The critical path method has a significant role to play in managing resources on construction projects by relating time and money. Different combinations of construction methods, equipment, crew sizes, and working hours are performed in any construction project. The key factors dominating the selection of the best combination may be cost and time or both (Anthill and Woodhead 3). These relate to the contractor’s cash flow, and the cash flow analysis, the relationship between activity times and their respective costs.
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Cash flow problems exist when a construction firm does not have sufficient funds to meet current financial obligations. It is possible for a profitable construction undertaking to generate insufficient funds for current expenditure leading to the failure. To avoid this predicament, there is a thorough investigation which focuses on the flow of money, called a cash flow analysis. It entails separate analyses of expenditure in the course of construction and the expected revenue. A positive cash flow indicates that the cumulative revenues are greater than the cumulative expenditure outlay. This extra cash can be suitably invested in a short-term project to generate revenue. A negative cash flow indicates that the money spent exceeds the money received. In this situation, the firm needs to take steps to obtain supplementary funds from within the firm or lending institutions.
Contractor’s operations are often more complicated than they look in terms of financial operations. From the processes of cost determination, bid submittal and award of contract, the contractor will have an estimate of the profit to be realized. In an ideal situation, the profit realized on completion of the works will be equivalent to the estimate, but this is rarely the case due to the effect of time on the value of money. This effect is due to the effects of inflation and the delay in the actual receipts of all payments. Since contractors are only paid for completed work, there is often a considerable delay in receipt of payments after construction costs are paid. Interest rates also affect profitability and cash flow, even with inflation being exceptionally low. Therefore, it is material for a contractor to determine the interest rate to use for cash required to cover negative cash flow. These interest rates may vary depending on the source of funds. They should indicate the cost of borrowing money, or the value of opportunities forgone for the use of a firm’s internal funds. The timing of cash disbursements and receipts on a project will impact the cash surpluses or deficits in the course of a project. Funds for various functions, which include labor, equipment, materials and subcontractors are disbursed. The timing of labor disbursements is crucial to cash flow, and as such is to a large extent regulated by law. Disbursements for equipment are often monthly unless the leases are for shorter periods and they do not change much depending on equipment ownership (Hinze 166). Materials suppliers are commonly paid a month after delivery. Subcontractors also typically request payment for services rendered on a monthly basis. The contractor should have a clear appreciation of all expenditure to be incurred and the timing of payments (Hinze 167). There, however, are some contractual obligations that will affect the cash flow on a project. Some of the items to be considered include the payment schedule, the retainage, materials, mobilization, monthly payment and final payments. There are also some policies of the project owner which will have an effect on the cash flow. The contractor can only know of these from experience or trade talk and should obtain information on how the owner uses his discretion (Hinze 168).
In the cash flow analysis, there is a thorough examination of the disbursement of funds and the receipt of payments. This will also inform the determination of the markup to be applied to a project. The flow of funds, both revenues and disbursements, is plotted against project time, with cumulative funds on the ordinate and the abscissa with project time. This plot assumes an upward curving S shape and the relationship of the disbursements to the receipts will indicate whether the cash flow is positive or negative (Hinze 171). Studying this output will enable the contractor to track the use of resources, hence determine the distribution of costs and income over time and come up with the best overall plan of operation.
Anthill, James and Ronald Woodhead. Critical path methods in construction practice. New Jersey: Wiley-IEEE, 1990. Print.
Hinze, James. Construction Planning and Scheduling. New Jersey: Pearson/Prentice Hall, 2004. Print.