Cash flow and profit margins study – Term Paper

3.0 Literature Review

Construction contracts entitle employers to give out variations in the project through omission. This implies that employers will not go through the argument of termination when it can de-scope. De-scoping is an alternative for employers when they cannot put themselves in arguments relating to contract termination. Termination of contracts for convenience or mistake generates disputes for contractor and employer; however, owners avoid this situation by committing parts of the work. Mega projects sustain principals of FIDIC contracts forms, although changes are prone (Katoddrytis & Mitchell, 2015, p.115).

 The balance integers with risk allocation between parties involved. Most of UAE contracts are biased towards the employer. The contracts are similar to those used by Dubai municipality, drafted for use Dubai municipality that was a government entity, and however they found their way into UAE employers. This makes the signing of these contracts a risky situation as they do not conform with FIDIC standards contracts and a party should be aware of low risk allocation in case of adjustments (Sanchez & Roelants, 2011, p.83).

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All the same, construction either contracts standards or otherwise, contains a variation clause. The clause and provision cushions the contractor or the employer as they cannot deviate from the contract as agreed in the scope of works. Absence of variation means that the contractor is not compelled to perform extra work, while the employer cannot omit work agreed on, as this leads to a contract breach. Variation clauses in the construction industry introduce the flexibility needed in the rigid rules governing partys obligations in the contracts. This means that variations are not part of the contract and that parties should perform as per their contract agreement. Changes in the projects must get parties approval and amend the contract in writing. This provision entitles employers to amend project works without tempering with the initial contract (Gorgenlander, 2010,p. 175).

Cash issue in the construction industry are common and complicated, while drafting contracts contractors clearly state the expected cash flow throughout the projects life. Cash shortages lead to business bankruptcy and project failure. Other research works on cash flow in the context of business failure, project delay and forecasting, are numerous, however, the patterns and trends in negative cash flow when it comes to projects receive minimal attention despite the duration, amount and distribution of negative cash flows that are critical for the survival of the construction industry (Bricault, 2011).

The study looks into cash flow and profit margins by, minimizing negative cash flows in mega projects to ensure timely completion as it uses alternatives such as rescheduling activities based on the availability of cash. A genetic algorithm technique, utilized to devise finance schedules that minimize negative cash flow and reduction in profit maximization by timing and gauging outflow or inflow periodically. By minimizing negative flow, a smooth environment reduces pressure by assigning duties and shifting financial pressure of projected duration leading to a greater profit margin (Roy & Ong, 2011, p.101). 

Since a contractor submits the estimates of progress payments in the entire projects, this enables the employer to have clear understanding of their cash requirements. As the project progresses the contractor monitors inflow and outflow of cash while keeping updates of their cash flow profile. Although two different issues, profitability and cash flow are interactive. This enables the contractor to investigate any possible source of finance that can run the project; there are usually other sources of finance other than a companys investment. Financial institutions and banks require that contractors estimate needed to fund the project and timing of cash flow in the entire duration (Madura, 2011, p.88). Once they have the source of financing they manage the cash by balancing inflow and outflow while minimizing the interest on borrowings.

 The importance of project financing is important since most projects face cash flow problems that translate to delay or termination of projects, Contractors risk losing their profit margins. However, scheduling and financial factors aid contractors in assessing overall project performance while minimizing loses. Cash flow is an important component in project management and financial influences such as payment conditions and credit limit play a major role in the attainment of project completion schedule. Cash flow is an important financial model that is crucial in predicting demand for money to meet project cost and income pattern it will generate (Brunns 2011).

The use of cash flow techniques is important in the construction process, if the contractors doubt the sufficiency of the funds in covering deficits in the ongoing project. According to constructional literature, cash flow is either cash received or net disbursement, the former is cash in while the latter is cash out taking place is in interest period. A positive cash flow is an indication of net receipt in a particular period, whereas a negative cash flow will indicate a net disbursement in the period. A second look on cash flow is the transfer on moneys into or out of the company. Money flowing into the company is regarded positive and is credited as cash received while paid outs are a negative flow and is debited. The difference from negative and positive cash flows is a net cash flow. To lessen the time taken to complete a project, the critical path program/method and review technique (CPM/PERT) is accepted and widely employed in the construction industry (Cleland 2010).

Some optimal, heuristic and suboptimal methods that aim at modifying CPM/PERT, however, none considers the availability of cash as a variable when it comes to balancing project expenditure. A proposal of using integer programming in finance-based scheduling to devising CPM/PERT, this allows projects to get financing at certain credit limits. Another methodology to maximize profit is the use of genetic algorithms in devising finance-based schedules. When it comes to multiple projects, constraint programming is a better approach to finance scheduling. Although, there are many proposals researchers have not agreed on the suitable mode in construction projects (Madura, 2011, p.98).

The profit margins that contractors get, is dependent on project managers, performance estimators and their clients. The best approach that contractors can apply in maximizing the profit margins is by either using completed project profits analysis (CPPA) or moving out of price based environment. CPPA approach is better in pursuit of maximizing profits for contractors rather than improving workers performance. It is important for contractors to employ competent staff that will endeavor to maximize their profits. However, work in progress reports are not very effective in identifying performance of contractors in maximizing their profit margins compared to CPPA (Gorgenlander 2010).

To ensure that the construction industry in UAE remains competent; there is need for continuous research that will enable organizations to grow (Turner, 2004, p, 232). UAE in general demands knowledgeable specialist in their construction industry. The demand became evident at the start of 2008-2009 financial crises. The international Energy Agency (IEA) was mandated to produce a report that assesses oil Supply and its disruption in 2010. IEA provided valuable information about the energy sector. Their findings proved that consumption by buildings, governmental and residential amounted to 40%. This led to governments coming up with strategies aimed at reducing energy consumption. Generally, construction wastes make up to 10-30% of landfill sites globally (Gorgenlander 2011).

Clients in the construction industry are demanding and they need value for their money this makes contractors to meet their demands despite factor that interfere with profit margins in UAE construction industry. (Turner, 1995, p. 302). According to Berliner (2000), three important key components in the construction industry are schedule, scope, and project parties. The tree needs to cooperate effectively in order to achieve objectives and successfully complete their projects. It is essential to have high levels of knowledge and expertise when managing mega projects in UAE, to ensure satisfaction by all stakeholders.

 As Wagner (2000) emphasis on clients adopting strategic and efficient management when dealing with other parties in their projects; Proper management of all entities that define the construction industry in UAE will minimize disputes delays and losses it will also mitigate possible claims. All stakeholder need to work in unison and come up with policies that will sustain the project. Profit margins though variable can be stabilized when all factors that affect projects execution are considered.

The construction industry is different from other industries. The organization and execution of projects is different as peculiar factors such as political contractual economic and the physical environment affect most inputs. Materials are priced before purchase, competition while bidding, preliminary expenses are high. A common problem is the unreliable cash flows. Other factors are related to seasonality in UAE region as it affects person-hours, fluctuating cost of living government policies and changing client preference (Information resources management association, 2016).

According to Smith (2007), it is paramount to exercise transparency and sharing of information that is crucial in implementing a project. The relationship with stakeholders affects profit projections performance and competitive advantage by a company. The financial position of a company is important in building client confident on successful completion of the project. This eliminates disputes that are bound to arise while the project is ongoing. Thaw win win relationship for contractors in UAE construction industry is an important aspect in maintaining projected margins and development of long-term sustainable relationship. According to Clarke (2008), poor relations lead to disputes that affect project completion duration. The levels of performance rely on policies, relations, and management of all entities that relate to effective project performance.