2007AACEInternationalTrans

actions

PM.02

ABCofCashFlowProject
ions
MarkT.Chen,PECCE

ashflowisthelifelineofabusiness.Manysta
rtupcompaniesfailbecauseofinsufficientcas
hflow.Fromtheperspectivesofbothownerand
contractor,managingcashflowisvitaltoasuccessfu
lproject.Cashflowiswheretheprojectcostmeetstheschedule
.Cashflowprojectionsdevelopedfromcredibleprojecte
xecutionplansbecomethebasisofprojectcontrols.Combinin
gthecashflowandearnedvaluetechnique,aprojectcantr
acktherealstatusofprogressanddetectanyearlycostde
viation.Apoorcashflowprojectioncouldleadtoaninabi
litytofundtheprojectorimposeunduestresstotheproje
ctexecutionteam.
Aprojecttypicallygoesthroughmultiplephasespri
ortothefinalapproval.Costestimates,scheduleanda
nexecutionplanare developedat each phase.Cash
flow projection is alsopre-paredto support
funding decision at eachphase.The sophisticationofcashflowprojectionincreasesasitmovestow
ardthefinalprojectapproval.Eachprojectisuniquei
nitsexecutionandhenceinitscashflowprojection.Ho
wever,therearebasicconceptsthatareapplicabletod
evelopmentofanycashflowprojection.Thispaperdesc
ribessimplifiedtoolsthatwillfacilitatethecashflowprojection.

ernaloperationcashfloworfinancestheprojectfromouts
idesources.
Contractorsperformtheworkandhavetomeettheweekl
ypayrollobligation.Inaddition,materialsareprocur
edtosupporttheconstructionastheprojectprogresses.Depend
ingontheconstructioncontractstyle,contractorsusu
allyreceivepaymentsfromtheownerbasedonmilestoneprogressorother
negotiatedmeasurements.Contractorshavetopreparei
nvoiceswithsupportingdocumentspriortopaymentsu
bmittalrequests.Ownersalsotaketimetoreviewinvoic
esandprocesspayments.Itisnotunusualforcontractor
storeceivediscretepayments30to60daysafterthecost
wasactuallyincurred.Thedifferencebetweentheactu
alexpenditureandpayment

CASHFLOWVS.EXPENDITURE
Thetermscashflowandexpenditureareusedinterchang
eablybymanyprojectteamsandorganizations.Inastricts
ense,expenditureisthecostincurredafterreceivinggo
odsorservices.Accrualliabilityincludesinvoicesreceivedonhand
,butnotyetprocessedandrepresentsaportionofpayment
obligation.Fromanownersperspective,theprojectca
shflowistheactualpaymentsmadetomeetexpenditureobl
igations.Acorporationfundstheprojectthroughtheint
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2007AACEInternationalTrans
actions
receivedisthecashflowthatacontractorneedstofin
yearcashflowandexpenditureforecasts.Inaccurateca
anceonashortshflowprojectionofalargeprojectcouldsteerbusiness
termbasis.Contractorsgenerallyrecoversuchfinan leaderstomakedecisionsthatarenotinthebestintercechargesthroughoverhead,feesorlargeupfrontmob estofthecompany.Inordertorecoverfinancecharges,co
ilizationcharges.Refertofigure1foranexampleofa n-tractorsdependonthecash
typicalcontractorcash
flow
chart flowprojection.Apoorlydevelopedprojectioncouldlea
presentedinthe
November dtoeitheroverorunderbiddingacontract,resultinginl
2006CostEngineeringjournalbyTarekHegazy[4] ostbusinessopportunityorincurredfinancialloss.For
.
acontractortomaintaincompetitiveness,construction
cashflowprojectionsmustberealisticandaccurate.Apr
eferredmethodisforanownertonegotiatepaymentschedu
lewithacontractorusingacashneutralapproachtominim
izethecontractorsfinancecharges.Usingacashneutralmethod,
discretepaymentsreceivedfromanownerareessentially
sufficienttocovertheprojectedcontractorscashflo
wrequirement.
The
projectcashflow
projectionisderivedfrom
anexecutionplanandestimatedexpenditure.Manyprojec
tstreatestimatedexpendituresascashflowprojections
.Infact,cashflowgenerallylagsactualexpenditurebyoneaccountingperiod;i.
Figure1ContractorsProjectCashFlow
e.,onemonth.Aplannedprojectcashflowisthebaselinef
orcomparAccuratecashflowprojectionsareimportanttobotha
isonwiththeactualprojectexpenditure.Deviationfrom
nownerandacontractor.Acorporationsbusinessplan
theplannedcashflowisanalyzedbytheprojectcontrolss
generallyincludesmultipecialist
and/orprojectmanagertodetermineanycorrectiveact
rangesfromtwoweekstotwomonthsdependingonthecon
ionsrequiredfortheremainingwork.Forexample,isth
tractstyleandcontractorsmanagementcapability
eprojecttrulyaheadofscheduleorheadstowardtheine
.
vitablefinalcostoverruniftheactualspendingistoo Inherenttimedelayassociatedwiththeinvoiceappro
fast?
valcycle.
Owners
Conversely,whentheactualspendingistooslow,isthe
approvalandactualpaymentcheckreleasecouldtake3
projectbehindthescheduleorexpectstoachieveabudg
0daysormoreafterreceivinganinvoice.
etunderrun?
Delayinreceivingequipmentorconstructionmater
Byincorporatinganearnedvaluesystem,anobjectivee
ialsthatimpactstheengineeringorconstructionp
valuationwillrevealthetrueprojectstatus.
rogress.
Tominimizecashflowvariance,itisessentialtodevelo
pacredibleprojectexecutionplanwithinputsfromtheown
FACTORSLEADINGTOCASHFLOWVARIANC er,keyequipmentsuppliers,engineersandcontractorsat
E
projectfrontend
planning.
When
key
partiesarenotavailable,analyzingpastsimilarproject
Finalprojectcostsofmanysuccessfulprojectsaret scanbeusedasasecondmethod.Whenusingthismethod,mate
ypicallywellwithin
a
reasonablerangeof rialdifferencesinschedule,laboravailability,and/or
theapprovedbudget.However,theactualexpenditure geographiclocationsshouldallbetakenintoconsideraperperiodmightvaryfromtheplannedcashflowbyalarg tion.
emargin.Keyfactorsleadingtocashflowvarianceincl
Capitalizedinterestiscalculatedfromtheactualcash
udethefollowing.
flowonamonthlybasis.Itisacomponentofthetruecosttoi
mplementaproject.Acorporationsannualfinancialrep
Projectmanagersaretypicallyoptimisticanddevel
ortalsoincludescapitalizedinterestsfromallprojects
opexe.Itistheprojectmanagersresponsibilitytoprovideac
cutionplanandprogresscurvesbasedonanearlystar
curatecashflowdatatomeetthecortschedule.[3]
porationsbusinessstrategyandeverincreasingaccoun
Aggressivelargecontractnegotiationsgenerallyr
tingrequirements.
esultinreleasingpaymentsfromownerslaterthanth
einitialplan.
PRE Acontractorincursthecostfirst,butneedstimetoa
REQUISITEOFACASHFLOWPROJECTION
ssembleallinvoicesupportingdocuments.Thetimedelay
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2007AACEInternationalTrans
actions
Acashflowreflectsgoodsandservicesreceived.Proce
otherhand,theconstructionresourcetendstoreachapea
ssequipmentpaymentschedulesaretypicallytiedtocrit klevelovera
icalengilongperiod,andthenquicklyrunsdowntowardtheconstru
neeringdocumentsandmanufacturingprogress.Engineer ctioncompletion.Bothengineeringandconstructionres
ingandconstructioncashflowsfollowcloselywiththere ourceprofilesresembletrapezoidswithdifferentpeak
sources(i.e.,workhours)applied.Engineeringresourc resourcelevelsasshowninfigure2.Trapezoidalapproxi
eisneededattheprojectsfrontend.Itbuildsuptoapea mationcanbeappliedtomostprojectsexceptshutdowntur
klevelquicklythentapersoffoveralongperiodtosuppor naroundprojects.[1,2].
tconstruction.Onthe
Theaccuracyrequirementofcashflowprojectionvarie
swithprojectphase.Aquickandsimpleprojectionisneed
edattheopportunitystudy.Asaprojectmovesthroughthe
feasibilitystudyandfinalapproval,theexpecteddegre
eofaccuracy

Figure2
EngineeringandConstructionResource
ProfileApproximation
increases.Thispaperwilllimitthediscussiontothepro
jectsearlyphasecashflowprojection.
Aprojectioncanbeeasilypreparedwitharelatively
fewsup-porting documents.The resulting accuracy
will
dependon
thedetaillevelsavailable.Theminimumrequireddocu
mentsare:
Projectmajorcostbreakdown.
Projectsummaryschedule,includingengineering
,pro-curementandconstruction.And,
Availablepaymentschedulesofmajorcontracts.
BASICSTEPSOFDEVELOPI
NGACASHFLOWPROJECTI
ON
Atypicalconstructionprojectwillincludeatleastfi
vework/costbreakdowns:procurement,engineering,con
struction,commissioningandprojectmanagement.Wewil
lusethesefivebreakdownstooutlinethebasicstepsinde
velopingacashflowprojection.
Step1 Confirmkeycostbreakdown.
Step2
Identifythetimeline(duration)ofeachbreakdown.
Step3
Secureavailablepaymentschedulesofmajorcontracts.
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2007AACEInternationalTrans
actions
Step4
Step5 Convertcashflowfrom
Assignpercentageofcashflowwithineachbreak%to$usingdatafromSteps1and4.
Step6
downusingdatafromSteps2and3.
Calculateperiodicandcumulativecashflow.
Step7 Plotcashflowcurve.

PM.02
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Table1Twelve-MonthCashFlowCalculation
Step8
Performrealitycheckofthecashflowprojectionag
ainstexecutionplanandpastsimilarprojects.
TWELVE-MONTHPROJECTCASHFLOWEXAMPLE
A12monthfasttrackprojectwillbeusedtodemonstratethe
basicconceptofdevelopingacashflowprojection.
Assumptions
1. Onemajorprocessequipmentcommitmentwasmadepri
ortothefinalprojectapproval.Paymentschedulei
ncluding
10percentretentionwasagreedupon.Theremaining
equipmentisprocuredasengineeringprogresses.
2. Constructionstarts after three
monthsofengineeringprogress.
3. Constructionmaterialsareprocuredregularlyast
heinstal-lationprogresses.
4. Usetrapezoidalapproximationtoforecastbothengin
eeringandconstructionresources.
5. Projectmanagementhasastraightlinestaffinglev
el,exceptatfrontandbackends.
Procedure
Step1 Enterkeycostbreakdownintable1.
Step2
Confirmengineeringandconstructiondurati
onsof10and7months,respectively.
Step3
Securemajorprocessequipmentpaymentschedule.St
ep4
Entermajorequipmentpaymentscheduleandapplytra
pezoidalapproximationsto engineeringand constructioninpercent.Spreadremainingequipment
paymentsevenlyover10months.
Step5
Convertcashflowofeachcostbreakdownfromper
-centtodollars.
Step6 Calculateperiodicandcumulativecashflow.
Step7
Plotcumulativecashflowcurveinpercentass
howninfigure3.

Step8

Performcashflowrealitycheck.

TWO-YEARPROJECTCASHFLOWEXAMPLE

Figure3Twelve-MonthCashFlowCurve
Thesamebasicstepsusedonthe12monthprojectcanalsobeappliedtoalargerprojectwith
longerduration.Wewillusea$100millionprojecthavin
gatwoyearprojectdurationtodevelopaquarterlycashflowpr
ojectionforseniormanage-mentsfeasibilityreview.

Sitepreparationbeginsonequarterafterthestart
ofengi-neering.
Seventypercentofconstructionbulkmaterialsare
purchasedearly,withtheremainingquantityprocured
afterengineeringinformationbecomesavailable
.
Usetrapezoidalapproximationtoforecastbothengin
eeringandconstructionresourcecashflow.
Projectmanagementteambuildsuptoasteadystaffi
nglevelandthenquicklyrunsdownattheend.

Procedure
Step1 Enterkeycostbreakdownintable2.
Step2
Onemajorprocessequipmentwasorderedwithacanc
Confirmengineeringandconstructiondurationsw
ellaillstretchoversixquarters.
tionclausepriortothefinalprojectapproval.T
Step3
heremainSecuremajorprocessequipmentpaymentschedule.
ingequipmentisprocuredinconcertwithenginee
ringprogress.

Assumptions

Table2Two-YearQuarterlyCashFlowCalculation
Step4Entermajorequipmentpaymentschedule
andapplytrapezoidalapproximationstoengi
neeringandcon-structioninpercentages.
Step5Convertcashflowofeachcostbreakdownfr
omper-centtodollars.
Step6 Calculateperiodicandcumulativecashflow.
Step7Plotcumulativecashflowcurveinperce
ntasshowninfigure4.
Step8 Performcashflowrealitycheck.

Cashflowprojectionsestablishtheprojecttrackingb
aseline.Asaprojectprogresses,effortswillbefocused
oncapturingtheactualexpenditure,analyzingdeviatio
nfromtheplan,andforecastingtheremainingwork.Timelycorrectiveactionsmi
ghtberequiredtoaccomplishtheprojectgoalsandobject
ives.Mostprojectsdevelop cash flow projections
based
solely
on
the
anticipatedexpenditures.Recognizinganinherenttimelagbe
tweentheactualcashpaymentreleaseandactualexpendit
ure,arealisticcashflowfinancialobligationwouldtypicallybeo
ffsetbyonetotwoprojectperiods.Theyearendpaymentcouldbefurtherinfluencedbythecorporationscashflowconstrai
ntsordesiretoimprovethebalancesheet.

ashflowprojectionsaredevelopedtosupportbus
inessdecisionsateachprojectphase.Onlyasimp
leandhighlevelcashflowprojectionisneededattheopporctexecutionplanwithbuyinfromkeyshareholdersincludingsuppliers,engineersa
ndcontractorsistherealkeytoenhancingtheaccuracyofcashflowprojections.Forpracticalpurpose,itis
besttolimitthehighlevelcost/workbreakdownstolessth
antwentycriticalelements.

Figure4TwoYearQuarterlyCashFlowCurveCASHF
LOWPROJECTIONREFINEMENT
Theabovetwoexamplesuseonlyfivekeycost/workbreak
downsforsimplecashflowprojections.Additionalcost/
workbreakdownswillprovidefurtherrefinementandimpr
ovetheaccuracyofprojections.Havingarealisticproje

tunitystudyphase.Moredetailedandaccuratecashfl
owprojectionsareexpectedastheprojectmovesthroughfeasib
ilityandfinalapprovalphases.Theapprovedcashflo
wprojectionbecomestheprojecttrackingbaseline.C
orporationsusesuchprojectionstoreservefundstom
eetprojectobligationsandenabletotalprojectport
foliomanagement.
Contractorsincurcostsastheconstructionprogres
ses.Contractorshavetomeettheongoingweeklypayroll
andmonthlymaterialpaymentobligationswhilewaiting
forownersdiscretepayments.Thegapbetweencumulat

iveexpensesandactualpaymentsreceivedwillbefinance
d.Contractorsusuallyrecoversuchfinancinginterestc
hargesthroughoverhead,feesorlargeupfrontmobilizationcharges.Forthebestinterestoftheo
verallproject,itwouldbeprudentforanownertonegotiateacontractorpaymentscheduleusingacashneutral
basistoachievethelowesttotalprojectcost.
Thispaperdemonstratessimpleandfastmethodstodeve
lopcashflowprojectionsforbothshortandlongprojectd
urations.Additionalrefinementsarerequiredtofinetu
netheprojectionstoalignwiththerevisedexecutionpla
nandaccuracyexpectedbytheorganization.

REFERENCES
1. Bent,JamesA.andKennethK.Humphreys.TheFastTrackProgramandTrapezoidalTechnique,Effecti
veProjectManagementThroughAppliedCos
tandScheduleControl,pages109125,MarcelDecker,NewYork.
2. Chen,MarkT.ApplyingTrapezoidalTechniqueinRe
sourceManagement,2006AACEInternation
alTransactions,pagesPS.03.1-PS.03.7.
3. Goodwin,BarryL.TheDevelopmentandUseofProgr
essCurves,1990AACETransactions,pagesH.4.1
-H.4.6.
4. Hegazy,Tarek.SimplifiedProjectManagementfor
ConstructionPractioners,CostEngineering,Vol.
48/No.11,November2006.

MarkT.Chen,PECCE37
34SW313thSt.
FederalWay,WA980232142Phone:
+1.253.924.4631
Email:mark.chen@weyerhaeuser.c
om