2 International/ 8 Construction Specialty Conference e 2 confrence internationale / 8 confrence spcialise sur le gnie de la construction

nd

th

St. Johns, Newfoundland and Labrador / St. Johns, Terre-Neuve et Labrador May 27-30, 2009 / 27-30 mai 2009

CASH FLOW ANALYSIS OF CONSTRUCTION PROJECTS

Yaqiong Liu ,Tarek Zayed and Shujing Li 1, 3 Graduate student of Concordia University 2 Associate Professor, Department of Building, Civil, and Environmental Engineering, Concordia University, Montreal, Quebec, Canada, H3G 1M8 Abstract: Construction projects are complex and risky. According to the literature, even profitable construction companies can fail due to poor cash flow. In order to survive in this rapidly changing environment, effective cash flow management is essential. Many unforeseen factors affect a construction projects cash flow. The objective of the research presented in this paper is to examine the impact of these factors on contractor cash flow during the construction process. A model has been established by integrating analytic hierarchy process (AHP) and simulation to examine the impact of various factors on cash flow. Results show that cash outflow varied approximately from 12.9% to 20.4% with a mean value of 16.7% considering the effects of all factors on the basis of 30% total cost variation. By analyzing the results of the developed model, contractors will recognize which factors contribute the most to contractor cash flow performance. Professional cash flow management (i.e. prediction) might greatly reduce failures in the construction business.
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1. Introduction Contractors cannot survive in the competitive construction industry without effective cash flow management. Studies and investigations have shown that lack of liquidity is a major problem causing construction project failure (Al-Issa and Zayed, 2007). A model for accurately predicting trends in a projects cash flow prior to the construction phase has been as elusive as the Holy Grail. But advance knowledge of the factors affecting cash flow and an understanding their impact is essential to the contractor. Financial management has long been recognized as an important management tool. Throughout the construction process, contractors need to be comparing the actual income and expenses against the forecasted values. If there are discrepancies between these values, the contractor needs to adjust the schedule and update the project plan to match the estimated situation as early on as possible. With good knowledge of cash flow forecasting, the contractor could more efficiently and accurately manage cash flow during the construction process to prevent extra expenses and avoid project collapse. Many methodologies have been applied to analyzing cash flow forecasting (Blyth and Kaka, 2006). The non-mathematical approaches, mostly referred to as project-oriented forecasting models, were greatly used in traditional research (Khosrowshahi and Kaka, 2007). These forecasting models, which were established based on historical project data, were used to monitor and modify project process. The models were used to forecast cost flow in construction projects, and offered a clear explanation as to the origin and nature of the resulting forecast (Khosrowshahi, 1991, 1996, and 1998, and Kaka, 2007). However, establishing the model consumed much time and money and the model could only be applied to similar types of the projects, and not with any desirable measure of accuracy. Since construction projects are usually uncertain, complex and unique, mathematical models, conversely, provide much simpler and cheaper approaches.

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Qualitative and quantitative techniques have been used to study the relationship between a set of independent and dependent variables in cash flow forecasting. The mathematical models intend to investigate the behavior of the phenomenon (Khosrowshahi 1998). A visual model for a cash flow forecast was developed by Kaka using a deterministic approach (Kaka 2007). This model has been established using the mathematical components of several key factors that can be negotiated to generate priorities. The model generates a forecast by "combining the outcome of data analysis with the experience and knowledge of the forecaster (Ibid.). In forecasting cash flow, there are both factors that can be considered to be fairly concrete, or certain, and others which are more difficult to estimate. Several factors impacting cash flow have already been identified and studied and sorted into seven categories: financial, supplier, subcontractor, factors prior to/during project, and communication throughout the whole project (Al-Issa and Zayed 2007). The objective of our research is to study the effects of cash flow factors on a contractors cash flow performance and to forecast cash flow more realistically by incorporating these factors.

2. Research Methodology The methodology of this research passes through various steps, i.e. reviewing literature about cash flow factors and analysis, establishing a new forecasting model, and predicting the cash flow based on the newly developed model. First, the literature review comprises several stages: (1) study previous cash flow forecasting models to find the advantages and limitations of each, (2) identify and collect the factors and categorize them, and (3) acquire a comprehensive knowledge of research techniques. Second, design a data collection tool, e.g. questionnaire, to collect information relative to factors impact on cash flow from engineers and experts in the construction management field. Based on the questionnaire data, it was possible to determine the weight and effect of every factor of cash flow forecasting using stochastic analysis. The analytic hierarchy process (AHP) technique was used to calculate the factors weight. Then, a simulation model was developed to forecast cash flow and draw the overdraft. Finally, the model development results were analyzed and conclusions drawn.

3. Data Collection A strong background in cash flow forecasting is an essential requirement for improving the current cash flow forecasting models. After a comprehensive literature review and several interviews with construction engineers, forty-three factors were identified as having an impact on cash flow in construction projects. These factors were categorized to provide additional information regarding their effect on cash flow and forecast this effect. To this end, data were collected from experts and engineers through a questionnaire and on-site interviews. The experts were asked to rate the importance of various factors on a scale of 1-9, where 1 signifies that a factor is "slightly important and 9 signifies extremely important. Two hundred and thirty-three questionnaires were sent to more than two hundred construction companies in North America and China by e-mail and fax. A hundred responses were received for a return rate of 43% (100/233).

4. Model Development Clearly, there are many factors at play in forecasting cash flow. Forty-three factors were selected to aid in investigating the performance of project cash flow in seven categories (Al-Issa and Zayed, 2007). Table 1 lists all of these factors and categories. A model based on the stochastic mathematical process-Monte Carlo simulation combined with AHP was developed to evaluate the impact of these factors and forecast cash flow. The collected data were categorized and probability distributions were fit for various factors and their weights. Best fit software was used to generate these probability distributions. The AHP

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technique has been widely used and applied in multi-criteria decision making, planning and resource allocation, conflict resolution, and prediction problems (Saaty, 1994). According to Saaty, the analytical hierarchy process is performed by pair-wise comparisons; in this case, the comparison is between two distributions (Ibid.). Then, the weights were calculated based on the pair-wise comparisons using mathematical techniques such as eigen value and eigen vector, mean transformation, or row geometric mean. In this paper, all of the input values are probability distributions. Consequently, the weights obtained should be probability distributions as well. However, in order to compare with previous studies, the most likely weight needs to be concluded from the distribution. Due to space limitations, only the main categories weight comparison is presented in Figure 1. The bar chart in Figure 1 indicates that the results differ slightly from the previous study that was done by Al-Issa and Zayed (2007). Table 1. Factors that affect the project cash flow: contractor perspective (Al-Issa and Zayed, 2007) Category Factors F1-Change of progress payment F7-Loan repayment(O) Financial duration (I) F8-Payments of material (before/after arrival) Management F2-Change of progress payment (O) conditions(I) F9-Over work measurement(I&O) F3- Receiving front payment(I) F10-Under work measurement(I&O) F4-Large retention percent(I) F11-Change of labour and staff wages(O) F5-Delay in releasing retention(I) F12-Bank interest(O) F6-Finanical position(O) Sub-contractor Sub1-Decisions to sub-contract(O) Sub3-Failure of sub-contractor(I&O) Sub2-Over/under measurement(O) Sub4-Renting vs. buying equipment(O) Suppliers Sup1-Delay of making payments(O) Sup3-Delay in delivery(I&O) Sup2-Procurement problems(O) Sup4-Price change(O) Prior to P1-Poor design(O) P4-Cash flow forecasting(O) construction P2-Inaccurate bid items(I&O) P5-Competitors(I) P3-Estimating strategies(O) During D1-Mistakes in executing the D5-Small projects duration increase/decrease Construction work(I&O) (I&O) D2-Lack of adequate insurance(O) D6-Project delayed(I&O) D3-Replacement of defective D7-Material and equipment shortages(O) work(I&O) D8-Lack of skilled labour(O) D4-Large projects duration D9-Improper planning and management(I&O) increase/decrease (I&O) C1-Disputes between contractor and C3-Relations with owner(I&O) owner(I&O) C4-Relations with consultant team(O) C2-Poor communication contractor staff(I&O) Others O1-Weather condition(I&O) O3 Negative change order (Omit work) (I&O) O2-Positive change order (addition O4-Inability to manage change orders(I&O) work) (I&O) O5-Number of claims(I&O) Note: (I), affect cash-in; (O), affect cash-out; (I&O), affect cash-in/cash-out. In this paper, not only the weights of factors are calculated, but the impacts of these factors are also integrated into cash flow forecasting. As previously discussed, cash flow includes cash inflow and outflow. It is necessary to distribute the forty-three factors into three sections: factors affecting cash inflow, factors affecting cash outflow, and factors affecting both. All the factors are tagged with letter I, O or I&O to indicate these sections, respectively. To evaluate the degree to which the factors affect cash flow, several mathematical expressions were developed: [1] Ek= Communication skills

ek/9

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Where, Ek is the effectiveness index of k factor, the value of effectiveness is between 0-1, it can be obtained from the questionnaire. The ek is a random sample selected from the effectiveness distribution of this factor. The value 9 is the maximum effect that a single factor can have on the cash flow. For example, if a factor is rated as 9, its effectiveness is the peak value of 1.

Figure 1. Comparing the newly developed model with Al-Issa and Zayed (2007): main categories weights [2] Where, W k is a random sample selected from the distribution of factor Ks weight calculated by the integration of AHP with simulation; P is the amount of cash that is involved in the calculation considering all the factors effect. It is assumed to be from 0% to 50% with a mean percent of 30% applied to the overall cost. The Cout-m is the estimated expense of the project at the specific time m. [3] Where, W l is a random sample selected from the distribution of factor Ls weight calculated by the integration of AHP with simulation; P is the amount of cash that is involved in the calculation considering all the factors effect; Cin-m is the expense of the project at the specific time m. [4] The overdraft at the specific time m could be either positive or negative. It is noted that the new cash flow forecasting has been defined by parameters W, P, and E. An effectiveness index is generated directly from the collected data using equation 2. These parameters are all derived from the engineers or experts opinions and judgement. They are all embedded in the model as probability distributions as shown in Table 2. The parameters can define the specific characteristics of the cash flow shape. Peak point values, slop values, expenditure intensity and distortions of the cash flow profile are related to several variables

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Table 2. Fitted probability distribution for factors importance and effect (W*E) criteria 95% +C -C Chi-Sq confidence Test F1 0.02617 0.00765 0.00021 0.02638 0.02596 43.47 F2 0.019 0.00752 0.00021 0.01921 0.01879 61.41 F3 0.01997 0.01368 0.00038 0.02035 0.01959 55.30 F4 0.01802 0.0079 0.00022 0.01824 0.0178 46.38 F5 0.01387 0.00844 0.00023 0.0141 0.01364 54.86 F6 0.02192 0.00767 0.00021 0.02213 0.02171 40.87 F7 0.01648 0.00721 0.0002 0.01668 0.01628 52.75 F8 0.01861 0.00799 0.00022 0.01883 0.01839 60.85 F9 0.01562 0.00904 0.00025 0.01587 0.01537 46.72 F10 0.01475 0.0088 0.00024 0.01499 0.01451 47.03 F11 0.01105 0.00761 0.00021 0.01126 0.01084 61.30 F12 0.0109 0.00846 0.00023 0.01113 0.01067 55.98 Sub1 0.01427 0.00659 0.00018 0.01445 0.01409 58.14 Sub2 0.01292 0.00668 0.00019 0.01311 0.01273 59.97 Sub3 0.0195 0.0096 0.00027 0.01977 0.01923 59.66 Sub4 0.0133 0.00712 0.0002 0.0135 0.0131 49.81 Sup1 0.01615 0.00649 0.00018 0.01633 0.01597 39.75 Sup2 0.01411 0.00734 0.0002 0.01431 0.01391 55.95 Sup3 0.01798 0.00878 0.00024 0.01822 0.01774 36.84 Sup4 0.01203 0.00802 0.00022 0.01225 0.01181 56.30 D1 0.01789 0.00898 0.00025 0.01814 0.01764 51.27 D2 0.00953 0.00754 0.00021 0.00974 0.00932 56.50 D3 0.01139 0.00513 0.00014 0.01153 0.01125 57.20 D4 0.0184 0.00861 0.00024 0.01864 0.01816 56.67 D5 0.01253 0.00678 0.00019 0.01272 0.01234 39.51 D6 0.02208 0.00778 0.00022 0.0223 0.02186 38.84 D7 0.0179 0.00907 0.00025 0.01815 0.01765 49.23 D8 0.00528 0.00465 0.00013 0.00541 0.00515 61.37 D9 0.02275 0.00511 0.00014 0.02289 0.02261 46.94 P1 0.01907 0.00973 0.00027 0.01934 0.0188 52.48 P2 0.01168 0.00797 0.00022 0.0119 0.01146 52.75 P3 0.01446 0.00764 0.00021 0.01467 0.01425 49.50 P4 0.01915 0.008 0.00022 0.01937 0.01893 40.83 P5 0.01145 0.00741 0.00021 0.01166 0.01124 48.33 C1 0.01615 0.00635 0.00018 0.01633 0.01597 55.20 C2 0.01321 0.00681 0.00019 0.0134 0.01302 59.73 C3 0.01589 0.00739 0.0002 0.01609 0.01569 60.28 C4 0.00896 0.0053 0.00015 0.00911 0.00881 54.27 O1 0.01765 0.00974 0.00027 0.01792 0.01738 60.83 O2 0.0173 0.0097 0.00027 0.01757 0.01703 53.20 O3 0.0105 0.00751 0.00021 0.01071 0.01029 51.70 O4 0.02141 0.01072 0.0003 0.02171 0.02111 60.30 O5 0.02043 0.01134 0.00031 0.02074 0.02012 61.24

CV at = 0.25 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665 61.665

Type Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal Lognormal

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(Khosrowshahi and Kaka, 2007). In this paper, the variables effect is controlled by W, P, and E. By manipulating the three parameters, the profile geometry of cash flow can be identified. We used the original input value of cash in and out to obtain the base cash flow curves as a reference. Then, new cash flow curves were obtained by applying equations 2, 3 and 4. By using these equations, the factors impact was considered in forecasting the cash flow. Statistical tests were implemented to choose the best fit probability distribution for each parameter. The chi-squared statistic is the best known goodness-of-fit statistic. Table 2 presents the result of the chisquared test, which indicates that lognormal distribution is the best fit for W*E. It also shows the mean () and standard deviation () for each factor. The critical values at significant level =0.25 have been chosen to compare with the chi-squared test result. Since the significant level value is higher than the chisquared statistical results, the lognormal distribution cannot be rejected as the best-fit software selected the lognormal probability distribution at 0.25 significant level. For instance, if the chi-squared test result is 43.47 for F1, and the critical value at 0.25 significant level is 61.665, obviously the lognormal distribution is the best fit. The same method has been applied to the rest of the factors. A confidence interval of 95% was shown in Table 2; it is widely used in the stochastic variables in analyzing the results of the developed models. For instance, the F1: Change of progress payment duration has a 95% confidence interval upper limit of 0.02638, and lower limit of 0.02596, with an average value as 0.02617; therefore, the lognormal distribution fit test was acceptable. Different scenarios have been studied for the factors impact. The best case is when none of these factors occurs. Then, no modifications the original forecast are warranted to. The worst case occurs when all of the factors exist and happen for a particular project. The other, middle cases occur when several factors exist while the others do not. Simulation results indicate that if all of the cash inflow factors occur, the cash inflow will fluctuate from 9.7% to 16.3%, with a change of 12.4% being the most likely, based on the original value. On the other hand, if all of the cash outflow factors occur, the cash outflow will fluctuate from 12.9% to 20.4%, with a change of 16.7% being the most likely, based on the original value (30% of total cost will be involved in variation).

5. Model Implementation to a Case Study Diagram type software has been programmed to implement the cash flow forecast of any given construction project. The result can be presented using a cash flow overdraft diagram. The steps are described as follows: 1. User inputs several parameters which have been defined in the contract, such as the amount of pre-estimated cost/income per month, interest, up-front payment, etc. 2. Identify and select the factors that might occur in this particular project. 3. Apply the simulation model to the project using the selected factors effect and equations [3], [4], and [5]. 4. Synthesize the series of cash inflow, outflow and overdraft, and the most likely cash flow profile. Table 3. Project estimated cost and payment Milestone Cost Payment Unit Received ()Yuan Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 38% completed 62% completed 85% completed 95% completed Complete Complete 2,496,622 1,576,814 1,511,114 657,006 328,503 0 0 2,675,647 1,689,882 1619470 704,118 352,059

Data were collected from a building located in Tianjian, China. The estimated cost was 6,570,059 YUAN (Currency rate CAD to YUAN: 1:5.3 at March 12, 2009)with a 7.1% profit margin. The project lasted five months. Monthly interest of 0.5% was applied to negative cash flow only. No payment was received up-

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front. The contractor received the payment from the owner on a monthly basis according to the percentage of the project that had been completed. Front-end loading was not allowed in this project. Table 5 gives the details on the financial condition. According to the project manager, the factors that might occur in this project were: F2, F4, F5, F7, F9, F12, Sb1, Sb4, Sp2, Sp4, D1, D3, D5, P2, P3, P4, C2, C3, O1 and O2.Each project has a unique profile that is defined in terms of the values of its profile variables (Kaka, 2007). Similarly, in this paper, the specific factors affecting the project must be specified before conducting any calculations. Instead of a unique profile, a series of cash flow curves are obtained where the cash flow profile values fluctuate around the most likely value. The peak and mean values are presented in the final result. In order to run the developed program, contractors not only need to input the preliminary forecast data, but also need to select the importance of the various factors specific to their knowledge and situation. Unlike this case, the contractors must predict the factors that might potentially affect the project in order to be able to forecast the cash flow profile. Only the selected factors will be included in the calculation. Equations 3 and 4 have been used to calculate the modified estimated cash inflow and outflow for each month, respectively.

Figure 2. Cash flow curves and profiles for 500 runs

Figure 3. Mean cash flow curves and profile

In order to obtain an accurate value for the cash flow forecast, the iteration number has been set at 500. Figures 2 and 3 present the 500 cash flow curves and the mean cash flow curve, respectively. These figures show that the values are close and the deviation from the average is not high. They also have the same trend of positive and negative slopes. The program calculates the maximum, minimum, and mean value of each point on the overdraft profile and compares them with actual overdraft data that are collected from the project. Table 4 also lists the actual price (AP), actual accumulative price (AAP), actual cost (AC), and actual accumulative cost (AAC), which are collected from the project to calculate the actual overdraft (AO). Results show that the actual overdraft is among the range of the forecasted overdraft in which the difference between AO and mean overdraft is approximately 2%. For example, the AO is 1,546,625 for Yuan at the end of month 2; it is more than the minimum overdraft and less than the maximum overdraft. The difference between AO and the mean O is 7,765.77 Yuan, which is a 0.5% variance compared to its original value.

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Table 4. The actual overdraft (AO) vs. calculated overdraft (O)

M1 M2 M3 M4 M5 M6 AP 0 2,724,964 1,721,030 1,649,320 717,095.8 358,547.9 AAP 0 2,724,964 4,445,994 6,095,314 6,812,410 7,170,958 AC 2,692,923 1,578,666 1,512,888 657,777.5 339,888.7 0 AAC 2,692,923 4,271,589 5,784,477 6,442,255 6,782,143 6,782,143 AO -2,692,923 -1,546,625 -1,338,483 -346,940 30,266.61 388,814.5 Min O -2,754,299 -1,738,466 -1,605,491 -617,915 -219,408 134,486.7 Max O -2,495,099 -1,396,188 -1,130,988 -87,652.7 327,784.4 697,484.4 Mean O -2,623,982 -1,538,859 -1,363,678 -366,518 26,239.43 390,851.8

Note: AP, actual price; AAP, accumulative actual price; AC, actual cost; AAC, accumulative actual cost; AO, actual overdraft; Min O, calculated minimum overdraft; Max O, calculated maximum overdraft; Mean O, calculated mean overdraft.

6. Conclusions The research presented in this paper focuses on identifying and assessing the effects of several factors on cash flow forecasting. Based on the factors identified, a stochastic model was developed by integrating AHP with simulation. Results show that financial management, at 27.72%, plays the most important role in cash flow forecasting. Special caution must be taken in anticipating the following factors' occurrence in the project: change of progress, payment duration, financial position, project delay, improper planning and management, inability to manage change orders, and number of claims. These factors contributed very high percentages on cash flow risk compared with the other factors. This research may serve as an advance warning sign for the contractor, that mitigation procedures should be undertaken. Contractors should pay attention to the maximum and minimum overdraft to avoid the worst case scenarios. It is an advantage to have a prior knowledge of cash flow forecasting and understand the impact of various cash flow factors. In conclusion, the developed cash flow model can be of benefit in forecasting cash flow progress.

7. References Al-Issa, A. and Zayed, T. 2007. Projects cash flow factors-contractor perspective, Construction Research Congress (CRC) conference, ASCE, Bahamas, May 5-8. Blyth, K. and Kaka, A. 2006. A novel multiple linear regression model for forecasting S-curves Engineering, Construction and Architectural Management 31:82-95 Khosrowshahi, F. and Kaka, A. 2007. A decision support model for construction cash flow management, Computer-Aided Civil and Infrastructure Engineering, 22: 527539 Khosrowshahi, F. 1998. A visual approach to the analysis of curve profile: a case in construction industry, 1998 IEEE Conference on Information visualization,,Computer Society, Los Alamitos, California, 29-31: 321 326 Khosrowshahi, F. 1996. Value profile analysis of construction projects, Journal of financial management of property and construction, 1: 55-77. Khosrowshahi, F. 1991, Simulation of expenditure patterns of construction projects, Construction Management and Economics, 9: 113-32. Saaty, T.L. 1994, Fundamentals of Decision Making and Priority Theory with the Analytic Hierarchy Process, RWS Publications, Pittsburgh, PA.

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