6: Cashflow Forecasting

6:Cashflow Forecasting

Introduction

A positive cashflow is essential for the financial health and survival of any business and contracting is no exception. In other words, all businesses need to ensure that at all times they have money in the bank; payments into their accounts must be greater than payments out, or payments in must be made before payments out.

The first consideration must be the flow of work into the organisation; in order to maintain a healthy bank balance, a regular and profitable flow of work must be maintained. Ideally there should be a fairly constant level of work without periods of under or over stretching of resources.In order to ensure this, the contractor should have in place systems for the monitoring of work levels and obtaining new work. While some staff are engaged in handling current work, others should be employed in advance setting up of financial systems for work which is imminent and which the contractor has been awarded but which has not yet started.

These points are mentioned to make you aware of the fact that a cashflow forecast for a given project might simply be part of an overall much larger equation such as the preparation of annual budgets as a part of an overall accounting strategy.

Pre-tender Forecasts

As part of the tendering process, the contractor collects information which can be used to produce a basic forecast of their projected cashflow during the project, and which may also be used by the client, if they wish, to indicate their own cashflow requirements for the project.

The information which the contractor may need to have at this stage may include whether or not there are likely to be times when large amounts of money will be needed to finance the expenditure peaks in the project, and what the financial commitments to the project will be in its early stages. This is necessary, given that the initial outlay may not be reimbursed by the client until anything up to six weeks after the commencement on site.

The client may wish to know how much money they will need to find at each stage of the project.

Cashflow calculations for the client

There are two models which can be used to give the client an indication of their likely costs over time. The first assumes all the payments made by the client will be of equal value, each payment being the total value of the project divided by the number of anticipated payments, with a small adjustment for retention. The second method is slightly more accurate and assumes that during the project, money will be spent as follows:

  • In the first third of the total project duration time, one quarter of the total project costs will be spent;
  • In the second third of the total project duration time, one half of the total project costs will be spent;
  • In the third third of the total project duration time, the remaining quarter of the total project costs will be spent.

The second method of calculation can be shown diagrammatically as an S-curve, as illustrated in figure 6.1 below, which is taken from Brook1.

Figure 6.1: Simple ‘S’ Curve for cumulative value calculated at ‘third’ points

Project Cost %

100
75
50
25

0% 33.3% 66.7% 100%

Project Duration

It should be remembered that both techniques discussed above are guides only and, because they are theoretical, they can take no account of differences in individual projects.

When considering the client’s cashflow forecast, it must be remembered there are other issues besides payments to the contractor. A typical UK client’s cashflow expenditure projections might include the following expenditure items:

  • Land purchase costs
  • Local authority fees in respect of planning applications
  • Feasibility and value management advice
  • Design and other professional fees
  • Legal fees for land purchase
  • Finance and interest charges
  • Marketing.

In giving cost and financial advice, the client’s consultant quantity surveyor will need to build some if not all of the foregoing items into the client’s schedule of expenditure for the project. The dates when payments become due are of as much significance for the client as they are for the contractor when considering their own outgoings.

Pre-tender cashflow forecasts for the contractor

The S-curve method used to calculate approximate cashflow requirements for the client, to enable them to schedule their payment liabilities, can also be used to indicate the contractor’s cumulative cost forecast. To achieve this, it will be necessary to deduct the contractor’s profit from the original S-curve values; leaving only the contractor’s estimated costs which can be plotted to produce a new cost curve.

A more accurate forecast of the contractor’s outgoings for a project is based on the calculation of weekly costs. To calculate weekly costs, the estimator’s rates are linked to work activities on the project programme, and the total costs for each work section are divided by the time allowed.

If the client’s payments are based on the ‘S’ curve representing the contractor’s cumulative value, and the contractor’s costs based on the weekly forecast mentioned above are superimposed on the graph, the difference will represent either the contractor’s net income or cash outflow at a given point in time. In building up such a model, the value will have to be adjusted to take account of retention, and the model should take account of the time lapse between the time of certification of an interim payment to the contractor, and the time at which the client honours that certificate.

This is illustrated in figure 6.2 which gives a weekly tabulation of the forecasts of gross value, cumulative income (less retention), cumulative cost commitment, and the resulting positive or negative cashflow.

Figure 6.2: Cashflow forecast related to income and expenditure on given project

Week / Gross Value Forecast / Cumulative Income / Cumulative Costs / Cumulative Forecast / Remarks
Nr / £ / £ / £ / £
1 / 5,000 / 0 / 0 / 0
2 / 25,000 / 0 / 1,000 / -1,000
3 / 50,000 / 0 / 5,000 / -5,000
4 / 80,000 / 0 / 10,000 / -10,000 / Interim Valn 1
5 / 95,000 / 70,000 / 40,000 / 30,000 / Payment £70k
6 / 105,000 / 70,000 / 50,000 / 20,000
7 / 140,000 / 70,000 / 65,000 / 5,000
8 / 150,000 / 70,000 / 75,000 / -5,000 / Interim Valn 2
9 / 175,000 / 140,000 / 90,000 / 50,000 / Payment £70k
10 / 185,000 / 140,000 / 105,000 / 35,000
11 / 200,000 / 140,000 / 135,000 / 5,000
12 / 220,000 / 140,000 / 150,000 / -10,000
13 / 240,000 / 140,000 / 175,000 / -35,000 / Interim Valn 3
14 / 265,000 / 230,000 / 185,000 / 45,000 / Payment £90k
15 / 280,000 / 230,000 / 205,000 / 25,000
16 / 310,000 / 230,000 / 210,000 / 20,000
17 / 345,000 / 230,000 / 230,000 / 0 / Interim Valn 4
18 / 385,000 / 320,000 / 255,000 / 65,000 / Payment £90k
19 / 405,000 / 320,000 / 265,000 / 55,000
20 / 430,000 / 320,000 / 310,000 / 10,000
21 / 450,000 / 320,000 / 315,000 / 5,000
22 / 475,000 / 320,000 / 325,000 / -5,000 / Interim Valn 5
23 / 495,000 / 450,000 / 345,000 / 105,000 / Payment £130k
24 / 510,000 / 450,000 / 350,000 / 100,000
25 / 550,000 / 450,000 / 450,000 / 0
26 / 580,000 / 450,000 / 455,000 / -5,000 / Interim Valn 6
27 / 600,000 / 550,000 / 460,000 / 90,000 / Payment £100k
28 / 630,000 / 550,000 / 465,000 / 85,000
29 / 645,000 / 550,000 / 545,000 / 5,000
30 / 650,000 / 550,000 / 550,000 / 0 / Interim Valn 7
31 / 650,000 / 620,000 / 555,000 / 65,000 / Payment £70k
32 / 650,000 / 620,000 / 560,000 / 60,000
33 / 650,000 / 620,000 / 620,000 / 0
34 / 650,000 / 620,000 / 625,000 / -5,000 / Practical compl
40 / 650,000 / 635,000 / 630,000 / 5,000
52 / 650,000 / 650,000 / 635,000 / 15,000 / Final Payment

NOTES

(1)The difference between the gross value forecast and estimated cumulative costs in theory equals profit;

(2)The difference between the forecast of cumulative income and cumulative costs equals anticipated positive or negative cashflow;

(3)An interval of one week has been allowed from the time of the interim valuation/certificate and client payment;

(4)The contractor anticipates that the full value of the work will be executed by week 30.

(5)Ongoing costs after week 30 will include for making good defects, and outstanding costs of paying material suppliers and sub-contractors; removing temporary works; reinstatement; removal of site establishment including accommodation; staff salaries and redundancy payments, etc.

You should now turn to Appendix ‘K’, and examine an example taken from Ashworth2 illustrating, (in Fig. App. 6.1), a table showing statement of income and expenditure, and (in Fig. App. 6.2) an ‘S’ curve graph depicting the contractor’s predicted value of executed work and expenditure, superimposed with ‘saw-tooth’ lines showing the relationship between expenditure and income.

Interim Valuations

The main source of ongoing income for a contractor is through interim certificates, and so the production of interim valuations is one of the main functions of the contractor’s quantity surveyor. It is their responsibility to ensure that the contractor is paid regularly and in full for work carried out on site.

As previously discussed the provisions in the contract for the issue of interim certificates, and their purpose; you are advised to refer to it in order to refresh your memory on these matters before proceeding with this unit.

It is the responsibility of the architect to issue interim certificates at set periods as defined in the contract, and the maximum length of time which may elapse before payment is made is also determined in the contract.

There is UK legislation dealing specifically with the requirement for the client to make prompt and regular interim payments to the contractor during the course of the works. This includes the requirement to inform the contractor by means of formal notices issued in advance, of any adjustments to be made to the contractor’s anticipated payment.

Within an interim certificate will be included:

  • Preliminaries
  • Measured works
  • Valuation of architect’s instructions
  • Valuation of variations
  • Measurement of provisional items
  • Re-measurement of provisional quantities
  • Adjustments of prime cost sums (PCs), including valuation of nominated subcontractors and suppliers
  • Fluctuations, (i.e. increased costs)
  • Materials; unfixed on the site.

Interim valuations are usually carried out jointly between the contractor’s quantity surveyor and the consultant quantity surveyor so that an agreement is reached between them before a certificate is issued. Certain standard forms of contract within the UK stipulate that it is the quantity surveyor’s responsibility to prepare the interim valuation; other standard forms including those commonly used with civil engineering works place the obligation on the contractor.

The contractor’s quantity surveyor will, if possible, prefer to complete the valuation themselves before seeking agreement from the consultant quantity surveyor, so as to be able to keep control of the format to suit their own requirements. Consultant quantity surveyors are usually happy with this arrangement as it reduces their workload. They will nevertheless seek to satisfy themselves that the contractor’s valuation is fair, and that amounts included in previous valuations in respect of nominated sub-contractors and suppliers have indeed been paid.

Setting a date

Interim valuations are usually carried out monthly, (UK government works contracts sometimes make provision for fortnightly payments). It is therefore sensible for the contractor to review their financial obligations before setting the date of the first interim valuation, so as to take account of regular outgoings such as the payment of salaries and wages, which will form a large part of the contractor’s regular financial commitment. Cashflow will be aided if interim valuations are paid before the regular salary pay date.

A second large component of the contractor’s financial commitments is the payment of materials suppliers. In the UK, suppliers usually expect to be paid within 30 days of the end of the month in which the materials were supplied and invoiced.

It is usual for salaries to be paid at the end of each month, (wages are normally paid weekly), and materials suppliers will also require payment at about the same time each month. It follows that it would be wise to set interim valuation dates so as to allow for payments to reach the contractor’s bank account before these two large items are due to leave that account.

Most contracts require payment of interim certificates to be made no later than fourteen days after their issue by the architect or engineer. It is often advantageous to the contractor, therefore, to set dates for interim valuations early in the month so that payment will reach their bank account before the end of the month, thus being in time to meet the large payments discussed above.

Other factors influencing the date upon which interim valuations are carried out each month may be existing commitments of the contractor’s and client’s quantity surveyors to other projects, and the client’s arrangements for payment of the resulting interim certificates.

It is usual for the contract to stipulate that the first interim certificate should be issued within a month of the commencement of the project; the actual date for the issue of the first certificate, and therefore for the issue of subsequent certificates will be mutually agreed and will take into account the factors discussed above.

Some contracts require an outlay of considerable sums of money before commencement of the project, or in the very early stages of it, e.g. for such items as mobilisation and, in the UK, statutory charges to utilities and local authorities, or consultants’ fees. If these are not to create cashflow problems for the contractor, arrangements must be made for early payments by the client to cover these costs, or the contract must contain special provision for the contractor to pay.

Sometimes a letter of intent issued by the client prior to the formal entry into contractual relations may provide the mechanisms for the contractor to proceed, and for them to receive early payment.

How are they to be produced?

The method by which the interim valuations are to be valued will depend upon the type of project being undertaken, and once again will need to be agreed between the contractor’s quantity surveyor and the client’s.

Stage payments

This method is suitable for projects such as housing, and other schemes where it is convenient to break down the Bills of Quantities into work groups. or into a series of repeated units. These groups or units can be marked or ticked off on a progress schedule as the work is completed, and the number of completed units multiplied by the combined rate for the unit taken from the Bills of Quantities.

In order to achieve such a breakdown it is necessary to gain a clear picture of the sequence of construction work, after which stage descriptions can be written and a progress schedule produced following the order in which work is to be undertaken.

As the stage values will form the basis of interim valuations, it is essential that they are as accurate as possible. The greatest accuracy can be achieved by keeping the stage values low and the number of work groups/unit stages high. This will increase the length of time needed to produce a valuation and therefore the cost of doing so; if there are too many stages, it may even bring into question the validity and cost effectiveness of using this method of valuation.

In order to produce a stage value, all the elements of work in that stage must be taken from the Bill of Quantities and included in the value. When all the stages have been analysed, the totals should be checked against the Bill to ensure that the totals agree and that nothing has been omitted.

On any project it is likely that there will be ‘rogue’ items or items which do not conveniently break down into definable units for stage payments. Examples of such items would include substructures, external works and other works for which there are no firm quantities, and which will be in any event subject to re-measurement. In these circumstances it will be necessary to measure the work as it is executed in much the same way as described below.

Measuring work item by item

For projects involving larger and more complex structures, this is the usual and preferred method of valuation. The consultant or contractor’s quantity surveyor works through the Bills of Quantities, assessing percentage completion against each item; or, where appropriate, a whole page or series of pages of related items.

This method lends itself well to computerised application, but in order to work efficiently notes of site progress must be well documented. Where work items are provisional and subject to re-measurement, the items will be extracted from the Bills and on-going running totals of completed work applied until the works for such items are fully completed and re-measurement for the final account has been agreed.

Where measurements are being applied, as opposed to percentages of measured quantities taken straight from the Bill, it will be necessary to keep records of on-going measurements. With works such as drainage, detailed schedules should be kept, and monthly totals for the completed works abstracted and placed directly into the valuation; complex works such as mechanical and electrical installations, both external and internal can also be measured using a schedule.

Any works involving ground excavation subject to re-measure will require an initial site survey, from which all original starting levels of excavation can be ascertained. It is usual for the contractor to be provided with site survey drawings at the commencement of the project to assist with setting-out the works. The quantity surveyor will use these drawings for record purposes to establish depths of excavation. There may be occasions when the contractor disagrees with the original survey; in such cases, with agreement from the client’s advisors, new survey drawings can be produced.

In all works where the measured amounts of work may change over a series of months, it will be necessary to keep a fully up to date marked up set of drawings and records; you will recall from, that small errors in valuations may have a disastrous effect on either the contractor’s or client’s cashflow requirements, and as a result the ultimate financial outcome for the project!

Figure 6.3 below gives an example of an interim valuation where assessments of measured items have been made, using the Bills of Quantities.

Figure 6.3 Part of a typical page in an interim valuation

BQ ref / Item Description / Value (£)
2/17 a-k / Substructures complete / 125,000.00
3/21 a-c / Concrete frame 34% / 61,350.00
3/29 g-k / External masonry walling 17% / 7,210.55
3/44 d / High performance windows 4 nr @ £509.10 / 2,036.40

Valuations may be prepared using a combination of work units, agreed percentages of completed measured work, and re-measurements of work where the dimensions have been agreed, billed and priced as part of an on-going ‘rolling’ final account. There is no absolute and over-riding method; each aspect of the works must be assessed and valued in the way that best suits it.

Discussion above has dealt with the data providing an infrastructure for the ‘official’ valuation. The means by which the site progress notes are transformed into the definitive valuation vary. The data may be hand-written on site, mutually agreed, and fed into the computer for computation.