Modelling cash flow in construction projects in countries in transition

Transcription

1 Modelling cash flow in construction projects in countries in transition Mladen Raduj kovic Faculty of Civil Engineering, University of Zagreb, Zagreb, Croatia Summary The paper describes the modelling of cash flow in construction projects in countries in transition. Data of construction contribution in investment is shown, as well as GDP and total employed personnel in Croatian construction industry. Analysed are the most important changes which affect construction in a country in transition as well as those changes which affect the modelling of cash flow. In the central part of the paper, the effect of risk and time slacks on the ability to form theoretical curves of cost flows is analysed. Results of research related to the effect of risk on time and cost, performed on 100 randomly chosen construction projects, are presented. The main sources of risk are described. The analysis of the effect of risk is performed with the aid of interpolation of various curves for costs between planned and actually recorded cost curves on the observed projects. Testing for each individually obtained curve for costs is performed through the bestfit approach with 18 theoretical functions. Ranking is performed according to the (hi-square and Kolmogorov-Smirnov tests. The analysis shows that the effect of risk increases the interval of possible shapes of the cost curves and the various possible forms of best approximation. The testing of the effects of reserves for completion also indicates various possible deviations from a single curve. From that then, this paper proposes the creation of a value interval instead of a single theoretical curve. In order to ensure a practical value of results, proposed are criteria by which projects can be grouped. The concluding part of the paper discusses possible application of modelling of cash flow in connection with possible directions of development in a particular country in transition. For example in Croatia the emphasis is oriented on tourism, which like most human activities affects the natural resources which acted like a base for its development. From this then, the paper discusses the need for the development of a model of sustainable development, which includes a balance between commercial success of a project and environmental protection. In the calculation of cash flow it is necessary to include costs of protection of natural resources, but according to a model which protects and unites the interests of investors, government and institutions of environmental protection. Key words: cash flow, country in transition, construction projects, risk, development

2 1. Cash Flow Data related to monetary transactions is not complete if it does not indicate time duration along with cash amounts. Planned cash flow is, therefore, equally important for all partners in construction projects. From the early phases of projects up to the time of contract signing, no partner has the necessary information for the creation of a precise plan for billing or payouts of money. The flow of cash is exceptionally difficult to determine ahead of time due to the influence of a large number of variables which give an unlimited interval of possible profiles. With an insufficient amount of exact information, every partner relies on estimates based on personal experience attained on previous similar structures. Complete repetition of previous steps is acceptable if measures and factors are the same on both projects. In this case it happens seldom, so precision in planning calculations is not guaranteed. During recent years, certain methods of prediction and modelling of cash flow profiles in projects have been developed. All approaches are generally based on the use of certain mathematical formulas and computers. The product is usually a profile with the shape of an S-curve which shows the cumulative value with weaker beginning and ending growth rates in phases of work start-up and finishing. Developed models follow the same concept of cash flow development. That is, the difference of cash in and cash out originated through the conversion of cumulative value curves and cumulative cost commitment curves, using time delays and retention [I]. The primary emphasis of the research is placed on the creation of ideal curves for the various types of projects - Bromilow & Henderson 1977 [2], Hudson 1978 [3], Singh & Won 1984 [4], Tucker 1988 [5], Skitmore 1992 [6], Kaka 1996 [ 11. The importance of past researches have been pointed out by various authors [8, 91, but there still remain various opinions about the level of precision of the proposed methods. 2. Construction in economies in transition Development and construction activity in previously socialist countries was significantly determined by political ideals. In the former Yugoslavia, politics favoured large industrial projects and massive residential building. This was primarily due to the political idea that every worker must have a permanent job and a flat in which to live for a minimal cost. Together with permanent investment in infrastructure, that insured the construction industry in Croatia a portion of about 50% in investments and about 10% in GDP, and S-10% of all employed people worked in the construction industry [IO]. Like the other industrial branches, construction had insured employment and market through required government support in cases of poor functioning of some company. So, for the evaluation of the success of a construction project, emphasis was placed on the technical correctness and functionality of a structure, while cost and time were not primary criteria for the evaluation of success. Methods of evaluating and keeping record of cash flows in construction projects were only partially used. There are few examples in modern history where such a large amount of significant changes occurred in a short period simultaneously like in Croatia: war, creation of state, change in social organisation, change in the economic system and a shift to a market

3 economy, privatisation,... For the construction industry, the following changes are especially significant: Reduction of investments and employment in construction. Insufficient capital in companies. Absence of government support in cases of poor performance. Opening of the market for foreign competition. Significant reduction of the number of employees in large companies, with simultaneous changes in the structure of employed personnel in favour of production workers and the opening of a large number of smaller companies. Change in the ownership structure of the company in which significant shares are taken over by groups of individuals, therefore, a change in the manner of managing and decision making. Removal of non-construction and secondary activities in the structure of the company. Time and money spent on construction and later on maintenance of the structure become important criteria for evaluating success s Id II g 80 z k8 60 a Year Fig. 1: GDP, investment, construction works and employment (1990. y. =loo%) [lo] In each of the mentioned changes the significance of money, which is much in demand on the market, was emphasised. The way money is managed becomes a key factor for success for individuals and companies, and, therefore, for the general economy in transition. Planning and control of cash flow in construction projects becomes exceptionally significant for every contractor and investor. 3. Influence of risk on cash flow The formula which was most commonly used for predicting cash flow in construction projects was the one published by the Department of Health and Social Security in Great Britain [3]. That is one formula with which it is necessary to use a series of pairs

4 of parameter values for the creation of the correct curve for a project of a particular size. The DHSS formula was tested by numerous researchers with the goal of improving and simplifying it. Skitmore [6] analysed the DHSS formula on 27 completed construction projects grouped into four basic types. Research into various models for predicting best values for parameters shows that they are all equally productive, and that well grouped structures significantly improves the quality of forecasting. Tucker 1988 [S]. proposed an alternative form and use the Weibull function with seven parameters. Kaka and Price [IS] performed research on about 150 completed construction projects, who s individual and group analyses determined that cost commitment models are more accurate and reliable than value models. Kaka 1996 [l] proposed a model with a large number of variables and stochastic simulation which includes analysis of the effects of risk. Taking into consideration results of previous research which indicated that the shape of a curve depends on the sum of costs [5], type and size of project, and type of contract [6, 81, we have attempted to look into additional effects - especially risk and activity time slacks k Construction projects finished in Fig. 2: Occurrence of overruns of planned times and planned money in samples of construction projects in the year of Our beginning research [ 11, 121 consisted of creating project plans for a large number of construction projects. Curves of planned costs were then constructed from these project plans. At various points of completion, status control was exercised and data was collected. With the data it was possible to: 1. Construct an actual cost curve. 2. Perform further forecasting for a planned curve at individual points of completion. 3. Analyse the causes of deviation between planned and actual cost curves. For modelling cash flow especially significant are results related to deviations between planned and actual cost curves. Research into 100 randomly chosen construction projects showed an average of 66% overruns in planned times and an average of 1 7% overruns in planned costs [ 131, with about 18% of extreme cases with a time overrun of

5 over 100%. Added research in the year of 1997, with data from 1996/97, shows that overruns of planned times occurred in 74% of projects, and overruns of planned costs in 69% of projects. Research shows that in about 2/3 of construction projects there exists a general trend of problems with overruns of planned times and costs. The analysis of risk indicates that a dominant portion, 58%, of risk is from internal sources which have causes rooted in the project. That shows that although there exists a problem of large changes in the transition market, individuals and companies that adapt too slowly to the changing global market are largely responsible for project shortcomings. Five dominant sources of risk according to occurring frequency are climate, local permits, poor project preparation and participant optimism, unsolved financing of the project and incomplete technical documentation. The analysis of sources of risk in a transitional market like in, Croatia, indicates that according to occurring frequency criteria and degree of negative influence on planned time and cost goals in construction projects, the dominant problems are unrealistic and overoptimistic planned goals and unsolved financing along with various forms of limitations. The effects of risk are a significant factor which creates differences in cash flow in construction projects. Risks cause differences even between completely similar projects, so it is therefore difficult to group projects by particular criteria and automatically have similarities in cash flows. For the analysis of effects of risk we have performed an interpolation of various cost curves between planned and actually recorded cost curves on observed projects. We took into account that initial plans were overoptimistic and varied the effect of risk. Testing of individual obtained cost curves was performed through the bestfit approach with 18 theoretical functions [ 141. Ranking was done according to the Chi square and Kolmogorov-Smirnov tests. Analysis shows that with increased elimination of effects of risk normal distribution becomes dominant, however, if risk is included in projects then variations in results are increased. Rayleigh Beta 10% Erlang 2% Logistic 17% Weibull 21% Fig. 3: Results of bestfit approach - rank according to Chi square test - minimal risk effects included

6 Performed research indicates that: 1. Effects of risk significantly influence the possible shape of cash flow curves. 2. Considering the impossibility of eliminating all risks in a project, or the ability to exactly forecast all risks in early phases of projects, research shows that the precision of individual theoretically obtained curves is questionable. It is, therefore, better to determine an interval of possible values instead of attempting to predict exact individual values. 4. Influence of time slacks on cash flow The other significant factor affecting the shape of cost flow curves is the allowance to complete certain activities at various times. The use of network planning techniques enables the identification of noncritical activities who s planned completion is always within the area of Early Start (ES) - Late Start (LS). In practice, this means that instead of one specific cost flow curve it is possible to construct an area of cost flow with boundaries ES and LS curves. All values within the boundary area are possible and represent completion according to plan. Reserves in completion an activity time are positive in every case of management, and contractors closely study them during preparation. From this point of view as well, then, it is also difficult to determine one particular curve which will absolutely represent cash flow in a construction project. On Fig. 4., shown is the area of LS cost flow curve for a group of projects concerning small tourist structures with 4 floors and an average completion time of one construction season and an average price of construction works of 1.5 mil. DEM (without furnishings). In comparison shown is cost curve obtained through the application of theoretical formulas from literature [5], for which it can be said that it probably represents an interpolation within ES and LS areas g E 40 a * Time +1 -a-2 +3 *4 -m-s lo -D-l1 +12 *13 -m-14 -nub j@D20 Fig. 4: Examples of cost curve areas for late start and minimal effects of risk (19 = average sample for late start Weibull(l.92 ; 0,60); (20 = theoretical Weibull curve (1,98;0,53) [5] ;)

7 The area between curves 19 and 20 might represent an interval of probably values for cost curve in this case, with included minimal effects of risk and no final time and cost overruns. Using results of our work and work done by other researchers, for a practical application we have adopted an approach which dictates that for determining cost flow curves, boundaries of curve group intervals should be set. In order for results to have practical values the interval has to be sufficiently narrow. This is achieved by grouping projects by numerous similarity variables: 1. Similar technical characteristics of structures. 2. For costs in intervals up to 1; 1-2; 2-4;...(mil. DEM). 3. For project duration in intervals up to 0,5; 0,5-l; l-2; 2-3, more than 3 (years). 4. In conditions of control or effect of similar primary sources of risk. 5. Same type of contract. 6. Same size of contractor. 5. Sustainable development and cash flow planning in economies in transition The motive for a new project in every economy is the desire for development and profit. In an economy in transition these wishes are even more evident but at the same time are limited by a shortage of cash for investment into development. During the socialist era, development was carried out in the name of development through which the success of political ideals was proved. Through political and economic changes, countries in transition are trying to follow economic laws of market economies in order to achieve a standard and level equal to that in developed countries. In this approach, complete copying of development paths and development of the same areas could be contraproductive. Economies in transition have to follow their own development path in which the speed and quality of development will be harmonious. It is precisely the quality of development which points toward a need for orientation in the direction of traditional resources and wealth of a country in transition. An alternative to secondary or unclear production which is simply transferred from developed countries can be found in modelling of sustainable development. For example in, Croatia, this could be an emphasised orientation on services in which tourism development dominates. Tourism is a significant factor in development plans in many countries in transition. Culture, history, and natural beauty can serve as an excellent base for the development of tourism if the safety of tourists and acceptable prices and quality of service can be guaranteed. However, like most human activities tourism has consequences that affect the base which determines its initial development. This implies a spiralling reduction in natural resources: scenery, water,... A high level of information, a conscientious plan of environmental protection and the monitoring of laws and bylaws in developed countries enables countries in transition to make good decisions on time. In the case of tourism this is controlled sustainable development, in which at the project planning phase it is necessary to include plans for protection of natural resources. In, Croatia, research looking into air and water pollution control, and solid waste disposal is being developed. Some results for example indicate that it is possible to solve the solid waste problem of the tourist area of the southern Adriatic coast in,

8 Croatia, with a yearly investment of about 4 mil. DEM. [ 151. With cash flow modelling, or economic parameters of projects, it is possible to find a model for parallel tourism development and environmental protection. Since investors are significantly burdened with expectations of maximum profit, and, hence, minimum costs, it is probable that local and government authorities will have to control the process. This could happen through permits, concessions, regulations, laws, bylaws, and a system of penalties or benefits. That is an important co-operative effort between the investor, government, and institutions which ensure environmental protection. Success primarily depends on the modelling of an acceptable cash flow solution in projects according to balanced criteria settled bv all parties involved. 6. Referen.ces Kaka A.P. (1996) Towards more flexible and accurate cash flow forecasting, Construction Management and Economics 14, Bromilow F. J & Henderson J.A. (1977) Procedures for Reckoning and Valuing the Performance of Building Contracts, CSIRO Div. of Building Research, Highett Hudson K. W. (1978) DHSS expenditure forecasting model, Chartered Quantity Surveying Quartile, 5, 3,42-45 Singh S. & Woon P.W. (1984) Cash flow trends for high rise buildings, Proceedings of the International Symposium on Organisation and Management of Construction, University of Waterloo, Canada, pp Tucker S. N. (1988) A single alternative formula for DHSS S-curves, Construction Management and Economics 6, Skitmore M. (1992) Parameter prediction for cash flow forecasting models, Construction Management and Economics 10, Singh S. (1996) Cash flow trends for infrastructural works in residential developments, Shaping theory and practice (vol. 2) E&FN Spoon, London. Kaka A.P. & Price A.D.F. (1993) Modelling standard cost commitment curves for contractors cash flow forecasting, Construction Management and Economics 11, Harris & McCaffer (1989) Modern Construction Management, BSP, Oxford. Statistical yearbook of Croatia, 1994., 1995., Statisticki zavod RH, Zagreb. Izetbegovic J. & Radujkovic M. (1996) Research on projects realisation trends, Proceedings of international symposium Information systems 95, University of Zagreb, Varazdin 1995, p. Bl-5. Simic T. & Pejovic T. & Radujkovic M. (1997) Information system for planning and control of cash flow in a project, Proceedings of international symposium Information systems 96, University of Zagreb, Varazdin 1996, p. 16 l Radujkovic M. (1997) Risk sources and drivers in construction projects, Management risks in projects, E&FN Spoon, London, Bestfit, Palisade Co., N.Y., Milcic J. (1997) Solution to the problem of solid communal waste from Makarska to Dubrovnik, Gradevinar 49-4, p