CIVL3103 Construction Project Management 1

Topic 7 – Part 2
Cash Flow Management

Ir. Dr. Cliff LEUNG

Department of Civil Engineering

Revision: R0
CIVL3103 Construction Project Management 2

Cash Flow Forecasting

CIVL3103 Construction Project Management 3

Cash Flow Forecasting

Illustrative Example 1
The table below shows the estimated monthly contract values of works to be completed by a
contractor for a project with duration of 10 months. The contract values were estimated based
on a profit margin of 5%.

Month 1 2 3 4 5 6 7 8 9 10

Contract value of works to be

$3M $6M $10M $15M $18M $16M $10M $8M $8M $6M
completed

Profit margin 5% 5% 5% 5% 5% 5% 5% 5% 5% 5%

Other terms and conditions are:

• no advance payment from the client, and monthly interim payment against certified works
will be made by the client to the contractor at the end of the following month;
• the retention will be withheld at 10% for every monthly interim payment up to a maximum of
$8 million; the client has agreed to release 50% of retention along with the last interim
payment upon practical completion of the works, while the remaining 50% is to be released
at the end of the defects liability period, which is set for 6 months;
• the contractor has committed to pay all costs immediately when they are incurred.
CIVL3103 Construction Project Management 4

Cash Flow Forecasting

Illustrative Example 1 (Cont’d)
Please do the following:
1. Calculate the monthly and cumulative cash inflows and outflows, as well as the net cash
flows, for the project period plus the defect liability period.
2. Draw the cash inflow curve, cash outflow curve, and net cash flow curve up to the end of
the defect liability period.
3. Identify the value of the largest negative cash flow and when would this value occur.
CIVL3103 Construction Project Management 5

Cash Flow Forecasting

Illustrative Example 1 – Answer (Part 1)
The calculated inflows and outflows are summarized in the table below. Monetary values in the
table are in $M.
Month 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Contract value of works

0 3 6 10 15 18 16 10 8 8 6
to be completed

Profit margin 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5%

Retention 0 0.3 0.6 1 1.5 1.8 1.6 1 0.2 0 0 -4 0 0 0 0 -4

Cumulative retention 0 0.3 0.9 1.9 3.4 5.2 6.8 7.8 8 8 8 4 4 4 4 4 0

Monthly cash inflow 0 0 2.7 5.4 9 13.5 16.2 14.4 9 7.8 8 10 0 0 0 0 4

Monthly cash outflow 0 2.85 5.7 9.5 14.25 17.1 15.2 9.5 7.6 7.6 5.7 0 0 0 0 0 0

Cumulative cash inflow 0 0 2.7 8.1 17.1 30.6 46.8 61.2 70.2 78 86 96 96 96 96 96 100

Cumulative cash outflow 0 2.85 8.55 18.05 32.3 49.4 64.6 74.1 81.7 89.3 95 95 95 95 95 95 95

Net cash flow

0 -2.85 -8.55 -15.35 -24.2 -32.3 -34 -27.3 -20.5 -19.1 -17 -9 1 1 1 1 1
(just before month end)
Net cash flow
0 -2.85 -5.85 -9.95 -15.2 -18.8 -17.8 -12.9 -11.5 -11.3 -9 1 1 1 1 1 5
(right at month end)
CIVL3103 Construction Project Management 6

Cash Flow Forecasting

Illustrative Example 1 – Answer (Part 1) (Cont’d)
The calculations for the values under Month 4 are provided below.

The calculations for table values (a) to (h) are as follows:

(a) Retention = 15 x 10% = 1.5
(b) Cumulative retention by Month 4 = 1.9 + 1.5 = 3.4
(c) Monthly cash inflow on Month 4 = Interim payment for works
completed on Month 3 – Retention on Month 3 = 10 – 1 = 9
(a)
(d) Monthly cash outflow on Month 4 → which is all the costs to be
incurred in Month 4 → can be determined by using the profit
(b)
margin formula (see Topic 7 Part 2) → cost = contract value of
(c) Month 4 x (100% - profit margin) = 15 x (100% - 5%) = 14.25

(e) Cumulative cash inflow by Month 4 = 8.1 + 9 = 17.1

(d)
(f) Cumulative cash outflow by Month 4 = 18.05 + 14.25 = 32.3
(e) (g) Net cash flow just before end of Month 4 = 8.1 – 32.3 = -24.2

(f) (h) Net cash flow right at end of Month 4 = -24.2 + 9 = -15.2

(g)

(h)
CIVL3103 Construction Project Management 7

Cash Flow Forecasting

Illustrative Example 1 – Answer (Part 1) (Cont’d)
Calculations for some other values in the table are provided below.

(a) 50% of the cumulative retention is

released upon practical completion, ∴
50% of 8 = 4. Value is negative because
retention is being released.

(a) (b) (b) This is the remaining retention that is

being released by the end of DLP.
(c) Monthly cash inflow on Month 11 =
Interim payment for works completed on
(c) Month 10 + Retention money released =
6 + 4 = 10.
CIVL3103 Construction Project Management 8

Cash Flow Forecasting

Illustrative Example 1 – Answer (Part 2 and 3)
The cash flow curves are plotted as follows.
120

100
$89.3M
$81.7M $86M
80 $74.1M $78M
$64.6M $70.2M
60 $61.2M
$49.4M
$46.8M
Cash ($M)

40 $32.3M
$30.6M
20 $18.05M
$8.55M $17.1M
$8.1M
0 Month
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
-20 -$15.35M
-$20.5M
-$24.2M -$27.3M
-40 -$32.3M -$34M

-60
Cumulative Cash Inflow Cumulative Cash Outflow Net Cash Flow

The largest negative cash flow occurs just before the end of Month 6 and is amounted to
$34M.
CIVL3103 Construction Project Management 9

Capital Lock-Up
CIVL3103 Construction Project Management 10

Capital Lock-Up
Capital lock-up occurs when capital is used to finance certain operation or activity, in this case
the project, and cannot be retrieved for the time being, hence it is termed lock-up.
When a contractor experiences negative cash flow, he/she would need to borrow money or use
his/her own’s cash reserve to cover for it. This would represent a lock-up on the contractor’s
capital. Moreover, there will be a cost for the lock-up. For example, if the money under
lock-up is obtained from a bank loan, then there would be interest incurred.

The hatched area bounded by

the cash outflow curve and
cash inflow curve as shown
below represents the lock-up
of capital in a project. This
Cash flow ($)

area is actually the same as

the hatched area bounded by CAPTIM = Hatched area
the net cash flow curve and Time
the time axis.
In the context of construction
finance, this area is called CAPTIM = Hatched area
CAPTIM, which stands for
capital x time.
CIVL3103 Construction Project Management 11

Capital Lock-Up
The interest on the lock-up is given by

Interest = CAPTIM x interest rate

When calculating interest, the interest rate given should be converted to one with period the
same as the time scale used for CAPTIM. For example, if the interest rate is given as 12% per
annum, but CAPTIM is in terms of month, then the interest rate would need to be taken as 1%
per month.
CIVL3103 Construction Project Management 12

Capital Lock-Up
Illustrative Example 2
The table below shows a contractor’s project estimation and intended profit margin for a newly
awarded contract.
Month 1 2 3 4 5 6 7 8 9 10

Contract value of works to be

$2M $3M $4M $8M $9M $9M $8M $5M $4M $2M
completed

Profit margin 6% 6% 6% 6% 6% 6% 6% 10% 10% 10%

Other terms and conditions are:

• no advance payment from the client, and monthly interim payment against certified works will be made by
the client to the contractor at the end of the following month;
• the retention will be withheld at 10% for every monthly interim payment; the client has agreed to release
half of retention along with the last interim payment upon practical completion of the works, while the
remaining half is to be released at the end of the defects liability period, which is set for 6 months;
• the contractor has committed to pay all costs at the end of the month following the month at which
the costs are incurred.
Please do the following:
(1) Construct the inflow, outflow, and net cash flow curves.
(2) Calculate the cost of interest on the locked-up capital for an interest rate of 12% per annum.
CIVL3103 Construction Project Management 13

Capital Lock-Up
Illustrative Example 2 – Answer (Part 1)
The calculated inflows and outflows are summarized in the table below. Monetary values in the
table are in $M.
Month 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Contract value of works

0 2 3 4 8 9 9 8 5 4 2
to be completed

Profit margin 6% 6% 6% 6% 6% 6% 6% 6% 10% 10% 10%

Retention 0 0.2 0.3 0.4 0.8 0.9 0.9 0.8 0.5 0.4 0.2 -2.7 0 0 0 0 -2.7

Cumulative retention 0 0.2 0.5 0.9 1.7 2.6 3.5 4.3 4.8 5.2 5.4 2.7 2.7 2.7 2.7 2.7 0

Monthly cash inflow 0 0 1.8 2.7 3.6 7.2 8.1 8.1 7.2 4.5 3.6 4.5 0 0 0 0 2.7

Monthly cash outflow 0 0 1.88 2.82 3.76 7.52 8.46 8.46 7.52 4.5 3.6 1.8 0 0 0 0 0

Cumulative cash inflow 0 0 1.8 4.5 8.1 15.3 23.4 31.5 38.7 43.2 46.8 51.3 51.3 51.3 51.3 51.3 54

Cumulative cash outflow 0 0 1.88 4.7 8.46 15.98 24.44 32.9 40.42 44.92 48.52 50.32 50.32 50.32 50.32 50.32 50.32

Net cash flow

0 0 0 -0.08 -0.2 -0.36 -0.68 -1.04 -1.4 -1.72 -1.72 -1.72 0.98 0.98 0.98 0.98 0.98
(just before month end)
Net cash flow
0 0 -0.08 -0.2 -0.36 -0.68 -1.04 -1.4 -1.72 -1.72 -1.72 0.98 0.98 0.98 0.98 0.98 3.68
(right at month end)
CIVL3103 Construction Project Management 14

Capital Lock-Up
Illustrative Example 2 – Answer (Part 1) (Cont’d)
The calculations for the values under Month 4 are provided below.

The calculations for table values (a) to (h) are as follows:

(a) Retention = 8 x 10% = 0.8
(b) Cumulative retention by Month 4 = 0.9 + 0.8 = 1.7
(c) Monthly cash inflow on Month 4 = Interim payment for works
completed on Month 3 – Retention on Month 3 = 4 – 0.4 = 3.6
(a) (d) Recall that the contractor has committed to pay all costs at the
end of the month following the month at which the costs are
(b)
incurred. Therefore, the monthly cash outflow on Month 4 is the
cost incurred in Month 3.
(c)
Cost incurred in Month 3 = contract value in Month 3 x (100% -
profit margin) = 4 x (100% - 6%) = 3.76
(d)
(e) Cumulative cash inflow by Month 4 = 4.5 + 3.6 = 8.1
(e)
(f) Cumulative cash outflow by Month 4 = 4.7 + 3.76 = 8.46
(f) (g) Net cash flow just before end of Month 4 = Net cash flow right at
the end of Month 3 = -0.2
(g)
(h) Net cash flow right at end of Month 4 = Cumulative cash inflow
on Month 4 – Cumulative cash outflow on Month 4 = 8.1 – 8.46
(h) = -0.36
CIVL3103 Construction Project Management 15

Capital Lock-Up
Illustrative Example 2 – Answer (Part 1) (Cont’d)
The cash inflow, outflow, and net cash flow curves are plotted in the graph below.
60

$50.32M $50.32M
50 $48.52M
$46.8M
$44.92M
$43.2M
40 $40.42M
Cash flow ($M)

$38.7M
$32.9M $31.5M
30
$24.44M $23.4M
20
$15.98M $15.3M
10 $8.46M $8.1M
$4.7M $4.5M
$1.88M
0 Month
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
-10
Cumulative Cash Inflow Cumulative Cash Outflow Net Cash Flow
CIVL3103 Construction Project Management 16

Capital Lock-Up
Illustrative Example 2 – Answer (Part 2)
To determine the cost of interest on the lock-up, we need to determine CAPTIM first. CAPTIM
is simply the area bounded by the time axis and the negative part of the net cash flow curve.
Therefore, we only need the net cash flow curve for calculating CAPTIM. The cash inflow and
outflow curves have been removed from the graph and only the net cash flow curve is shown in
the graph below.
Net cash flow ($M)

-$0.08M $0.98M
-$0.2M
-$0.36M
Month

-$0.68M
-$1.04M
-$1.4M
-$1.72M

CAPTIM and the cost of interest are calculated as follows.

CAPTIM = hatched area = (0.08M + 0.2M + 0.36M + 0.68M + 1.04M + 1.4M + 1.72M + 1.72M + 1.72M) x 1 =
8.92M
Interest = CAPTIM x interest rate = 8.92M x (12% p.a. / 12) = $0.089M
Therefore, the cost of interest on the capital lock-up is $0.089M
CIVL3103 Construction Project Management 17

End of Topic 7 - Part 2