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www.downloadslide.com www.downloadslide.com C ONSTRUCTION A CCOUNTING AND F INANCIAL M ANAGEMENT SECOND EDITION Steven J Peterson, MBA, PE Weber State University Prentice Hall Upper Saddle River, New Jersey Columbus, Ohio www.downloadslide.com Library of Congress Cataloging-in-Publication Data Peterson, Steven J Construction accounting and financial management / Steven J Peterson 2nd ed p cm Includes bibliographical references and index ISBN-13: 978-0-13-501711-1 ISBN-10: 0-13-501711-4 Construction industry—Accounting Construction industry—Finance Managerial accounting I Title HF5686.B7P48 2009 624Ј.0681—dc22 2008019396 Vice President and Executive Publisher: Vernon R Anthony Acquisitions Editor: Eric Krassow Editorial Assistant: Sonya Kottcamp Production Manager: Wanda Rockwell Creative Designer: Jayne Conte Cover Designer: Bruce Kenselaar Cover Image: Getty Images, Inc Director of Marketing: David Gesell Marketing Manager: Derril Trakalo Marketing Coordinator: Alicia Dysert This book was set in 10/12 ITC Mendoza Roman Book by Aptara®, Inc It was printed and bound by Hamilton Printing Company The cover was printed by Phoenix Color Corp Microsoft® Excel is a trademark of the Microsoft Corporation Microsoft product screen shot(s) reprinted with permission from Microsoft Corporation DISCLAIMER: The sample Excel spreadsheets in this book are to provide the reader with examples of how Excel may be used in accounting and finance, and as such, are designed for a limited number of accounting and finance situations Before using the spreadsheets in this book, the reader should understand the limits of the spreadsheet and carefully verify that the spreadsheets (1) are applicable to their situation and (2) produce an acceptable answer The reader assumes all risks from the use and/or performance of these spreadsheets Copyright © 2009, 2005 by Pearson Education, Inc., Upper Saddle River, New Jersey 07458 Pearson Prentice Hall All rights reserved Printed in the United States of America This publication is protected by Copyright and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise For information regarding permission(s), write to: Rights and Permissions Department Pearson Prentice Hall™ is a trademark of Pearson Education, Inc Pearson® is a registered trademark of Pearson plc Prentice Hall® is a registered trademark of Pearson Education, Inc Pearson Education Ltd., London Pearson Education Singapore Pte Ltd Pearson Education Canada, Inc Pearson Education—Japan Pearson Education Australia PTY, Limited Pearson Education North Asia Ltd., Hong Kong Pearson Educación de Mexico, S.A de C.V Pearson Education Malaysia, Pte Ltd Pearson Education Upper Saddle River, New Jersey 10 ISBN-13: 978-0-13-501711-1 ISBN-10: 0-13-501711-4 www.downloadslide.com This book is dedicated to John Peterson, a good friend who encouraged me to study business www.downloadslide.com This page intentionally left blank www.downloadslide.com Preface Several years ago I was asked to teach a course on construction accounting and finance The course was to cover the fundamental principles needed by construction managers to successfully manage the finances of construction companies In preparing to teach this course I found that these principles were scattered among many disciplines, including business management, engineering economics, accounting, estimating, project management, and scheduling After I reviewed the available textbooks, two things were apparent First, the material was often presented in a generic fashion and failed to address how the principles applied to the construction industry For example, in most accounting textbooks only a few pages were devoted to the accounting procedures for long-term contracts, which comprise a bulk of the projects for general construction companies Second, with the topics scattered among many disciplines and textbooks, the topic of how the different components of construction financial management were interrelated and interacted was being ignored Financial management may be defined as the use of a company’s financial resources and encompasses all decisions that affect a company’s financial health Many everyday decisions affect a company’s financial health The difference between a marginally profitable and a very profitable company is good financial management Business schools teach the fundamental principles of financial management; however, because of the many unique characteristics of the construction industry, the usefulness of these financial principles as taught by business schools is limited To be useful, these principles must be adapted specifically to the construction industry For example, in the construction industry equipment is mobile and may be needed for multiple jobs during a single month Traditional accounting methods and financial statements not allow a company to properly manage and account for its equipment This book was written to help construction professionals—both those who are working in the construction industry and those seeking a degree in construction management—learn how the principles of financial management can be adapted to and used in the management of construction companies This book will be most useful for general managers and owners of companies who are responsible for managing the finances of the entire company; however, many of these principles are useful to project managers and superintendents For the project manager or v www.downloadslide.com vi PREFACE superintendent who desires to stand out in a company, there is no better way than to improve the profitability of their project through the principles of sound financial management The book also discusses how owners and general managers can manage construction projects by sound management of their project managers, superintendents, and crew foreperson This book explains common financial principles, demonstrating how these principles may be applied to a construction situation and how these principles affect the financial performance of a company Many of the examples included in this book are based on actual situations encountered by the author This book is organized in five parts: introduction to construction financial management, accounting for financial resources, managing costs and profits, managing cash flows, and making financial decisions The first part—comprising Chapter 1—introduces the reader to construction financial management, explains why construction financial management is different than financial management in other industries, and defines the role of a construction financial manager The second part—comprising Chapters through 6—describes how to account for a company’s financial resources Accounting for these resources is built around a company’s accounting system The third part—comprising Chapters through 11—examines how to manage the costs and profits of a construction company This must be done at the project level as well as at the company level The fourth part—comprising Chapters 12 through 16—looks at how to manage a company’s cash flows and how to evaluate different sources of funding cash needs The fifth part—comprising Chapters 17 and 18—explores ways to quantitatively analyze financial decisions After reading this book, you should have a better understanding of the following: ❑ The basic financial principles that are widely used in the business world and how to modify them so that they work for the construction industry Application of these principles will help you better manage your business ❑ Construction accounting systems, which will help you manage the accounting systems and use accounting information to manage a company ❑ Financial and accounting principles, so that you may interact with accountants and bankers at a professional level To access supplementary materials online, instructors need to request an instructor access code Go to www.pearsonhighered.com/irc, where you can register www.downloadslide.com PREFACE vii for an instructor access code Within 48 hours after registering, you will receive a confirming e-mail, including an instructor access code Once you have received your code, go to the site and log on for full instructions on downloading the materials you wish to use This textbook brings all of the key financial management principles needed by construction managers under one cover, addressing how they are applied in the construction industry and how they interact Many of the examples in this book are based on my fourteen years of experience in construction financial management Join me on a journey of discovery as we discuss the fundamental principles of financial management that are needed to make a construction company a financial success Particular thanks are due to Richard J Gebken (Missouri State University), Ahmad Hadavi (Northwestern University), Kelly Strong (Iowa State University), Syed M Ahmed (Florida International University), Laura Lucas (Indiana University–Purdue University, Indianapolis), Jonathan Shi (Illinois Institute of Technology), and Brent H Weidman (Brigham Young University) for their assistance with the text review Best Wishes, Steven J Peterson, MBA, PE www.downloadslide.com This page intentionally left blank www.downloadslide.com Contents PART I INTRODUCTION TO CONSTRUCTION FINANCIAL MANAGEMENT C HAPTER CONSTRUCTION FINANCIAL MANAGEMENT What Is Financial Management? Why Is Construction Financial Management Different? Project Oriented Decentralized Production Payment Terms Heavy Use of Subcontractors Who Is Responsible for Construction Management? What Does a Financial Manager Do? Accounting for Financial Resources Managing Costs and Profits 10 Managing Cash Flows 11 Choosing among Financial Alternatives 13 Conclusion 13 Problems 13 ix www.downloadslide.com 280 CHAPTER 12 Because the owner does not make a payment during the first month, the first point in time we calculate the benefit is at the end of the first month From Example 12-3 the monthly bill to the owner is $129,600 and the monthly benefit is calculated using Eq (12-4) as follows: Cashn ϭ CashnϪ1 ϩ Billsn Ϫ Receiptn Cash1 ϭ $0 ϩ $129,600 Ϫ $0 ϭ $129,600 At the end of the first month the construction company and its suppliers and subcontractors have provided the project’s owner with $129,600 in funding for the project The next point in time we need to calculate the benefit to the owner is just before receipt of the first payment from the owner, which occurs at the end of the second month The benefit just before the payment has been received is equal to the cash from the previous month plus the cost of the work completed between the end of the previous month and just before receipt of payment from the owner The cost of the work completed between the end of the previous month and just before receipt of payment from the owner is approximately equal to the billing to the owner The benefit is calculated using Eq (12-4) as follows: Cash1¿ ϭ $129,600 ϩ $248,400 Ϫ ϭ $378,000 The benefit for the end of the second month is calculated as follows: Cash2 ϭ $129,600 ϩ $248,400 Ϫ $116,640 ϭ $261,360 The benefits for the third through seventh months are calculated as follows: Cash3¿ ϭ $261,360 ϩ $313,200 Ϫ $0 ϭ $574,560 Cash3 ϭ $261,360 ϩ $313,200 Ϫ $223,560 ϭ $351,000 Cash4¿ ϭ $351,000 ϩ $183,600 Ϫ $0 ϭ $534,600 Cash4 ϭ $351,000 ϩ $183,600 Ϫ $281,880 ϭ $252,720 Cash5¿ ϭ $252,720 ϩ $129,600 Ϫ $0 ϭ $382,320 Cash5 ϭ $252,720 ϩ $129,600 Ϫ $165,240 ϭ $217,080 Cash6¿ ϭ $217,080 ϩ $75,600 Ϫ $0 ϭ $292,680 Cash6 ϭ $217,080 ϩ $75,600 Ϫ $116,640 ϭ $176,040 Cash7¿ ϭ $176,040 ϩ $0 Ϫ $0 ϭ $176,040 Cash7 ϭ $176,040 ϩ $0 Ϫ $176,040 ϭ $0 As expected, when the owner has paid for the project in full, the benefit provided by the construction company and its suppliers and subcontractors is zero The maximum benefit provided by the construction company and its suppliers and subcontractors occurs during the third month and has a value in excess of half of the total cost of the project to the owner In other words, during the third month the construction company and its suppliers and subcontractors are providing over half of the funds needed to construct the project www.downloadslide.com 281 CASH FLOWS FOR CONSTRUCTION PROJECTS Sometimes a project will receive progress payment from the project’s owner at intervals other than monthly For example, a project may receive progress payments at 25, 50, 75, and 100% complete The procedures for calculating the project’s cash needs are the same as for a project that receives monthly payments, with cash flows being calculated at the end of each month and just before each payment is received Let’s look at a specialized cash flow that works for projects with multiple buildings of the same design This type of cash flow often occurs when constructing office condominiums, warehouse complexes, residential condominiums, and residences where the construction contractor gets paid monthly, as is the case for many subcontractors This type of cash flow is estimated by calculating a cash flow for each building type and then combining these cash flow projections with an estimated number of building starts for each month Example 12-6: A construction company is bidding on a contract to build homes for a developer The project consists of two types of homes and is scheduled to begin in June The first payment from the owner will occur in July The expected monthly homes starts are shown in Table 12-5 The cash flow that occurs between the end of the previous month and receipt of payment from the owner along with the cash flow for the entire month is shown in Table 12-6 Determine the monthly cash flows and total cash generated by the project at the end of each month and just before each payment is received from the project’s owner for the remaining months in the year What is the maximum amount of cash invested by the company during the remaining months of the year? TABLE 12-5 by Type Monthly Starts TABLE 12-6 Cash Flow by Type MONTH MONTH June July Aug Sept Oct Nov Dec TYPE TYPE 2 2 2 BEFORE PAYMENT IS RECEIVED (n’) ($) TYPE TYPE Ϫ5,800 Ϫ8,400 Ϫ17,100 Ϫ4,800 Ϫ2,100 Ϫ6,700 Ϫ9,500 Ϫ20,200 Ϫ4,800 Ϫ1,900 END OF MONTH (n) ($) TYPE TYPE Ϫ5,800 Ϫ1,900 7,500 2,300 3,100 10,500 Ϫ6,700 Ϫ2,500 9,700 3,000 3,600 12,800 www.downloadslide.com 282 CHAPTER 12 Solution: As in the past problems, we begin our calculations in the first month—June—and work our way to the last month—December Because the owner does not make a payment in June the first point in time we need to calculate the cash flow is at the end of June The cash flow for June includes only the first month’s cash flows for the June housing starts and is calculated as follows: Cash FlowJune ϭ Type I StartsJune (Type I Cash Flow1 ) ϩ Type II StartsJune (Type II Cash Flow1 ) Cash FlowJune ϭ 1(Ϫ$5,800) ϩ 2(Ϫ$6,700) ϭ Ϫ$19,200 The total cash invested at the end of the month of June is calculated using Eq (12-2) as follows: CashJune ϭ $0 ϩ (Ϫ$19,200) ϭ Ϫ$19,200 The next point in time we calculate the cash flow is just before the payment is received in July The cash flows for July includes the second month’s cash flows (from the end of the previous month to the time the payment is received) for the June housing starts and the first month’s cash flows (from the end of the previous month to the time the payment is received) for the July housing starts This cash flow is calculated as follows: Cash FlowJuly¿ ϭ Type I StartsJune (Type I Cash Flow2¿ ) ϩ Type II StartsJune (Type II Cash Flow2¿ ) ϩ Type I StatsJuly (Type I Cash Flow1¿ ) ϩ Type II StatsJuly (Type II Cash Flow1¿ ) Cash FlowJuly¿ ϭ 1(Ϫ$8,400) ϩ 2(Ϫ$9,500) ϩ 2(Ϫ$5,800) ϩ 1(Ϫ$6,700) Cash FlowJuly¿ ϭ Ϫ45,700 The total cash invested just prior to the July payment is calculated using Eq (12-3) as follows: CashJuly¿ ϭ Ϫ$19,200 ϩ (Ϫ$45,700) ϭ Ϫ$64,900 The next point in time we calculate the cash flow is at the end of July, which is calculated using the end of month cash flows as follows: Cash FlowJuly¿ ϭ Type I StartsJune (Type I Cash Flow2 ) ϩ Type II StartsJune (Type II Cash Flow2 ) ϩ Type I StatsJuly (Type I Cash Flow1 ) ϩ Type II StatsJuly (Type II Cash Flow1 ) Cash FlowJuly¿ ϭ 1(Ϫ$1,900) ϩ 2(Ϫ$2,500) ϩ 2(Ϫ$5,800) ϩ 1(Ϫ$6,700) Cash FlowJuly¿ ϭ Ϫ25,200 The total cash invested at the end of July is calculated using Eq (12-2) as follows: Cash July ϭ Ϫ$19,200 ϩ (Ϫ$25,200) ϭ Ϫ$44,400 www.downloadslide.com CASH FLOWS FOR CONSTRUCTION PROJECTS TABLE 12-7 MONTH June July Aug Sept Oct Nov Dec 283 Monthly Cash Flow and Cash Invested for Example 12-6 MONTHLY CASH FLOW ($) n’ n Ϫ19,200 Ϫ45,700 Ϫ109,700 Ϫ129,800 Ϫ151,900 Ϫ149,200 Ϫ145,300 Ϫ19,200 Ϫ25,200 Ϫ5,300 Ϫ500 27,100 57,500 50,700 CASH GENERATED ($) n’ n Ϫ19,200 Ϫ64,900 Ϫ154,100 Ϫ179,500 Ϫ202,100 Ϫ172,300 Ϫ110,900 Ϫ19,200 Ϫ44,400 Ϫ49,700 Ϫ50,200 Ϫ23,100 34,400 85,100 The monthly cash flows and the cash generated from the project are calculated in the same manner and are shown in Table 12-7 The maximum amount of cash invested occurs in October with a value of $202,100 The cash generated by Example 12-6 is shown in Figure 12-10 Example 12-6 could be solved using a spreadsheet by simply listing all of the houses to be started during the year in the rows and listing the month in the columns For each of the housing starts the monthly cash flows are entered under the month in which the cash flows occur Finally, the monthly cash flows are added up and the total cash invested for each month is calculated This is performed for both the end of the month and just before the payment is received The spreadsheet solution for Example 12-6 is shown in Figure 12-11 FIGURE 12-10 Cash Generated by the Project in Example 12-6 www.downloadslide.com CHAPTER 12 A B C D E F Before Payment Is Received July Aug Sept (8,400) (17,100) (4,800) (9,500) (20,200) (4,800) (9,500) (20,200) (4,800) (5,800) (8,400) (17,100) (5,800) (8,400) (17,100) (6,700) (9,500) (20,200) — (5,800) (8,400) — (6,700) (9,500) — (6,700) (9,500) — (6,700) (9,500) — (5,800) — — (5,800) — — — (5,800) — (6,700) — June (5,800) (6,700) (6,700) (19,200) (19,200) (45,700) (64,900) Starts Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Cash Flow Cash June (5,800) (6,700) (6,700) July (1,900) (2,500) (2,500) (5,800) (5,800) (6,700) Oct Sept Aug July June Dec Nov Oct Sept Aug July June Starts Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Type Cash Flow Cash Nov 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 Dec 284 FIGURE 12-11 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — (19,200) (19,200) — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — (25,200) (44,400) — — — — — — — — — — — (109,700) (154,100) — — — — — — — — — — — (129,800) (179,500) End of Month Aug Sept 7,500 2,300 9,700 3,000 9,700 3,000 (1,900) 7,500 (1,900) 7,500 (2,500) 9,700 (5,800) (1,900) (6,700) (2,500) (6,700) (2,500) (6,700) (2,500) (5,800) — (5,800) — (5,800) — (6,700) — — — — — — — — — — — — — — — — — — — — — — — (5,300) (49,700) (500) (50,200) Spreadsheet Solution to Example 12-6 G H Oct (2,100) (1,900) (1,900) (4,800) (4,800) (4,800) (17,100) (20,200) (20,200) (20,200) (8,400) (8,400) (8,400) (9,500) (5,800) (6,700) (6,700) — — — — — — — — I Nov — — — (2,100) (2,100) (1,900) (4,800) (4,800) (4,800) (4,800) (17,100) (17,100) (17,100) (20,200) (8,400) (9,500) (9,500) (5,800) (5,800) (6,700) (6,700) — — — — (151,900) (202,100) (149,200) (172,300) Oct 3,100 3,600 3,600 2,300 2,300 3,000 7,500 9,700 9,700 9,700 (1,900) (1,900) (1,900) (2,500) (5,800) (6,700) (6,700) Nov 10,500 12,800 12,800 3,100 3,100 3,600 2,300 3,000 3,000 3,000 7,500 7,500 7,500 9,700 (1,900) (2,500) (2,500) (5,800) (5,800) (6,700) (6,700) — — — — — — — — 27,100 (23,100) — — — — 57,500 34,400 Dec — — — — — — (2,100) (1,900) (1,900) (1,900) (4,800) (4,800) (4,800) (4,800) (17,100) (20,200) (20,200) (8,400) (8,400) (9,500) (9,500) (5,800) (5,800) (6,700) (6,700) (145,300) (110,900) Dec — — — 10,500 10,500 12,800 3,100 3,600 3,600 3,600 2,300 2,300 2,300 3,000 7,500 9,700 9,700 (1,900) (1,900) (2,500) (2,500) (5,800) (5,800) (6,700) (6,700) 50,700 85,100 www.downloadslide.com CASH FLOWS FOR CONSTRUCTION PROJECTS 285 CASH FLOW FOR PROJECTS WITH A SINGLE PAYMENT Projects with a single payment differ in three ways from projects where the construction company receives progress payments from the project’s owner First, because there are no progress payments the peak amount of cash required is equal to the cash required at the end of the month for all but the last month when the payment is received Second, retention is not held because there are no progress payments Third, the construction company may also be paying some, if not all, of the soft costs Soft costs include payments for the following: the purchase of the land; engineering and design fees; permitting and other fees charged by government entities; construction interest and loan fees; taxes and insurance; and other costs not typically included in the payments to the construction company Example 12-7: The construction company in Example 12-3 decides to act as the owner on the project The construction company plans to sell the project for $1,350,600 at the end of the seventh month In addition to the construction costs the construction company has the following soft costs: land purchase, $200,000; engineering and design fees, $30,000; building permits, $5,600; government fees, $20,000; and other miscellaneous costs, $15,000 The soft cost will be paid at the end of month zero The construction company pays material suppliers in full on the last day of the month following the month the materials were supplied to the project For example, materials supplied during the first month will be paid for at the end of the second month The subcontractors will be paid on the same schedule as the suppliers; however, the construction company will withhold 10% retention from the subcontractors’ payments, which will be paid to the subcontractors at the end of the seventh month The construction company pays for labor weekly Determine the monthly cash flows and total cash generated by the project at the end of each month and just before the payment is received What is the maximum amount of cash invested by the company during the completion of the project? Solution: As in the other examples we begin at the beginning of the project and work our way to the end of the project, calculating the cash flow and total cash generated as we go Because only one payment is received for the project, which occurs during the seventh month, we need to calculate only the cash flow and total cash generated at the end of the month for the first six months For the seventh month the cash flow and total cash generated will need to be calculated at the point in time just before the project is sold and after the project is sold www.downloadslide.com 286 CHAPTER 12 Because the first costs occur during month zero we begin by calculating the cash flow for month zero The total cash disbursements for the soft costs are as follows: Cash Disbursements0 ϭ $200,000 ϩ $30,000 ϩ $5,600 ϩ $20,000 ϩ $15,000 Cash Disbursements0 ϭ $270,600 The cash flow for month zero is calculated using Eq (12-1) as follows: Cash Flow0 ϭ $0 Ϫ $270,600 ϭ Ϫ$270,600 The total cash generated at the end of month zero is calculated using Eq (12-2) as follows: Cash0 ϭ $0 ϩ (Ϫ$270,600) ϭ Ϫ$270,600 No payments to material suppliers or subcontractors will be made during the first month During the first month the construction company will pay $34,900 for labor The cash flow for the first month is calculated using Eq (12-1) as follows: Cash Flow1 ϭ $0 Ϫ $34,900 ϭ Ϫ$34,900 The total cash generated at the end of the first month is calculated using Eq (12-2) as follows: Cash1 ϭ Ϫ$270,600 ϩ (Ϫ$34,900) ϭ Ϫ$305,500 At the end of the first month the construction company will need to have $305,500 of cash invested in the project During the second month the construction company will pay out $30,400 to material suppliers and $48,900 to cover the cost of the labor The construction company will have to pay for the first month’s subcontractor costs, less the 10% retention The monthly subcontractor payments are as follows: Subcontractor Payments2 ϭ $54,700(0.90) ϭ $49,230 The cash flow for the second month is calculated using Eq (12-1) as follows: Cash Flow2 ϭ $0 Ϫ ($30,400 ϩ $48,900 ϩ $49,230) ϭ Ϫ$128,530 The total cash generated at the end of the second month is calculated using Eq (12-2) as follows: Cash2 ϭ Ϫ$305,500 ϩ (Ϫ$128,530) ϭ Ϫ$434,030 The cash flow and cash generated for the third through the sixth months are calculated in a similar manner and are shown in Table 12-8 The next point in time when we need to perform our calculation is just before the payment is received for the project By this time the construction company has paid no additional costs; therefore, the total cash www.downloadslide.com CASH FLOWS FOR CONSTRUCTION PROJECTS 287 TABLE 12-8 Monthly Cash Flow and Cash Invested for Example 12-7 MONTH 7’ MONTHLY CASH FLOW ($) Ϫ270,600 Ϫ34,900 Ϫ128,530 Ϫ241,820 Ϫ237,260 Ϫ151,520 Ϫ98,500 1,243,130 CASH GENERATED ($) Ϫ270,600 Ϫ305,500 Ϫ434,030 Ϫ675,850 Ϫ913,110 Ϫ1,064,630 Ϫ1,163,130 Ϫ1,163,130 80,000 generated is equal to the total cash generated at the end of the previous month, which is $1,163,130 The payment of $1,350,600 for the project is received at the end of the seventh month At the end of the seventh month the construction company will pay out $15,400 to material suppliers and will pay the subcontractors the retention held during the first six months plus the full amount of the work performed by the subcontractors during the sixth month The retention held during the first six months is as follows: Retention ϭ $0 ϩ $54,700(0.10) ϩ $123,800(0.10) ϩ $136,400(0.10) ϩ $106,800(0.10) ϩ $66,000(0.10) Retention ϭ $48,770 The seventh month’s payment to the subcontractors is as follows: Subcontractor Payments7 ϭ $48,770 ϩ $43,300 ϭ $92,070 The cash flow for the seventh month is calculated using Eq (12-1) as follows: Cash Flow7 ϭ $1,350,600 Ϫ ($15,400 ϩ $92,070) ϭ $1,243,130 The total cash generated at the end of the seventh month is calculated using Eq (12-2) as follows: Cash7 ϭ Ϫ$1,163,130 ϩ $1,243,130 ϭ $80,000 At this point the project is complete The monthly cash flow and the cash generated at the end of each month are shown in Table 12-8 At the completion of the project the cash generated by the project should equal the profit and overhead realized on the project, which equals the profit and overhead markup for this example The cash generated by the project is shown in Figure 12-12 The maximum amount of cash needed by the construction company occurs just before the payment is received For the construction company to complete this project, it would need at least $1,163,600 in cash www.downloadslide.com 288 CHAPTER 12 FIGURE 12-12 Cash Generated by the Project in Example 12-7 From this example we see that the construction company’s needs for cash continue to increase throughout the life of the project with the maximum amount of cash required occurring just before the payment for the project is received, in this case when the project is sold CONCLUSION A construction company needs cash to pay bills and labor costs while it waits to receive revenue from the construction project A lack of cash is a major source of failure for construction companies For construction companies that receive progress payments, the greatest need for cash on an individual project occurs each month just before payment is received from the owner Additionally, the amount of cash tied up in the form of retention increases as the work progresses The cash needs—excluding cash tied up in the form of retention—is greatest when the rate of progress is greatest A construction company can reduce its cash needs by increasing its use of subcontractors, thereby using the subcontractor’s cash; reducing the retention rate; increasing its profit and overhead markup on the project; or decreasing the maximum rate of progress on the project The latter may be accomplished by leveling the work so that it occurs at a more uniform rate or by performing the work over a greater period of time Performing the work over a greater period of time causes other problems, such as increasing overhead costs For the construction company that receives a single payment at the completion of the project, the maximum cash requirement occurs just before the payment is received www.downloadslide.com CASH FLOWS FOR CONSTRUCTION PROJECTS 289 PROBLEMS A construction company is negotiating on a construction project with a sixmonth duration On the last day of each month the construction company may bill the owner for the work completed during the month The owner pays the monthly bills one month after they are received The owner also holds a 5% retention Final payment is expected one month after completion of the project and includes payment of the retention The construction company pays material suppliers in full when it receives payment from the owner The construction company pays subcontractors when it receives payment from the owner but withholds 5% retention from the subcontractor’s payment The construction company pays for labor weekly The projected monthly material, labor, and subcontractor costs as well as the amount the construction company will bill the project’s owner each month are shown in the following table Determine the monthly cash flows and the total cash generated by the project at the end of each month and just before each payment is received from the project’s owner What is the maximum amount of cash invested by the company during the completion of the project? MONTH MATERIALS ($) COSTS LABOR ($) SUB ($) BILL TO OWNER ($) Total 8,800 14,200 21,000 6,800 5,100 4,100 60,000 8,100 11,900 19,800 7,600 7,000 4,100 58,500 13,100 31,400 31,700 28,100 17,900 9,300 131,500 33,000 63,200 79,800 46,800 33,000 19,200 275,000 A construction company is negotiating on a construction project with a sixmonth duration On the last day of each month the construction company may bill the owner for the work completed during the month The owner pays the monthly bills 15 days after they are received The owner also holds a 10% retention Final payment is expected one month after completion of the project and includes payment of the retention The construction company pays material suppliers in full when it receives payment from the owner The construction company pays subcontractors when it receives payment from the owner but withholds 10% from the subcontractor’s payment The construction company pays for labor weekly The projected monthly material, labor, and subcontractor costs follow Determine the monthly cash flows and the total cash generated by the project at the end of www.downloadslide.com 290 CHAPTER 12 each month and just before each payment is received from the project’s owner What is the maximum amount of cash invested by the company during the completion of the project? MONTH MATERIALS ($) COSTS LABOR ($) SUB ($) BILL TO OWNER ($) Total 33,700 54,100 69,600 17,200 14,700 11,600 200,900 25,300 42,400 77,900 17,900 21,900 12,700 198,100 35,600 125,200 93,600 105,700 60,400 35,600 456,100 101,200 237,200 258,000 150,700 103,800 64,100 915,000 A construction company is bidding on a contract to build homes for a developer The project consists of two types of homes and is scheduled to begin in September The expected monthly housing starts, the cash flow that occurs between the end of the previous month and receipt of payment from the owner, and the cash flow for the entire month are shown below Determine the monthly cash flows and total cash generated by the project at the end of each month and just before each payment is received from the project’s owner for the remaining months in the year What is the maximum amount of cash invested by the company during the remaining months of the year? Monthly Starts by Type MONTH Sept Oct Nov Dec MONTH TYPE TYPE 2 BEFORE PAYMENT IS RECEIVED (n’) ($) TYPE TYPE Ϫ5,400 Ϫ8,200 Ϫ15,500 Ϫ4,400 Ϫ2,000 Ϫ6,500 Ϫ8,700 Ϫ19,800 Ϫ4,400 Ϫ1,700 END OF MONTH (n) ($) TYPE TYPE Ϫ5,400 Ϫ1,800 7,300 2,200 3,000 9,500 Ϫ6,500 Ϫ2,400 9,300 2,800 3,400 11,900 www.downloadslide.com CASH FLOWS FOR CONSTRUCTION PROJECTS 291 The housing contract from Problem continues on into the next year, with the last housing start occurring in April, as shown in the following table Determine the monthly cash flows and total cash generated by the project at the end of each month and just before each payment is received from the project’s owner for the remaining months in the year What is the maximum amount of cash invested by the company during this year? Monthly Starts by Type MONTH TYPE TYPE Jan Feb March April 2 The construction company in Problem decides to act as the owner on the project The construction company will be paid $500,000 for the project at the end of the seventh month In addition to the construction costs, the construction company has the following soft costs: land purchase, $150,000; engineering and design fees, $15,000; building permits, $3,000; government fees, $5,000; and other miscellaneous costs, $10,000 The soft costs will be paid at the end of month zero The construction company pays material suppliers in full on the last day of the month following the month the materials were supplied to the project The subcontractors will be paid on the same schedule as the suppliers; however, the construction company will withhold 5% retention from the subcontractors’ payments, which will be paid to the subcontractors at the end of the seventh month The construction company pays for labor weekly Determine the monthly cash flows and total cash generated by the project at the end of each month and just before the payment is received What is the maximum amount of cash invested by the company during the completion of the project? The construction company in Problem decides to act as the owner on the project The construction company plans to sell the project for $1,250,000 at the end of the seventh month In addition to the construction costs the construction company has the following soft costs: land purchase, $250,000; engineering and design fees, $30,000; building permits, $7,000; government fees, $15,000; and other miscellaneous costs, $10,000 The soft costs will be paid at the end of month zero The construction company pays material suppliers in full on the fifteenth day of the month following the month the materials were supplied to the project For example, materials supplied during the first month will be paid for on the fifteenth of the second month The subcontractors will be paid on the same schedule as the suppliers; however, the construction company will withhold 10% retention from the subcontractors’ payments, which will be paid to the subcontractors on the fifteenth day of the seventh month The construction company pays for www.downloadslide.com 292 CHAPTER 12 10 11 12 13 labor weekly Determine the monthly cash flows and total cash generated by the project at the end of each month and just before the payment is received What is the maximum amount of cash invested by the company during the completion of the project? Set up a spreadsheet to solve Problem Set up a spreadsheet to solve Problem Set up a spreadsheet similar to Figure 12-11 to solve Problem Set up a spreadsheet similar to Figure 12-11 to solve Problem Set up a spreadsheet to solve Problem Set up a spreadsheet to solve Problem Determine the monthly cash flows and total cash generated at the end of each month and just before the payment is received for the construction of a house with the following budget and schedule On the last day of each month the construction company may bill the owner for the work completed during the month The owner pays the monthly bills one month after they are received The owner also holds a 10% retention Final payment is expected one month after completion of the project and includes the retention The construction company pays material suppliers in full when it receives payment from the owner The construction company pays subcontractors when it receives payment from the owner but withholds a 10% retention from the subcontractor’s payment The construction company pays weekly for labor Often costs will be paid throughout the month that costs are incurred The projected monthly material, labor, subcontractor, and other costs follow The construction company will add a 10% profit and overhead markup to these costs when billing the owner Solve this problem using a spreadsheet ITEM MAT ($) LABOR ($) SUB ($) OTHER ($) Sanitary Sewer Water Line Excavation Footing and Foundation Sub-rough Plumbing Slab/Floor Rough Carpentary Ext Doors and Windows Rough Plumbing Rough HVAC Rough Electrical Insulation Drywall 0 3,490 1,150 18,560 4,800 0 0 0 0 3,750 600 12,340 1,000 0 0 1,500 1,500 2,500 2,000 0 4,000 3,750 3,000 1,650 4,000 0 0 0 0 0 0 START FINISH 4-Jun 6-Jun 8-Jun 12-Jun 21-Jun 25-Jun 27-Jun 1-Aug 6-Aug 9-Aug 13-Aug 17-Aug 22-Aug 4-Jun 7-Jun 11-Jun 20-Jun 22-Jun 26-Jun 31-Jul 3-Aug 8-Aug 10-Aug 14-Aug 17-Aug 29-Aug (continued) www.downloadslide.com CASH FLOWS FOR CONSTRUCTION PROJECTS ITEM MAT ($) LABOR ($) SUB ($) OTHER ($) Doors and Trim Paint Cabinetry Overhead Door Shower Surround Hardware and Bath Access Ceramic Tile Floor Coverings Finish Plumbing Finish Mechanical Finish Electrical Appliances Blinds Roofing Masonry Siding Rain Gutters Site Concrete Fencing Landscaping Supervision Temporary Utilities Trash Disposal Building Permit Clean Up Total 6,250 0 0 900 0 0 2,300 1,000 0 0 1,365 0 0 0 39,815 1,000 0 0 300 0 0 200 0 0 1,220 0 2,000 0 750 23,160 2,500 6,800 600 1,350 2,500 5,000 2,000 1,250 3,000 0 2,070 2,650 3,870 500 4,500 5,000 0 0 67,490 0 0 0 0 0 0 0 0 0 0 2,100 1,500 1,000 4,600 293 START FINISH 30-Aug 5-Sep 13-Sep 13-Sep 18-Sep 20-Sep 24-Sep 28-Sep 3-Oct 8-Oct 9-Oct 11-Oct 12-Oct 17-Aug 22-Aug 29-Aug 5-Sep 6-Sep 13-Sep 20-Sep 1-Jun 1-Jun 1-Jun 1-Jun 17-Oct 4-Sep 12-Sep 17-Sep 13-Sep 19-Sep 21-Sep 27-Sep 2-Oct 5-Oct 8-Out 10-Oct 11-Oct 12-Oct 21-Aug 28-Aug 4-Sep 5-Sep 12-Sep 19-Sep 26-Sep 18-Oct 18-Oct 18-Oct 1-Jun 18-Oct www.downloadslide.com This page intentionally left blank ... Steven J Construction accounting and financial management / Steven J Peterson 2nd ed p cm Includes bibliographical references and index ISBN -13 : 978-0 -13 -5 017 11- 1 ISBN -10 : 0 -13 -5 017 11- 4 Construction. .. MACRS 10 8 Placing in Service and Disposing of an Asset 10 8 IRS Standard Recovery Periods and Depreciation Methods 10 9 Section 17 9 Deduction 11 8 Depreciation for Nontax Purposes 11 8 Conclusion 12 1... www.downloadslide.com Contents PART I INTRODUCTION TO CONSTRUCTION FINANCIAL MANAGEMENT C HAPTER CONSTRUCTION FINANCIAL MANAGEMENT What Is Financial Management? Why Is Construction Financial Management Different?