19 Cost and Financial Management

Introduction

Throughout the project, the team must always manage the costs and project finances. Cost Management has been defined by Gartner (2022) as ‘the process of planning and controlling the costs associated with running a business’.

We have already covered the first part of Cost Management, which is to develop an estimate for the cost of work to be performed.

Cost Budgeting

Once an organization has developed a cost estimate, that estimate must then be converted into a budget that will be used to monitor the progress of the work versus the costs expended.  While an original unit price cost estimate can be quite detailed, identifying every element of work to be performed when constructing the project, the budget needs to be organized under a work breakdown structure that allows for the management staff to receive feedback regarding progress toward the budgeted quantities.  This typically requires that several estimated items be grouped into a single budget category.

Cash Flow Management

Project finances are managed at a project level.  Therefore, the cash flow of a project, from one organization’s perspective, is equal to the amount of funds received from the project (income) minus the amount of funds spent on project-related expenditures (expenses).

Project Cash Flow = Income – Expenses

If the Project Cash Flow is more than zero, then the company has a ‘positive’ cashflow on the project.  If the Project Cashflow is less than zero, then they have a ‘negative’ cashflow.  If a company has a negative cashflow, then they are either using their company reserves to support the expenditures on the project, or they need to borrow funds to cover the project expenditures.  Therefore, with all things equal, an organization should seek to maximize its cash flow on any given project within the constraints of the contractual agreements so that it can maintain a higher level of funds within its own accounts.  If they have negative cashflows on a number of projects, they will likely need to borrow funds for operating expenses, which then requires them to pay interest on the loans. 

All organizations within a project are aiming to manage their cashflow at the same time.  For example, the owner will need to pay funds to the designers and contractors.  Frequently, the owner is borrowing the funds for the project, and therefore they need to know when they require the funds to pay for the work as it progresses.  An owner will typically seek a cashflow projection from the contractor on a project so that they can plan for future expenditures. 

Each contractor will also be managing their cashflow, including the general contractor/construction manager along with their trade/subcontractors.  It is common practice to contractually arrange that subcontractors do not receive payment for their work activities until the general or prime contractor receives their payment.

Typical ‘S Curve’ Project Cash Flow

Cash flow on a typical project will typically align with a common pattern, although not always.  Typically, the project will begin with a slower pace of spending funds, e.g., some mobilization costs to set up the site office and fence and early demo or excavation.  Then, the expenditure will accelerate to include more people, equipment and materials to build the substructure and superstructure and work on the early stages of the finishes.  Toward the end of a project, the cost of work put in place will be reduced, performing work such as finishes and punchlist items.  This cashflow is represented in a typical S Curve regarding cash flow which illustrates the lower expenditures at the beginning and end of a project, and the high rate of cash flow during the core portion of the project.  When represented in a diagram of cost (y axis) and time (x axis), this is shown as an S Curve.

The Payment Process

On a typical general building project using common industry contracts, such as the AIA contract documents, the contractor will be paid on a monthly basis.  In this section, we will review the typical payment process using the AIA contract documents in order to gain an understanding of the process along with the impact that this process has on an organization’s cash flow.

Within the AIA document series, the template AIA

Video 1: Completing a Payment Application with the AIA G703 Application and Certification for Payment

Video 2: Completing the Continuation Sheet for the AIA G703 Application for Payment

Retainage

Common Errors in Payment Applications

1. Late Submission:  If you submit your application late, either as a prime contractor or subcontractor, your payment may be delayed.
2. Overbilling:  Never attempt to overbill for work that is not complete or materials that are not allowed to be included in the application for payment.  Do not ‘front end load’ the payment application.  Overbilling can cause a payment application to be rejected or delay payment due to having to revise the application.
3. Forgetting Supporting Documents:  Make sure that you check the contract to identify all required documents and submit all required documents and backup so that the owner, and for a subcontractor, the general contractor, can easily evaluate the application.
4. Calculation Errors:  Make sure that you double-, and triple-check your math on the payment applications.  Using software can help ensure that you do not make errors on the payment application.
5. Billing for Unapproved Change Orders:  The contractor is not due money for change orders that are not fully executed.  This means that the change order is documented as a formal, signed change order by all parties to the contract, e.g., the owner and contractor.