Financial Management & Accounting in Construction (CUE304) FINANCIAL MANAGEMENT. Dr. Ahmed Elyamany
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1 1 Financial Management & Accounting in Construction (CUE304) FINANCIAL MANAGEMENT Dr. Ahmed Elyamany
2 2 Course Content Project financial management: Cash flow prediction, Cash flow analysis, Cost of finance Basics of accounting: base of accounting, accounting conventions, Methods of income recognition Company financial documents: Balance sheet, Income statement Compilation of financial statement: Transaction recording, Book keeping fundamentals Analysis of financial statement: Vertical analysis, Horizontal analysis, Ratio analysis Construction financing: Sources of finance, cost of finance and company cost of capital
3 3 Project Pricing Price Cost Markup Direct Cost Indirect Cost Profit Financial Charge Risk Allowance
4 4 Project Consist of: Material Labors Equipment Sub-Contractors Money
5 5 Project Cost Project direct costs The costs and expenses that are incurred for a specific activity are termed direct costs. Project indirect costs Other costs such as the overhead costs are termed indirect costs. Part of the company s indirect costs is allocated to each of the company's projects.
6 6 Indirect costs The indirect costs are classified to: Project (site) overhead General (head-office) overhead.
7 7 Project overhead Project overhead are site-related costs and includes the cost of items that can not be directly charged to a specific work element and it can be a fixed or time-related costs. The Project Overhead includes the costs of Site utilities, Supervisors, Housing of project staff, Parking facilities, Offices, Workshops..
8 8 General overhead The costs that can not be directly attributed a specific project called general overhead. costs that used to support the overall company activities. The amount of the general overhead that should be allocated to a specific project equals: (Project direct cost x general overhead of the company in a year) / (Expected sum of direct costs of all projects during the year)
9 9
10 10 Financial Elements Balance Sheet Assets Liabilities Net Worth Current assets Fixed assets Cash flow Account receivables Inventories Lands, buildings, equipment
11 11 Cash Flow Forecasting Information Time Schedule Cost estimate Assign cost to activities Indirect cost for each period Mark up (profit+ general overhead) or Prices Time lag of payment (time between billing by contractor and payment by owner) Bank financing charges (interest rate) Retention
12 12 Cash Flow Forecasting Information In general for the contractor the expenses are more than the income until the project ends To overcome this difference during project time: contractor has to finance the project by loans (even if it is his own money it is considered money that has interest on it) The contractor need to calculate the overdraft requirements = maximum over draft value over the project period
13 13 How To reduce the over draft: Reduce Overdraft Subcontracting Delay supplier payment Initial or down payment Unbalancing the bid
14 14 Financial Management Objective is to supply the project financial requirements: How Much and When? Cash Flow Prediction: Cash flow = Cash in Cash out = Income Expense Cash Out (expenses): Time Schedule Cost Estimate Cash In (income payments): Time Schedule Unit Price
15 15 Financial Management S-Curve The curve represents the cumulative expenditures of a project direct and indirect costs over time Project Expenses (Cash out) represents the aggregate of the payments which the contractor will make over a period of time for all resources used in the project such as labor, equipment, material, and subcontractors.
16 16 Project Expenses (Cash out) Project direct costs The costs and expenses that are incurred for a specific activity are termed direct costs. Project indirect costs Other costs such as the overhead costs are termed indirect costs. Part of the company s indirect costs is allocated to each of the company's projects. The indirect costs classified to: project (site) overhead General (head-office) overhead.
17 17 Project Income (Cash-in) The flow of money from the owner to the contractor is in the form of progress payments. Retention Retention is the amount of money retained by the owner from every invoice, before a payment is made to the contractor. Advanced payment This is amount of money paid to the contractor for mobilization purposes.
18 18
19 19 How to Reduce negative Cash Flow? Unbalanced Bid: Raising the Price of the earlier items Down Payment : Needs conceptual approval by the owner(client) Using Sub-Contractor: He will fund the job (migrate the expenses) Trade Credit Finance: Crediting material and resources If all of the above is not applicable we can use External Source of Finance (e.g.: Bank)
20 20 Example 1 For a given construction project the monthly costs are provided in the following Table and given that: Project mark up = 10% Financing cost = 1% /month Retentions = 15% of the billing amount Time Lag of payment = 1 month Month Direct cost 25,000 70,000 90,000 35,000 Indirect cost
21 21 Example 1 You are required to: Draw the cash flow diagram for that project including: Cash out Cash in Over draft line Calculate the maximum over draft Calculate Contractor final profit considering the financing cost
22 22 Example 1 Month Direct cost 0 25,000 70,000 90,000 35,000 Indirect cost Total monthly Cost 0 30,000 75,000 95,000 40,000 billed retinage Money received ,000 Commulative cost Commulative money received 0 30, , , , , ,
23 23 Example , Commulative cost Commulative money received
24 24 Example , , Commulative cost Commulative money received Total amont financed
25 25 Example 2.1 Monthly Indirect cost 5000/Month Mark Up 5% Retain age 10% Periodic Payment are billed at the end of the month and received one month later. The accumulated Retain age will be paid within the last payment. Req.: Sketch the cash flow profile Sketch the net cash flow profile
26 Example
27 27 Example 2.1 Cash Out: Month 1=25,000+5,000=30,000 Month 2=65,000+5,000=70,000 Month 3=75,000+5,000=80,000 Month 4=15,000+5,000=20,000 Cash In: Pay 1=30, =28,350 Pay 2=70, =66,150 Pay 3=80, =75,600 Pay 4=20, , =39,900
28 28
29 29 Example 2.2 Using the previous example givens sketch the net cash flow when we use external source of finance (bank): Month Trans. Expenses 30,000 70,000 80,000 20,000 - Overdraft 30, , , , Interest 1% 300 1,003 1,529 1, Total 30, , , , (5747) Payments - 28,350 66,150 75,600 39,900 Residue 30,300 72,953 88,332 33,815 (5747)
30 30
31 31 Example 2.3 Using example 2 givens sketch the net cash flow if there is Down Payment 20% of tender price: Pay 0= ,000=42,000 Pay 1=30, =22,680 Pay 2=70, =52,920 Pay 3=80, =60,480 Pay 4=20, , =31, 920
32 32
33 33 Example 2.4 For the previous example, sketch the net cash flow if using external source of finance (bank): Month Trans Expenses - 30,000 70,000 80,000 20,000 - Overdraft , ,900 84,139 24,500 Interest 1% Total - 30,000 58, ,059 84, (7175) Payments ,680 52,920 60,480 31,920 Residue (42000) (12,000) 35,900 64,139 24,500 (7175)
34 34
35 35 Discounted Cash Flow The value of money is dependent on the time at which it is received. A sum of money on hand today is worth more than the same sum of money to be received in the future because the money on hand today can be invested to earn interest to gain more than the same money in the future. Studying the present value of money (or the discounted value) that will be received in the future is very important.
36 36 Present Value Present value (PV) describes the process of determining what a cash flow to be received in the future is worth in today's pounds. The Present Value of a future cash flow represents the amount of money today which, if invested at a particular interest rate, will grow to the amount of the future cash flow at that time in the future. The process of finding present values is called Discounting and the interest rate used to calculate present values is called the discount rate. F = P (1+r)n P = F / (1+r)n
37 37 Example 3 Find the present value of the following cash flow stream given that the interest rate is 10%. Year Cash flow Solution: 100 P = (1 +.1) 200 (1 +.1) 200 (1 +.1) 300 (1 +.1) =
38 38 Net Present Value (NPV) Net present value (NPV) is the summation of all PV of cash flows of the project, where expenses are considered negative and incomes are considered positive. A project will be considered profitable and acceptable if it gives a positive NPV. When comparing projects, the project with the largest (positive) NPV should be selected.
39 39 Example 4 The Table below illustrates the net cash flow of two projects over 5 years. Using the NPV, which project would you prefer if the discount rate 10%. Year Project A Project B Project A: NPV = (1 +.1) (1 +.1) (1 +.1) (1 +.1) (1 +.1) 1 = Project B: NPV = (1 +.1) (1 +.1) (1 +.1) (1 +.1) (1 +.1) 1 =
40 40 Internal Rate of Return (IRR) The internal rate of return (IRR) of a capital budgeting project is the discount rate (r) at which the NPV of a project equals zero. The IRR decision rule specifies that a project with an IRR greater than the minimum return on capital should be accepted. When choosing among alternative projects, the project with the highest IRR should be selected.
41 41 Example 5 Calculate the IRR for both projects presented in previous Example, and compare among them using the resulted IRR. Assume the return on capital equals 10%. Project A 0 = IRR = 16.82% Project B 0 = IRR = 13.28% 500 ( ( IRR + IRR + IRR + IRR + ) + (1 400 ) + (1 200 ) + ( IRR + IRR + IRR + IRR + ) + (1 200 ) + (1 200 ) + (1 400 ) ) (1 (1 100 IRR) 700 IRR) 5 5
42 42 Example 6 Assume the owner suggest two different diagrams for payment. Which one is the best Alternative? (MARR=2% Monthly)
43 NPV (1) > NPV (2) the original scenario better than the owner's suggestion 43
44 44
45 45 Project Monitoring and Control Monitoring Collecting, recording, and reporting information concerning project performance that project manger and others wish to know Controlling Uses data from monitor activity to bring actual performance to planned performance
46 46 Project Control Control process and activities needed to correct deviations from plan Control the constraints Time (schedule) Cost (budget, expenses, etc) Performance (specifications, testing results, etc.)
47 47 Project Control Cycle Correct deviations from plan RE-PLAN as necessary PLAN Specifications Project Schedule Project budget Resource plan Vendor contracts ACTION MONITOR Record status Report progress / cost Actual status against plan Schedule / Cost COMPARE
48 48 Cost Control Cost Control system has two functions: Keep the actual cost within the estimated value Collecting data for estimating cost for future projects. The Actual Cost affects the profit. Actual Cost Direct Cost Site Over Head MARK UP General O.H. Profit + Risk Construction Cost Tender Price
49 49 Cost Control Sequence: 1. Cost estimate 2. Measure and report actual field cost: a) Work Quantity b) Work hours c) Cost rate 3. Comparison between actual versus estimated cost 4. Variance Analysis (Earned Value Analysis) 5. Plan and implement corrective actions
50 50 Techniques for monitoring and control Earned Value Analysis A way of measuring overall performance (not individual task) is using an aggregate performance measure - Earned Value
51 51 Earned Value Analysis Refer to earned value chart basis for evaluating cost and performance to date If total value of the work accomplished is in balance with the planned (baseline) cost, and actual cost then top mgmt has no particular need for a detailed analysis of individual tasks Earned value concept combines cost reporting & aggregate performance reporting into one comprehensive chart
52 Earned Value Analysis 52
53 53 Earned Value Analysis Cost Variance = BCWP ACWP +ve Cost saving -ve Cost overrun Cost Performance Index (CPI) = BCWP/ACWP >1 Cost saving <1 Cost overrun Expected Final Cost = Total Expected cost/cpi
54 54 Earned Value Analysis Schedule Variance = BCWP BCWS +ve Ahead of schedule -ve Behind schedule Schedule Performance Index (SPI) =BCWP/BCWS >1 Ahead of schedule <1 Behind schedule Expected Final Duration = Original Duration / SPI
55 55 Earned Value Analysis Baseline cost to completion referred to as budget at completion (BAC) Actual cost to date referred to as estimated cost at completion (EAC) Identify several variances according to two guidelines A negative variance is bad Cost and schedule variances are calculated as earned value minus some other measure
56 56 Example The cost data for a small construction project are given in the following table; the schedule duration is 20 months the project has been worked on for 15 months. Calculate: BCWS, BCWP, ACWP Comment on Project Performance Predict the expected final Cost and Time No. Item Unit Q Estimated cost Cost report After 15 Months Quantity Completed Target Actual 1 Excavation m RC footing m RC columns m RC slabs m Actual Unit Cost
57 57 Example BCWS=(8 600) + ( ) + ( ) + (700 60) = BCWP= (8 600) + ( ) + (650 90) + (700 65) = ACWP= ( ) + ( ) + (645 90) + (705 65) =383475
58 58 Example Cost Variance = 378, ,475=-4,675 CPI = 378,800/383,475=0.98 (Cost Overrun) Expected Final cost = (8* * * *120) /0.98 = Schedule Variance = 378, ,800=-33,000 SPI = 378,800/411,800=0.92 (behind schedule) Expected Final duration = 20 / 0.92 = 21.7 months
59 59 EXAMPLE Assume that operations on a Work Package cost 1,500 to complete. They were originally scheduled to finish today. At this point, we actually spent 1,350. And we estimate that we have completed two thirds (2/3) of the work. What are the cost and schedule variances?
60 60 EXAMPLE CV = BCWP ACWP = 1500 (2/3) 1350 = SV = BCWP BCWS = 1500 (2/3) 1500 = CPI = BCWP/ACWP = 1500(2/3)/1350 = 0.74 SPI = BCWP/BCWS = 1500(2/3)/1500 = 0.67 Spending higher than budget, and given what we have spent, we are not as far along as we should be (have not completed as much work as we should have)
61 Contact: Dr. Ahmed Elyamany 61
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