cash flow issues, has been associated with decreased labour productivity
(Omopariola et al., 2020; Ellis et al., 2014; Shinde & Hedaoo, 2008)
. Furthermore,

the reduction in wage rates during periods of cash flow challenges, as evidenced by

various studies, highlights the intricate link between financial stability and labour
(Irfan et al., 2020; Turnea et al., 2020; Nikulin, 2015; Ellis et al., 2014)
productivity .

Ultimately, the evidence strongly justifies the assertion that poor cash flow can

significantly contribute to a decrease in labour productivity in construction projects.

2.3.5 Risk of Project Abandonment

V. Doraisamy et al. (2015) define an abandoned project as a situation where a

certain undertaking faces multiple challenges and reaches the point of no return in

which further progress towards it becomes impossible hence ceasing to be worked on

completely. In essence, an abandoned project is characterized by the inability to

overcome significant obstacles, prompting the discontinuation of work on the

(Doraisamy et al., 2016)
initiative .

According to Abdul-Rahman et al. (2015), construction project abandonment

is defined as uncompleted construction project or unready housing units for

occupation. Four criteria have been established by the ministry of housing and local

government (MHLG) of Malaysia as shown in Table 4 below:

Table 4: Project Abandonment Criteria in Malaysia

No. Criteria

1 No construction activities on site for six months or more

2 The developer wounds up

3 The developer declares an inability to complete the project

4 The MHLG declares the project abandoned pursuit to the housing

 development Act (118)

The MHLG will officially declare the abandonment of the construction

(Mac-Barango, 2017)
project if one or more criteria above are met .

The amount of housing projects abandonment has risen significantly since

(Dahlan, 2006)
1970’s . Moreover, another 59 housing projects were reported as

abandoned construction project in Malaysia in June of 2018

(National Housing Department, 2017)
. Recently, MHLG has newly identified another 281 cases of
(Salam et al., 2023)
construction project abandonment .

As noted by Omopariola et al. (2020), negative cash flows notably leading to

the abandonment of the project. Financial strain arises, impeding the project's ability

to meet obligations. In the context of cash flow analysis, the presence of negative

cash flows signals financial instability and questions the project's viability. If these

challenges persist without getting an effective solution, they may continue to escalate

and make the project financially unsustainable as well leading into decision of
(Omopariola et al., 2020)
abandonment . The briefs state that negative cash flows not

only spoil a project’s financial health, but they also lead to abandonment.

A few other researchers also claimed that the contractor’s cash flow problem
(Abdul-Rahman et al., 2009;
can eventually lead to construction project abandonment
Abdul-Rahman et al., 2006).
Besides, financial difficulties, specifically cash flow

related issue encountered by contractors were identified as significant contributing

(Na Ayudhya & Kunishima, 2017;
factors to project abandonment
Chen Tan et al., 2010)
. For instance, contractor may face delayed payment of retention money by

client as aforementioned and this will lead to their inability to make timely payments
to subcontractors. Subcontractors, less financially resilient, were dependent on

unpaid debts for their ability to continue working. Eventually, the unpaid debts and a

failure to handle cash flow issues raised the chance of project abandonment
(Na Ayudhya & Kunishima, 2017;
Chen Tan et al., 2010)
.

Previous study by Ariffin et al. (2018) discussed the possibility that a lack of

finances would have an influence on the project's cash flow and create a delay in site

possession, resulting in a delay in the project and perhaps project abandonment.

KWAME BOATENG AMOAKO -BSc (2011)
Lastly, has also examined that cash

flow problem of contractors arising from delayed payment or non-payment of client

may potentially lead to project abandonment. Poor cash flow of contractors has

restricted them from paying for the wages, materials, machinery, and equipment

involved in the project. Consequently, the contractor may decide to pause the work

until an employer settles payments that were outstanding before; however, if

financial challenges still persist after the payment of due amounts to employers, the

contractor may opt for liquidation which results in the project being abandoned since

it fails to fulfil obligations towards bankers, subcontractors and suppliers

(KWAME BOATENG AMOAKO -BSc, 2011)
.

Overall, the thorough review of literature demonstrably proves high

correlation between poor cash flow and termination of construction projects. The
V. Doraisamy et al. (2015)
definitions and criteria as given by and
Abdul-Rahman et al. (2015)
has explained the complicated nature of project abandonment. The report
Dahlan (2006)National Housing Department (2017) Salam et al. (2023)
by and about

the increasing number of abandoned housing projects in Malaysia further drives

Omopariola et al. (2020)
home the gravity of this issue. emphasizes that negative

cash flows are key drivers for project abandonment due to financial strain and
questioning sustainability of the projects. Other researchers including
Abdul-Rahman et al. (2009)
Na Ayudhya & Kunishima (2017) Chen Tan et al. (2010)
, ,
Ariffin et al. (2018)
KWAME BOATENG AMOAKO -BSc (2011)
and collectively confirm that

project abandonment can take place as a result of poor cash flow of contractors.
2.4 POTENTIAL STRATEGIES TO MINIMIZE THE IMPACTS OF

RETENTION MONEY PRACTICE ON SME CONTRACTORS’ CASH

FLOW AND ITS SUBSEQUENT IMPACTS ON THE PROJECT

PERFORMANCE

As per the Banwell Report from 1964, there is a recommendation to abolish

(Banwell, 1964)
the retention money practice in construction contracts . Similarly, the

International Labour Office (ILO) has proposed a reduction in retention money to

(Raina, 2015a)
improve the business environment for contractors . The House of

Commons report explicitly raised concerns about the uncertain benefits of retentions,
(Raina, 2015a)
advocating for their elimination . Sir Michael Latham has criticized

the ineffectiveness of retention money practices and suggested retention bonds as a

(Latham, 1994)
better alternative. Another researcher highlighted the importance of a

collective and responsible relationship in integrated teams to address issues related to

(Egan, 2002)
payment delays and retentions . Therefore, the literature about potential

strategies to minimize the impacts of retention money practice will be reviewed

under this section.

Upon analysis from the previous literature, the common potential strategies to

minimize the impact of retention money practice is listed in the table below.

Table 5: Analysis of strategies to minimize the impact of retention money practice

based on the literature

Strategy Source

Bausman (2004)
Raina (2015)
Escrow Account Amusan (2016)
Hartoonian (n.d.)
Cheng et al. (2009)
Retention Bonds (A. E. Oke (2013)
 (A. Oke & Ogunmola (2014)
Central Unit on Procurement (1994)
Latham (1994)
Raina (2015)
Ganiyu et al. (2015)
OPPAGA (2000)
Hartoonian (n.d.)
Line-Item Releases Stockenberg & Limbaugh (2002)
Bausman (2004)

2.4.1 Escrow Account

Escrow accounts allow the client to deposit the funds retained from

contractors into a third-party account. While the money is held in this account, it

remains reserved from the contractor. Importantly, this arrangement also ensures that

the client, who would typically withhold this sum, cannot employ the funds for its

own purposes, thus preserving the rightfully earned earnings of the contractor
(Bausman, 2004; Raina, 2015)
. Hence, escrow accounts, while not a direct

replacement for retention money, offer a different method of holding funds. This

variation bestows increased legitimacy upon the client’s decision to withhold money

from the contractor, as the funds are designated solely for insurance purposes and

cannot be utilized for any other reason. As a result, the use of escrow accounts has

the potential to foster greater trust among contractors regarding the client’s motives

for retaining funds, potentially reducing relational challenges such as cash flow
(Hartoonian, n.d.;
problem stemming from retention money controversies
Raina, 2015)
.

According to Amusan (2016) escrowing retention money by lodging in

escrow account has been rated as one of the retention money intervention systems to

minimize the impacts of retention money practice. Besides, according to the

literature review by Cheng et al. (2009) , it has been identified that the

implementation of escrow account as the strategy to minimize the impact of retention

money can be found in the construction industry of France, New Mexico, and Hong

Kong. In essence, the escrow account has been identified as the potential strategy to

minimize the impacts of retention money based on the previous research.

2.4.2 Retention Bonds

A retention bond provides a guarantee that, even after the contractor has

received complete payment upon concluding the contract, they are obligated to
(A. E. Oke, 2013)
promptly rectify any identified structural or other defects .

Retention bonds provide a dual advantage by ensuring clients receive an equivalent

level of protection for defective work, similar to the retention money practice.

Importantly, this is achieved without imposing any financial disadvantages on the

contractor, thereby contributing positively to the overall industry

(Oke & Ogunmola, 2014)
.

According to Central Unit on Procurement (1994), the data findings from the

research has shown that retention bonds provide contractors with enhanced and

predictable cash flow by ensuring full payment at each stage compared to retention

money practice. Moreover, Sir Michael Latham has also reported that the retention

money practice was not liked by many contractors and subcontractors, and they

suggested that the implementation of retention bond as a better alternative to

(Latham, 1994). (Raina, 2015)
retention money practice argues that incorporating

retention bonds can lead to enhanced cash flow for contractors, providing an

opportunity to allocate funds more effectively within the construction industry,

potentially resulting in reduced costs. To further strengthen the fact that retention

bond is a potential strategy to minimize the impact of retention money practice, the
retention bonds has been widely implemented in Europe and International contracts
(Raina, 2015)
and some major UK clients .

Additionally, a retention bond offers a mutually advantageous system where

clients receive monetary protection while contractors maintain control over their cash
(Ganiyu et al., 2015)
flow . Choosing a retention bond over cash retention not only

ensures financial security for clients but also brings cost savings for contractors. The

inclusion of a fixed expiry date in retention bonds provides clarity, preventing

prolonged holding of retention sums beyond the contractual period, a characteristic

(Ganiyu et al., 2015)
associated with retention money . Overall, retention bonds

provide a more structured and beneficial alternative compared to traditional retention

money practices.

2.4.4 Line-Item Releases

Retention money is commonly retained from the contractor's first progress

payment and is kept until the eventual completion of the project, which can span

months or even years. This practice imposes a substantial financial burden on cash

flow of certain contractors, particularly those engaged in early project stages like
(OPPAGA, 2000)
excavation or foundation work .

Line-item releases offer a solution to the previously mentioned problem

(Hartoonian, n.d.)
stemming from retention money practice . They allow for the

gradual release of retained funds based on the completion of a distinct section or

scope of work, rather than waiting for the entire project to be completed
(Hartoonian, n.d.;
Bausman, 2004)
. This ensures that trades achieving substantial completion can

receive their entitled retained money, even if the contract initially stipulates
(Hartoonian, n.d.)
completion of the entire project .
 In order to strengthen the fact that line-item releases is a potential strategy to
Stockenberg & Limbaugh (2002)
minimize the impact of retention money, have

stated that seven states presently have statutes allowing the line-item releases on

public projects. Moreover, in 2001, New Mexico passed a law requiring the release

of retainage in a line-item manner for private projects

(Stockenberg & Limbaugh, 2002)
.

2.5 SUMMARY OF THIS CHAPTER

This chapter presents a literature review on the definition of retention money,

SME contractor, cash flow, project performance, PAM construction contracts. The

inception of "Retention Money" dates back to the 1840s, suggesting the practice of

reserving a segment of payments until the project reaches completion to guarantee its

quality and serve as a safeguard against potential flaws. In the Malaysian

construction context, "SME Contractor" pertains to enterprises with less than 50

employees and an annual income below RM5 million, graded by CIDB from G1 to

G5."Cash Flow" is explored as the financial heartbeat of a project, with its

fluctuations impacting day-to-day operations. Moving on to "Project Performance,"

success is evaluated through key performance indicators, encompassing client

satisfaction, quality, safety, cost, and time. The narrative concludes by emphasizing

the significance of "PAM Construction Contracts," showcasing the widely utilized

PAM standard form in Malaysia, instrumental in delineating contractual

responsibilities and defining the project scope.

Chapter 2 also explores the impact of the "Retention Money" practice on the

cash flow of SME contractors in the construction industry. Retentions, withholding

payments until project completion, can lead to cash flow challenges for contractors

and subcontractors, resulting in the need for substantial borrowing during periods of
high interest rates and increased building costs for owners or clients. The chapter

further examines the repercussions, focusing on bankruptcy, increased contractor

debt, difficulties in procuring materials and equipment, and working capital

constraints. Bankruptcy is a looming threat, with financial difficulties more likely to

impact construction companies due to the industry's inherent challenges, intricate

nature of projects, and fierce competition. The delayed release of retention funds

directly impacts cash flow, hindering financial stability and potentially leading to

SME contractor bankruptcy. Additionally, increased contractor debt is identified as a

significant consequence, as delays in retention payments prompt contractors to

borrow money, straining their financial situation. The resulting capital lock-up not

only limits cash from earning interest but also contributes to an increase in debt for

contractors. Difficulties in procuring materials and equipment arise from cash flow

problems, with suppliers reluctant to engage with contractors facing financial

challenges. Lastly, working capital constraints emerge as a critical concern,

particularly for SME contractors who may face challenges securing trade credits and

resort to higher short-term debt to meet immediate financial needs, limiting their

ability to invest in long-term assets and hindering growth opportunities.

The following section of this chapter explores the multifaceted impacts of

retention money practices on project performance within the construction industry. A

Odeyinka (2005)
substantial body of research, including contributions from and
Latham (1994),
consistently highlights the adverse effects of retention on SME

contractors' cash flow, a pivotal element that permeates all aspects of construction

project implementation. Studies, such as those conducted in Kuwait and Ghana,

affirm that cash flow challenges arising from retention negatively influence project

performance. The subsequent sections delve into specific consequences of poor cash
flow, beginning with the widespread issue of project delays. Drawing on global

examples, the literature underscores the direct correlation between financial

difficulties, particularly related to retention payments, and project delays,

exemplified by studies in Jordan and Malaysia. Quality challenges emerge as another

significant concern, with the research consistently establishing a link between

unfavourable cash flow situations and compromised project quality, highlighted by

instances of sub-standard materials use. Cost overruns, a prevalent problem in the

Malaysian construction industry, are shown to be intricately tied to cash flow issues,

emphasizing the importance of sufficient cash flow for project financing and cost

management. The impact extends to decreased productivity in construction workers,

as cash flow problems hinder material procurement and timely wage payments,

affecting overall project efficiency. Finally, the heightened risk of project

abandonment is explored, with a clear association established between negative cash

flows, financial strain, and the decision to abandon construction projects.

The last part of this chapter delves into strategies to alleviate the adverse

impacts of retention money practices on contractors and project performance. The

Banwell Report's suggestion to abandon retention money is supported by the ILO

and the House of Commons. Alternative strategies include retention bonds, ensuring

client protection without financial burdens on contractors, escrow accounts,

preserving funds in a third-party account for proper use, and line-item releases,

allowing gradual fund release tied to project milestones. These strategies aim to

address financial challenges, enhance cash flow predictability, and ultimately

improve project outcomes, especially beneficial for SME contractors.

Last but not least, the next chapter will then describe and elaborate more on

the methodology of the research and the method of data collection for this research.
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