18 Chapter 18: Cost and Financial Management
Learning Objectives
After reading this chapter, you should be able to:
- Describe the core concepts required to effectively manage the costs and finances on a project.
- Describe the evolution of a construction cost estimate into a cost budget.
- Draw and analyze a cash flow diagram, and understand the impact of the timing of income and expenses on a project.
- Calculate the anticipated monthly payments for a project given expenditure, a project schedule, and contractual terms related to payments.
Introduction
Throughout the project, the team must always manage the costs and project finances. 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 their cash flow on any given project within the constraints of the contractual agreements so that they can maintain a higher level of funds within their 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 contractor receives their payment.
Exercises
