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Financial Management in Construction Contracting
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Table of Contents

About the Authors xvii Preface xviii 1 Finance in the construction industry 1 1.1 Introduction 1 1.2 The purpose of this book 2 1.3 Construction contracting 3 1.4 Work in progress 3 1.5 Reporting 4 1.6 Structure of the book 5 1.7 The construction industry 6 1.7.1 Industry reports 6 1.7.2 Industry reform: origins and responses 7 1.7.3 Housing Grants, Construction and Regeneration Act 1996 9 1.8 Industry output 12 1.9 Industry clients 15 1.9.1 Clients for small buildings 16 1.9.2 Major clients developing for their own occupation 16 1.9.3 Property developers 17 1.9.4 Private house buyers 17 1.10 Structure of the industry 17 1.10.1 Size and distribution of firms 17 1.10.2 Risk culture 19 1.10.3 Specialist contractors 20 1.10.4 Payment processes 21 References 22 2 Stakeholders and the regulatory environment 23 2.1 Accounting 24 2.1.1 Accounting reference period 24 2.1.2 Accounting reference date 24 2.1.3 Statutory compliance 24 2.1.4 Annual accounts 25 2.1.5 Audit procedures 26 2.2 The Companies Acts 26 2.3 Accounting standards 26 2.4 UK accounting standards 27 2.4.1 SSAP9 27 2.5 International accounting standards 28 2.6 Financial reporting 28 2.7 Financial reports 29 2.7.1 Management reports 30 2.7.2 Lenders and banking covenants 31 2.7.3 HMRC reports 33 2.7.4 VAT returns 33 2.7.5 Companies House 35 2.8 Annual accounts 35 2.8.1 Operating statement 36 2.8.2 Directors? report 36 2.8.3 Profit and loss account 37 2.8.4 Balance sheet 37 2.8.5 Movement of funds statement 39 2.8.6 Auditors? report 39 2.8.7 Notes to the accounts 41 2.8.8 Group accounts 41 References 41 3 Risk and uncertainty 42 3.1 Definitions 43 3.2 Risk and reward 45 3.2.1 Risk 46 3.2.2 Reward 47 3.3 Corporate governance 48 3.3.1 Definition 48 3.3.2 The Cadbury Report 48 3.3.3 The Financial Reporting Council 48 3.3.4 The Companies Acts 48 3.3.5 The Turnbull Report 49 3.4 Market risk 49 3.4.1 Definition 49 3.4.2 Market risk factors 49 3.4.3 Governance 50 3.5 Working capital 50 3.5.1 Sources of working capital 50 3.5.2 The annual accounts 51 3.5.3 Loan capital 51 3.5.4 Risk capital 54 3.5.5 Overdrafts 55 3.5.6 Trade credit 55 3.5.7 PAYE, NIC and VAT 55 3.5.8 Capital gearing 56 3.5.9 Working capital ratios 56 3.5.10 Liquidity 57 3.5.11 Cash flow 57 3.6 Competition 58 3.6.1 Definition 58 3.6.2 Procurement 58 3.6.3 Subcontractors 58 3.7 Profitability 59 3.7.1 Definitions 59 3.7.2 Income gearing 59 3.8 Work in progress 60 3.8.1 Payment in arrears 61 3.8.2 Valuations and payments 62 3.9 Insolvency risk 62 3.9.1 Industry structure 63 3.9.2 Sole traders 63 3.9.3 Limited liability 63 3.9.4 Large firms 64 3.10 Instability 64 3.10.1 Living with instability 65 3.10.2 Indicators of instability 66 3.10.3 Multiple discriminant analysis 66 3.11 Credit control 67 3.11.1 Debtor days 68 3.11.2 Creditor days 68 References 68 4 Contracts and documentation 70 4.1 Types of contract 70 4.1.1 Form of tender 71 4.1.2 Lump sum contracts 71 4.1.3 Measure and value contracts 73 4.1.4 Cost reimbursement contracts 73 4.2 Financial implications of contracts 75 4.2.1 Lump sum contracts 75 4.2.2 Measure and value contracts 76 4.2.3 Cost reimbursement contracts 77 4.3 Project documentation 78 4.3.1 Definitions 78 4.3.2 Priority of documents 79 4.3.3 Drawings 79 4.3.4 Specification 80 4.3.5 Bills of quantities 82 4.3.6 Schedule of rates 84 4.3.7 Schedule of works 85 References 86 5 Payments in construction 88 5.1 Industry credit system 89 5.1.1 Labour and wages 89 5.1.2 Materials 90 5.1.3 Subcontractors 90 5.1.4 Plant hire 91 5.1.5 Credit terms 91 5.1.6 Discounts 92 5.2 Payment problems 93 5.2.1 Trust and money 94 5.2.2 The Construction Act 1996 95 5.2.3 The Construction Act ? scope and application 95 5.3 The scheme for construction contracts 96 5.4 Payment under the Construction Act 96 5.4.1 Payment period 96 5.4.2 Periodic payments 97 5.5 Payment notification under the Construction Act 97 5.5.1 Contractual provisions 97 5.5.2 Payment notice 98 5.5.3 Default payment notice 98 5.5.4 Withholding (or pay-less) notice 98 5.6 Conditional payments 99 5.6.1 Pay-when-paid 99 5.6.2 Pay-when-certified 100 5.6.3 Pay-when-notified 100 5.7 Late payments 100 5.7.1 Legislation 100 5.7.2 Interest 101 5.8 Suspension of performance 101 5.9 Adjudication 102 5.10 Value Added Tax 103 5.10.1 VAT in construction 103 5.10.2 How VAT works 103 References 104 6 Managing the supply chain 105 6.1 Supply chain management 106 6.1.1 Definitions 106 6.1.2 Integrated supply chains 106 6.1.3 Managing cost and profit 107 6.1.4 Practical applications 107 6.1.5 Context 108 6.2 Subcontractors 108 6.2.1 The growth of subcontracting 108 6.2.2 Types of subcontractors 109 6.2.3 Construction Industry Scheme 110 6.2.4 Trade and other references 111 6.2.5 Bonds 111 6.3 Subcontract tenders 112 6.3.1 The decision to sublet 112 6.3.2 Tender enquiries/send outs 112 6.3.3 Scoping of work packages 113 6.3.4 Subcontractor selection 114 6.3.5 Pre-subcontract stage 114 6.4 Subcontract stage 115 6.4.1 Placing the subcontract 115 6.4.2 ?Battle of the forms? 116 6.4.3 The discount ?spiral? 116 6.4.4 Partnering 117 6.5 Payment 118 6.5.1 Terms of payment 118 6.5.2 Retention and defects correction 118 6.5.3 Valuations and applications for payment 119 6.5.4 Liabilities, claims and accruals 120 References 121 7 Getting work 122 7.1 Business development 122 7.2 Decision to tender 124 7.3 Competitive tendering 129 7.4 Tender lists 130 7.4.1 Open competition 131 7.4.2 Frameworks and approved lists 131 7.4.3 Ad hoc list 132 7.5 E-bidding and reverse auctions 134 7.5.1 Auctions 134 7.5.2 Online and reverse auctions 134 7.5.3 The process 135 7.5.4 Advantages 135 7.5.5 Disadvantages 135 References 135 8 Corporate governance and management 136 8.1 Definitions 137 8.1.1 Corporate Governance 137 8.1.2 Management 137 8.1.3 Directors 137 8.2 The UK Corporate Governance Code 138 8.2.1 Application 138 8.2.2 Principles 139 8.2.3 Other approaches to governance 139 8.2.4 Corporate governance and contracts 140 8.3 Turnover 140 8.3.1 Definition 140 8.3.2 Calculating turnover 140 8.3.3 Work in progress 141 8.3.4 Cost of turnover 142 8.4 Profit 142 8.4.1 Definition 142 8.4.2 Corporate profit 143 8.4.3 Project profit 144 8.4.4 Profit distribution 144 8.5 Long-term contracts 145 8.6 Management accounts 145 8.6.1 Control 145 8.6.2 Cost value reconciliation 146 8.7 Accounting for contracts 147 8.7.1 The role of directors 147 8.7.2 Work in progress 148 8.7.3 Short-term contracts 149 8.7.4 Long-term contracts 149 8.7.5 Worked examples 150 Reference 152 9 Company structure 153 9.1 Management functions 153 9.1.1 Principles 154 9.1.2 Estimating and tendering 155 9.1.3 Purchasing 156 9.1.4 Production 157 9.1.5 Quantity surveying 157 9.1.6 Supply chain management 158 9.1.7 Accounting 159 9.2 Organisation structures 159 9.2.1 Structure 160 9.2.2 SMEs 163 9.2.3 Large firms 163 9.2.4 Very large firms 163 10 Service departments 165 10.1 Estimating and tendering 166 10.1.1 Preparing the estimate 168 10.1.2 Tender enquires 169 10.1.3 Preliminaries 171 10.1.4 Employer?s requirements 172 10.1.5 Contractor?s requirements 172 10.1.6 Measured items 175 10.1.7 Attendances and profit associated with domestic subcontract works 175 10.2 Tender submission 176 10.2.1 Tender margin 176 10.2.2 Design risks 177 10.2.3 Construction risks/opportunities 177 10.2.4 Tender committee 177 10.2.5 Final adjustments 178 10.2.6 Qualification 178 10.2.7 Production of allowance bill 178 10.3 Planning 179 10.4 Buying 179 10.5 Accounting, costs and information 179 10.5.1 Definitions of costs 180 10.5.2 Timing of cost information flows and reporting 181 10.6 Company management accounting systems 181 10.6.1 Company information systems 181 10.6.2 Contract operational ledger 184 10.7 Contract cost reports 190 10.7.1 Principle of cost cut off 190 10.7.2 Direct costs and accruals 190 10.7.3 Cumulative and period reporting 194 10.7.4 Cost provisions 194 10.7.5 Individuals involved 196 10.8 Project audits and site processes 196 References 197 11 Financial management 198 11.1 Budgetary control 198 11.2 Definitions 200 11.2.1 Cost 200 11.2.2 Value 200 11.3 Cash flow 201 11.3.1 Movement of funds 201 11.3.2 Cash flow forecasting 202 11.3.3 Client and contractor 202 11.3.4 Cash flow forecast limitations 203 11.3.5 Simple forecasting models 204 11.3.6 Credit terms 208 11.3.7 Minimum and maximum cash requirements 209 11.3.8 Capital lock up 211 11.3.9 Expediting receipts 211 11.3.10 Delaying payment to suppliers 211 11.3.11 Project cash flow 214 11.3.12 Organisational cash flow 217 11.4 Working capital 218 11.4.1 Current assets 218 11.4.2 Current liabilities 221 11.4.3 Profitability ratio 221 References 221 12 Project governance 222 12.1 Introduction 223 12.2 Procurement methods 224 12.2.1 Traditional 224 12.2.2 Design and build 226 12.2.3 Management contracts 227 12.2.4 ?Pain and gain? systems 228 12.2.5 Partnering 229 12.3 Conditions of contract 229 12.3.1 Payment mechanisms 229 12.3.2 Payment procedures 230 12.3.3 JCT Standard Building Contract with Quantities 2011 (SBC/Q) 231 12.3.4 Infrastructure Conditions of Contract (ICC) ? Measurement Version 231 12.3.5 NEC Engineering and Construction Contract 3rd Edition 232 12.3.6 Other standard forms of contract 232 12.3.7 Conditions of subcontract 232 12.4 Method of measurement 237 12.4.1 Standard methods of measurement 237 12.4.2 Basis of quantities 237 12.4.3 Classification systems 238 12.4.4 SMM rules 239 12.4.5 Waste 239 12.4.6 Working space 241 12.4.7 Temporary works 243 12.5 Bills of quantities 244 12.5.1 The use of bills of quantities 244 12.5.2 Structure and layout 244 12.5.3 Preliminaries 245 12.5.4 Measured work 247 12.5.5 Prime cost sums 250 12.5.6 Provisional sums 251 12.5.7 Daywork 252 12.5.8 Contingencies 253 12.5.9 Final summary 254 12.5.10 Adjustment item 254 References 254 13 Budgets 255 13.1 Developing and monitoring budgets 256 13.2 Types of budget 256 13.2.1 Strategic budgets 256 13.2.2 Turnover budget 256 13.2.3 Overhead budget 257 13.3 Project level budgets 259 13.3.1 Project turnover budgets 259 13.3.2 Project cash budgets 259 13.3.3 Production budgets 260 13.3.4 Procurement budgets 260 13.4 Activity level budgets 262 13.5 De-scoping bills of quantities 263 13.6 Budget development 264 13.6.1 Labour 264 13.6.2 Materials 267 13.6.3 Plant 268 13.6.4 Preliminaries 269 13.7 Variance analysis 270 13.7.1 Productivity assessment: an example 270 13.8 Control procedures 272 13.9 Earned value analysis 272 13.9.1 Definition of EVA 273 13.9.2 The components of EVA 274 13.9.3 EVA in practice 275 13.9.4 Work breakdown structures 276 13.9.5 Establishment of an EVA management system 276 13.9.6 Benchmarking project performance using EVA 277 13.9.7 Predicting performance 277 13.9.8 EVA in action: an example 278 13.9.9 Making predictions based on the derived metrics 281 13.9.10 Benefits of EVMS 282 References 282 14 Resource procurement 284 14.1 Introduction 284 14.2 The resource budget 285 14.3 Resource procurement programme: subcontractors 285 14.4 Tender assessment 286 14.5 Tender negotiation 287 14.6 Buying gains and losses 287 14.7 Newer approaches to subcontract procurement 287 14.7.1 Reverse e-auction 288 14.7.2 Pre-auction stage 288 14.7.3 The auction stage 289 14.7.4 Post-auction stage 289 14.7.5 Live e-auction results 290 14.7.6 Reflections 291 14.8 Materials procurement 291 14.9 Plant procurement 292 14.10 Labour procurement 292 14.11 Labour-only subcontractors 293 15 Project risk and control 294 15.1 Introduction 294 15.2 Tender risk 295 15.2.1 Programme and method 295 15.2.2 Ground conditions 296 15.2.3 Subcontractors 299 15.2.4 Suppliers and materials 300 15.2.5 Commercial opportunity 304 15.3 Contract risk 307 15.3.1 Delay and disruption 307 15.3.2 Delay analysis 308 15.4 Claims 311 15.4.1 Extensions of time 311 15.4.2 Loss and expense 312 15.4.3 Evaluating prolongation expenses 314 15.5 Insolvency risk 315 15.5.1 Risk rating 315 15.5.2 Definitions 315 15.5.3 Legislation 316 15.5.4 Termination of main contracts and subcontracts 317 15.5.5 The effect of termination 317 15.5.6 Subcontractor?s insolvency 318 15.5.7 Employer?s insolvency 323 15.5.8 Contractor?s insolvency 324 References 328 16 Programme and progress 329 16.1 Contractor?s obligations 329 16.2 Programme 330 16.2.1 The tender stage 331 16.2.2 The pre-contract stage 333 16.2.3 The contract or master programme 334 16.2.4 Contractor?s method 337 16.2.5 Shortened programmes 337 16.2.6 The contract stage 338 16.3 Progress 338 16.3.1 Contractor?s obligations 338 16.3.2 The baseline programme 339 16.3.3 Extensions of time 339 16.3.4 Mitigation of loss 343 16.3.5 Measuring progress 343 16.4 S-curves 344 16.4.1 Principles 344 16.4.2 Measuring physical progress 344 16.4.3 Measuring financial progress 345 16.5 Project acceleration 349 References 351 17 Valuations and payments 352 17.1 Valuations and interim certificates 353 17.1.1 The purpose of valuations 353 17.1.2 The timing of valuations 354 17.1.3 The timing of interim certificates 354 17.1.4 The status of interim certificates 355 17.2 Interim payment 355 17.2.1 Contractual provisions 355 17.2.2 Methods of payment 355 17.2.3 Payment notification 356 17.2.4 Retention 356 17.2.5 Alternatives to retention 357 17.3 Principles and procedures 358 17.3.1 Valuation principles 358 17.3.2 Valuation procedures 359 17.3.3 Types of valuation 360 17.4 Valuation techniques 362 17.4.1 Inspection 362 17.4.2 Measurement 362 17.4.3 Ogive curve 363 17.4.4 Gantt chart 363 17.4.5 Adjustment and judgement 363 17.5 Materials on site 364 17.5.1 Valuing materials on site 364 17.5.2 Retention of title 365 17.6 Basic valuation procedure 366 17.7.1 Contract provisions 370 17.7.2 Components of an interim valuation 370 17.8 Preparing the external valuation 371 17.8.1 Measured work 372 17.8.2 Variations 372 17.8.3 Daywork 373 17.8.4 Prime cost sums 375 17.8.5 Provisional sums 377 17.8.6 Preliminaries 377 17.8.7 Progress 378 17.9 Internal valuation 378 17.9.1 Purpose 378 17.9.2 Link to the external valuation 379 17.9.3 Link to the estimate 384 17.10 Subcontract valuation 384 17.11 Final accounts 386 17.11.1 Purpose 386 17.11.2 Timing 387 17.11.3 Preparation 387 17.11.4 The final certificate 389 17.11.5 Contractual significance of final certificate 389 References 389 18 Cost value reconciliation 391 18.1 Introduction 392 18.1.1 Accounting standards 392 18.2 Guiding principles 393 18.2.1 Costs 393 18.2.2 Site cost information 395 18.2.3 Labour 395 18.2.4 Materials 397 18.2.5 Plant costs 398 18.2.6 Subcontract costs 399 18.3 Cost reporting 401 18.3.1 Timing 401 18.3.2 Overheads 403 18.4 Net sales value (NSV) 405 18.4.1 Calculation of net value 406 18.4.2 Calculation of profit 407 18.5 Losses 407 18.5.1 Foreseeable losses 407 18.6 Claims and variations 408 18.7 Valuation: application and internal valuation 409 18.7.1 Adjustments: overmeasure 411 18.7.2 Adjustments: undermeasure 412 18.8 Development of the internal valuation: an example 412 18.9 Reconciliation 414 18.9.1 On-costs in advance 414 18.10 Explaining variances 419 18.11 Summary 421 References 421 Glossary 422 Index 429

About the Author

Andrew Ross is Head of Postgraduate Programmes in the School of the Built Environment, Liverpool John Moores University. He teaches construction project financial management to undergraduate and post graduate students and has successfully supervised many PhD students as well as acting as external examiner to numerous UK and overseas Universities for undergraduate, postgraduate and research degree courses. Peter Williams is a Consultant and Lecturer with extensive practical experience in building, civil engineering and surveying. Formerly a chartered builder, chartered quantity surveyor and principal lecturer, he is now a writer, researcher, lecturer and consultant with particular interests in contracts and finance, delay analysis and health and safety management.

Reviews

Highly recommended Hi guys, thought I would share some thought provoking and agendastimulating reading I have recently come across. The book isentitled Financial Management in ConstructingContracting by Andrew Ross & Peter Williams, but couldeasily have been called The Constructor sAlmanac or Wisdens Construction Guide . If youwant the inside line on construction know how, thisbook covers it all. From an understated promise to explain how the financialposition on construction contracts is reported the bookexpands into every conceivable avenue the authors could explore intheir quest to open up, explain, walk through and map, theprocesses that guide the industry and control the businessoperation of a construction company, from finance to bidding,managing risk to delivery, and every stop in between. If you are a student, the early chapters on finance, accounting,contracts and procurement, will set out the basics of the industryin straightforward language, lots of good worked examples andclearly labelled diagrams. The later chapters address thesubtleties of cash management, budget control, risk and opportunitymanagement, progress monitoring, valuations and cost/valuereconciliations, in far deeper detail and with contemporary worksheets to guide you through and explain the complexities ofreporting cost and value in equal proportion. The authors have extensive practical experience of the industry,both having risen from the shop floor to the lecture theatre, aresuitably qualified to add insight to knowledge and have managed tocapture in many ways the essence of the industry, its conflicts,collaborations, power plays and team working. And if you are of thesocial networking generation there is even a website on which tohone your new found skills. Fully interactive, it provides detailedworksheets and schedules to further explain the lessons containedin the printed version. David Monaghan

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