Conference Paper 3

1Working Capital Management in Projects Case Study on Indian Construction Companies

Working Capital Management in Projects Case Study on Indian Construction Companies

Dr.Hiren Maniar1

Abstract: Construction is an essential part of any countrys infrastructure and industrial development. The

Indian construction sector is an integral part of the economy and a conduit for a substantial part of

Indias development investment. Forecasting working capital along with cash requirements is

essential for all construction contractors during the tendering stage since cash flow at the beginning

of the project is a major cause of construction companies failure. In the contracting business,

construction firms are generally more concerned with short-term financial strategies than the long-

term ones. Working capital management is the central issue of all short-term financial concerns.

Unfortunately, estimating least working capital (LWC) is not the mainstream practice of the majority of

contractors in India, who find that the present models for estimating LWC are cumbersome and

seldom give an accurate estimate. Therefore estimates of LWC made during the tendering stage

need to be simplified so they can be prepared quickly with least input. It is important for the developer

or owner to select a qualified contractor with competent financial backing. Main purpose of this

research is to establish the relationship among the factors like inflation, labor wages, material cost,

construction equipment & machineries cost, subcontractor charges, and overhead cost that

contributes to LWC requirements and presents a simple model that could be used as a guide to

estimate LWC for construction projects in India. The estimation is based on percentages of variables

of contract value based on the historical data that influence LWC; the LWC obtained is then

expressed in terms of percentage of contract value.

Key Words: Indian Infrastructure, Construction Projects, Least Working Capital, Factors, Contract value

Paper Published at PMI (Project Management Institute) India Research & Academic Conference December 2011 (PMIREC2011) 1 Dr.Hiren Maniar is working as a faculty in finance with L&T Institute of Project Management, Vadodara. He may be contacted at [email protected]


Introduction

Every business needs adequate liquid resources in order to maintain day to day cash flows. It

needs enough cash to by wages and salaries as they fall due and to pay creditors if it is to keep its

workforce and ensure its supplies. Maintaining adequate working capital; is not just important in the

short term. Sufficient liquidity must be maintained in order to ensure the survival of business in the

long term as well. Even a profitable business may fail if it does not have adequate cash flows to

meet its liabilities as they fall a due. Therefore when business make investment decisions they must

not only consider the financial outlay involved with acquiring the new machine or the new building

etc, but must also take account of the additional current assets that are usually involved with any

expansion of activity.

Working Capital Management (WCM) is the management of short term financing requirements of a

firm. This includes maintaining optimum balance of working capital components receivables,

inventory and payables and using the cash efficiently for day-to-day operations. Optimization of

working capital balance means minimizing the working capital requirements and realizing maximum

possible revenues. Efficient WCM increases firms free cash flow, which in turn increases the firms

growth opportunities and return to shareholders. Even though firms traditionally are focused on long

term capital budgeting and capital structure, the recent trend is that many companies across different

industries focus on WCM efficiency.

An understanding of working capital is crucial to understanding and analyzing the financial position of

construction contractors. The sureties base their bonding program to a great extent on the amount

and quality of working capital available to the contractor. Many contractors attempt to benchmark their

key ratios to industry standards without understanding what the ratios or benchmarks mean. The

questions posed when examining this subject are:

Why analyze working capital? What is working capital? How does it compare to current ratios? What are the concerns of the surety and the banker? How much working capital is enough, and how is that determined? Is there such a thing as too much working capital?


Is there a consistent manner of computing working capital? How does a company enhance working capital?

The purpose of this research paper is to provide a basic understanding of the requirement of LWC

(Least working capital) concepts for Indian construction contractors.

Literature Review

Working capital management involves the relationship between a firm's short-term assets and its

short-term liabilities. The goal of working capital management is to ensure that a firm is able to

continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and

upcoming operational expenses. The management of working capital involves managing inventories.

As part of a study of the fortune 500s financial management practices, Gilbert and Reichert (1995)

find that time value of money cash flow analysis is used to select projects in 91 percent of the firms.

Accounts receivable management models are used in 59 percent of these firms, while inventory

management models were used in 60 percent of the companies. Across a limited sample, Weinraub

and Visscher (1998) observe a tendency of construction firms with low levels of current ratios to also

have low levels of current liabilities. Combining accounts receivable and payable into one issue is hill,

Satoris, and Fergusons (1984) finding that payees define date of payment as the date payment is

received, while payers view payment as the postmark date. Additional WCM insight across firms,

industries, and time is needed. Maness and Zietlow (2002, pp. 51, 496) presents two models of value

creation through effective short-term financial management activities.

We can define Least Working Capital (LWC) for a construction project as the minimum cash

requirement for a contractor to complete the construction project within the construction period,

namely the maximum cumulative negative cash flow in the cash flow diagrams (Wilson 1975).

Main aim of this research is to establish the relationships among the factors that contribute to LWC

requirements and to present a simple model that could be used as a guide to estimating LWC for

Infrastructure construction projects in India like roads, bridges, airports, ports etc. Beneficiaries of the

model to be developed are owners or developers involved in the selection of qualified contractors

during the tendering stage. Navon (1996) proposed a relationship between cash flow, cost flow, and


expense flow. The cost flow is the projection of the projects costs as a function of time. In principle, to

compile the cost flow for a project, the costs of each activity have to be distributed over its duration.

Time lag is not taken into consideration when cost flow is prepared. The money could have been paid

before the activity is performed, that is, used as a down payment or for the services given.

Alternatively, the money may be paid later, upon completion of the credit period. In other words, the

time when a resource is used on the site differs from when it is paid for. This difference is called the

time lag and can be positive or negative, depending on the mode of payment.

Kenley and Wilson (1989) developed a model to forecast the net cash flow of construction projects.

The model is found to have an excellent fit for the data for 80% of the projects analyzed and is useful

for the post-examination of a construction projects net cash flows. This model is very flexible and

capable of adapting to a wide degree of inter-project variability.

Kaka (1996) suggested that further variables be added to enhance the flexibility of the cash flow

produced and proposed a model designed to use more than 50 variables to calculate cash flow for

one individual contract. He also listed five disadvantages of the traditional cash flow model, but the

terms of payment being applied in his model do not suit the terms applied in India.

Application of mathematical models for cost/cash flow forecasting has been discussed by Ashworth

(1997). The data needed for cash flow forecasting with these models are the projects duration, total

cost, and some specific data. Most of the mathematical models are developed for cost flow

forecasting only, while cash flow forecasting mathematical models are based on forecasting the cost

flow first and later translating it into cash flow.

Working Capital Management Concepts The working capital meets the short term financial requirements of a business enterprise. It is the

investment required for running day to day business. It is the result of the time lag between the

expenditure for the purchase of raw materials and the collection for the sales of finished products.

The components of working capital are inventories, accounts to be paid to suppliers, and payments to

be received from customers after sales. Financing is needed for receivables and inventories net of

payables. The proportions of these components in the working capital change from time to time


during the trade cycle. The working capital requirements decide the liquidity and profitability of a firm

and hence affect the financing and investing decisions. Lesser requirement of working capital leads to

less need for financing and less cost of capital and hence availability of more cash for shareholders.

However the lesser working capital may lead to lost sales and thus may affect the profitability.

The management of working capital by managing the proportions of the WCM components is

important to the financial health of businesses from all industries. To reduce accounts receivable, a

firm may have strict collections policies and limited sales credits to its customers. This would increase

cash inflow. However the strict collection policies and lesser sales credits would lead to lost sales

thus reducing the profits. Maximizing account payables by having longer credits from the suppliers

also has the chance of getting poor quality materials from supplier that would ultimately affect the

profitability. Minimizing inventory may lead to lost sales by stock-outs. The working capital

management should aim at having balanced; optimal proportions of the WCM components to achieve

maximum profit and cash flow.

Importance of Working Capital Management in the Construction Industry

Traditionally construction business is a low margin business, where the margins can get wiped out

fairly fast if the projects are not executed on time and to requisite quality. Working capital

management is the cornerstone of the construction industry. The working capital requirements flow

from the fact that the contractor has to show considerable progress in project execution before he can

bill his client. And once the bill is raised, the client does get some time before he has to pay up.

Construction contracts are of two types cost plus contract and fixed price contract. In a cost plus

contract, the contractor is reimbursed for permitted costs (permitted as per the construction contract)

plus a percentage of those costs or a fixed fee. These contracts are typically awarded for projects in

which it is very difficult for the owner of the project as well as the contractor to estimate project costs

upfront. This is typically the case for oneoff projects or projects where the scope of work cannot be defined clearly upfront. In a fixed price contract, the contractor agrees to a fixed contract price and

bears the risk of cost over runs. Typically, these projects are awarded by the owner by inviting a few

chosen contractors to bid for constructing the project, after clearly describing the scope of work, the


expected performance of the completed project etc. Usually the owner awards the project for

execution to the contractor who bids the lowest price. Needless to say, considering the higher risks to

the contractor than from fixed price contracts, they yield higher margins if the project is executed

flawlessly.

In a fixed price contract, once the contract is awarded, the contract price becomes sacrosanct and

few escalations are allowed. The contractor agrees to pay liquidated damages to the owner for any

delay in project execution. These damages could be structured as penalty per days delay, with or

without an upper cap on the extent of damages. Damages would also have to be paid should the

delivered project fall short on performance grounds. Even at the bidding stage for a project, the

bidders would have to post bid bonds in the form of bank guarantees in favor of the project owner.

This is to assure the owner that the bidder is serious in his bid. If a contractor is awarded the project,

but tries to back out of entering into a firm contract, the project owner can cash in the bid bond. Once

a project is completed, before the contractor gets his final payment, he has to post a performance

guarantee bond in favor of the owner, which the owner can cash in if the project does not perform to

requisite specifications. As a part of their business, contractors have to factor in bank guarantee

expenses for bid bonds and performance bonds. Liquidated damages and performance bonds create

contingent liabilities for construction contractors.

Contractors typically have more receivables than inventory (as work in progress projects are referred

to in some parts of the world). Basically, the work in progress bit is the revenue the company has

booked in its income statement along with associated costs, but has not billed the client for. The

moment the contractor bills the client, the workinprogress head gets converted into receivables. Because of the way the contractors book revenue on multi-year projects, credit analysts should be

wary when the work in progress head gets large, and possibly bigger than the receivables head. It

could imply that the company is overbooking revenue, which it is in no position to bill on account of

slow execution. Of course, it could be legitimate too if the billing milestones of the contracts

undertaken by the contractor are few and far between, it causes considerable accrual of the work in

progress head in the balance sheet. In that case, the contractor would require considerable amount of

short term debt to fund the big working capital gap. That would cause expending funds for short term

interest payment, which should be fine as long as it is priced into the contract.

The moment a project owner awards a project to a contractor, he pays the contractor a certain

amount as customer advance. This is recognized as a current liability under the head customer


advances. As the contractor starts executing the project and recognizing revenue, he writes down the

customer advance. This can be an excellent source of financing for the contractors at the early stage

of a project.

Construction, like any other business, requires short term working capital for its existence. When you

start a construction project, you will only have a limited amount of money. This money can be the

savings from your previous project or the upfront money given by the client for this project.

Unfortunately, this money may not be enough to complete the project. You will have to incur

overheads to run your business besides paying salaries to the people who work for you. A major

expense for you will be the procurement of raw materials like cement, structured steel and non-

ferrous metal to get on with the work. These materials can cost much more than what you have and

so it is important to have an alternate source of funding. So, what can one do to meet the

intermediate needs of construction projects? The best solution is to predict factors for considering

and determining working capital requirement for construction projects.

Factors requiring consideration while estimating working capital in construction projects

The average credit period expected to be allowed by suppliers. Total costs incurred on material, wages. The length of time for which raw material are to remain in stores before they are issued for

production.

The length of the production cycle (or) work in process. The length of sales cycle during which finished goods are to be kept waiting for sales. The average period of credit allowed to customers The amount of cash required to make advance payment

Factors determining working capital requirements in construction projects

Nature of business Size of business Production policy Manufacturing process Seasonal variations Working capital cycle


Rate of stock turn over Credit policy Business cycles Rate of growth of business Price level changes Earning capacity & dividend policy

Case Study on LWC (Least Working Capital) requirement for Indian Construction Companies Background of Global and Indian Construction Sector Despite the challenges of the current economic climate, the Indian construction industry has

managed to maintain marginally positive results in the port, civil engineering, and airport and

transport infrastructure sectors. Construction is an integral part of countrys infrastructure and

industrial development. The market size of global construction industry is US $ 7.2 trillion and India

accounts for 7% of market size, raking 3rd in the world2.As per Global Construction 2020 report, most

of the growth in world will come from Asia (mainly from China and India) and US in next 10 years.

Global Construction sector likely to reach at US $ 12 trillion by 2020. Please refer below figure for

Global Construction Sector growth.

2Source:Globalconstruction2020report,pleasereferwebsitehttp://www.globalconstruction2020.com/


Figure-1 Global Construction Sector Growth in 2010

Construction sector in India is second largest after agriculture in terms of employment and accounting

11% of total GDP. Infrastructure segments involve construction projects in different sectors like roads,

rails, ports, irrigation, power etc. The construction industry is primarily driven by Government of India

(GOI) investments on core infrastructure projects and creation of urban infrastructure; industrial

capital expenditure (capex) by corporate sector and development activities of real estate/housing

sector. The sector plays a pivotal role in developing the countrys infrastructure, a pre-requisite for

high levels of economic growth and an area of focus for the GOI. Construction sector accounts for

nearly 45% of the total investment in infrastructure and is expected to be the prime beneficiary of the

surge in infrastructure investment in the near to medium term. The importance that the GOI places on

bridging the countrys acute infrastructure deficit is evident from the two fold increase in the planned

outlay for the infrastructure sector in the 12th five year plan. Significant infrastructure investments,

along with revival in industrial Capex (Capital Expenditure) and improvement in real estate scenario,

are likely to catalyse growth for construction companies in India, going forward.

In construction projects, on an average, raw material cost accounts for 30-50% of the total cost major

and subcontracting cost accounts for about 20-40%. Other costs include labor cost, administrative


expenses and other operating expenses. Since these costs are different for projects in different

segments, cost structure of a particular construction company depends upon its order mix. Major raw

materials consumed by construction industry mainly include cement and steel. So any variation in the

prices of these two basic raw materials has a direct impact on cost of the project and in turn margins

of the companies.

Research Methodology

Most of the previous research pertaining to Working Capital Management in construction projects

focused mainly on project cash flow forecasting. In this research, emphasis is given to determine

LWC (Least Working Capital) requirement in Indian construction projects. Among previous research,

the relationship between cash flow, expense flow, and cost flow developed by Navon (1996) is a good

basis for further study of LWC estimation. Furthermore, this relationship can be adapted to the

construction environment in India.

A new model for LWC estimation for Indian construction projects can be developed by integrating the

knowledge ascertained by Stukhart (1982), Kenley and Wilson (1989), and Navon (1996). The

relationship between cash flow, expense flow, and cost flow developed by Navon (1996) is shown as

below

Expense flow = cost flow + time lag ------------------------------------------------------------------------- (1)

According to Kenley and Wilson (1989), the maximum cumulative negative cash flow is known as the

LWC requirement of the construction project for the main contractor to run the construction project

within the construction period, as follows:

LWC = maximum cumulative negative cash flow. Since the income flow is equal to zero before d13,

and then the model can be expressed as

LWC = expense flow unit d1 + overhead until d1 ---------------------------------------------------------- (2)

3d1 is time from beginning of construction until first payment received


Data Collection A detailed study has been conducted with 16 Indian construction companies4 with information of 2

projects from 16 construction companies, so that the total number of projects studied was 32, fulfilling

the minimum requirement of 30 projects for model development using multiple regression analysis

(Enns 1985). Most of the projects for 16 construction companies have been executed from 2005 to

2010 and accordingly factors like costs of subcontractor, overhead, material, equipment, and labor

were considered. Data were obtained through various project data base like database, websites and

other sources. The projects selected from these 16 construction companies are involved in

Infrastructure construction projects located in various parts of India. Responses obtained from this

study then formed the basis of the model being developed. Companies involved in this study are EPC

contractors with a paid-up capital of US $ 0.5 million to US $ 20 million5.

The type of information gathered included basic information about each project, including the contract

value of the project, duration of the construction activities, and working capital requirements for the

project studied. To enhance the validity of the study, information regarding the background of the

project team and their companies was also collected. In the study mostly Infrastructure Projects like

road, bridge, ports and other construction projects have been studied which are at different locations

in India. For the development of the model, terms of payment (time lag) and percentage of cost

elements (CE) such as costs of subcontractor, overhead, material, equipment, and labor were

collected.

Factors used in the Study of LWC requirement for Indian Construction companies

It was found from various studies that, 76% of Indian construction companies did not estimate the

LWC during the tendering stage, but only prepared the cash flow of projects upon request from their

clients. The contractors refused to estimate the LWC because they first assume they will have

sufficient funds to run the project based on their past experience, and second, they are more

concerned with securing the project than with estimating the required working capital for the project.

This study shows that the main factors that influence LWC in Indian Projects are inflation, labor

4 please refer Annexure I for details of 16 Indian Construction Companies 5 As per the paid-up capital data from various companies websites


wages, material cost, construction equipment & machineries cost, the subcontractor charges, and

overhead cost.

Inflation Rate (Infl)

The inflation rate is one of the factors that influence the LWC. The increased inflation rate of

the Indian economy from 5.1% in 2005 to 11.5% in 20106 has increased the burden on local

contractors. Most of the construction material, equipment, and overhead costs have increased

more than 20% according to the 2010 annual financial report. Inflation has influenced the

productivity of construction work because the LWC needs to be increased to meet the

expenses required by the project. Likewise, terms of payment given by suppliers have been

revised during this period to ensure their own smooth cash flow.

Labor Wages (LC)

The term labor is classified into two categories: direct labor and indirect labor. Direct labor is

employed directly by the main contractor, while indirect labor is employed by subcontractors.

Thus, the salaries of direct labor are the contractors responsibility, and this influences the

working capital requirement. This influence is evident in the findings of this study where labor

is one of the main factors that contributed to the LWC requirement. Since labor needs to be

paid at the end of every month, it is an expense that requires immediate cash payment.

Material Cost (MC)

This study ascertained that suppliers terms of payment would affect the total cash requirement

of contractors since the percentage of material cost is very high (more than 50%) when

compared to other cost items. Therefore the impact of material on the working capital

requirement should not be overlooked. Nevertheless, if the credit period given by suppliers is

longer than the duration from the beginning of construction until the first payment is received,

the material cost would not affect the working capital requirement.

6 As per RBI report 2010


Overhead Cost (OC)

Overhead cost includes all the expenses other than direct costs that need to be spent from the

design stage until completion of a project. It is extremely important to ensure the success of a

construction project. In India, contractors are required to pay a certain amount of money for

insurance, bonds, and other preliminary items to fulfill the tender specifications. These

expenditures will require a large amount of working capital before commencement of any

construction activity. Changes to other cost elements during the construction process will affect

the overhead cost. For example, interruption of material delivery, shortage of labor, or

extension of the use of the plant will increase overhead costs such as supervision, storage of

material, and extra administration.

Subcontracting Charge (SC)

A subcontractor plays a vital role in the construction industry, especially in India, where most

construction activities are awarded to different groups of subcontractors. Generally,

participation of subcontractors in construction projects would decrease the working capital

required for the main contractor as most of the cash required to run the initial work has

become the subcontractors responsibility. If the terms and conditions in the subcontract

require the main contractors to pay their subcontractors after payments are received from

clients, the working capital requirement will be reduced. But this will usually decrease the profit

margin of the main contractor.

Construction Equipment & Machineries Cost (EC)

Equipment and machinery used for construction are usually costly and expensive to move. The

cash requirement for equipment will depend on its ownership. Purchased equipment will need

a higher initial cost compared to hired equipment, and hence is among the factors that

influence the LWC requirement.


Research Model used for studying LWC Requirement After identifying the factors that influence LWC requirement in Indian construction projects, the

equation developed earlier can be refined as follows, from Eq. (2):

LWC = + EXP ----------------------------------------------------------------------------------------- (3)

Assuming that the expenditure (EXP) is uniform throughout the contract period (CP), Eq. (3) can be

simplified as Eq. (4):

LWC = [ + EXP ] ----------------------------------------------------------------------------------- (4)

At the beginning of any construction activity, expenses can be a submission of labor cost, equipment

cost, material cost, and subcontractor cost to carry out work before the first payment is received.

Expenses (EXP) = labor cost (LC) + Equipment Cost (EC) + Material Cost (MC) + Subcontractor Cost

(SC) ------------------------------------------------------------------------------------------------------------------- (5)

After combining equations (4) & (5), we get

LWC = [ + + + + ] -------------------------------------- (6)

As cited by Navon (1995), a different time lag for each cost element is important in cash flow

estimation. The same theory applies to LWC estimation. Therefore divergence between d1 and the

time lag of each payment needs to be carefully considered in estimating the cash requirement. Labor

and overhead costs are expenses that need to be paid promptly; hence there is no time lag for these

two costs. However, for equipment, material, and subcontractor costs, certain credit periods are given

to the contractor. These delays will reduce the cash requirement, especially during the initial stage of

construction. By considering these terms of payments, the formula becomes

(LWC) (CP) = d1 [ + ] + ( d1 delay EC) + ( d1 delay MC) + ( d1 delay SC) ---------------------------------------------------------------------- (7)


Both sides of the equation will be multiplied by 100/contract value so that the variables implied by

each element in the equation can be taken as a percentage of the contract value. This is because the

actual cost of each element is not available during the planning stage, and thus the estimated

percentage of these costs makes the estimation of LWC easier.

(LWC) (CP) (100 % Contract sum) = {d1 [ + ] + ( d1 delay EC) + ( d1 delay MC) + ( d1 delay SC) } (100 % Contract sum) ------------------------------------------ (8)

After the equation has been simplified from Eq. (8) the LWC is expressed in terms of percentage of

the contract value. The inflation rate is added into the equation because it is an important variable

that influences LWC requirement in India, especially for the projects studied, which are Infrastructure

construction projects where the contractors are not compensated for inflation. The inflation rate is

considered in this equation as the predicted average percentage of inflation rate during the

construction period.

(LWC) (CP) = d1 [ + ] + ( d1 delay EC) + ( d1 delay MC) + ( d1 delay SC) + inflation rate ---------------------------------------------------- (9)

All the cost variables from the 32 projects studied were analyzed by using multiple regression

analysis via SPSS7. The multiple regression analysis is one of the most widely used statistical

methods for analyzing multifactor data and provides a way of empirically identifying how a variable is

affected by other variables. It is also employed for making predictions and judging the strength of

relationships. The lc, oc, ec, and mc are presented in terms of percentage of the contract value; for

example, if the overhead cost of a project is 8% of the contract value, it would be punched in as 8 into

the software program, so that d1 and delay are the time period presented in the scale of weeks, and

C1 is a constant value without units. When variables are analyzed by using multiple regression

analysis, additional parameters k and C1 would be introduced; kx represents the magnitude of change

on the lwc with an increase of one unit magnitude on variable x, and C1 is the constant value that

represents the lwc intercept (y-axis) when all the variables are zero (Alreck and Settle 1985).

7 SPSS (Statistical Package for the Social Sciences) software version 10.0


(lwc) (CP) = d1( klc + koc ) + kec ( d1 delay ec) + kmc ( d1 delay mc) + ksc ( d1 delay sc) + kinf inflation rate + c1 ---------------------------------------------------------------------- (10)

The output of the multiple regression analysis shows that the F ratio (The F-ratio is used to determine

whether the variances in two independent variables are equal) of the equation is 2,079.1678, with a significant value less than 0.05 and R2 = 0.998. This shows that the independent variables

(subcontractor, material, inflation, equipment, labor, and overhead) can be confidently used in

estimating the variation in the dependent variable (lwc). Taking into consideration the coefficient of

each variable9 , the equation is rewritten as follows:

(lmc) (CP) = d1( 0.7196 + 0.6776 ) + 0.6636 ( d1 delay ec) + 0.8086 ( d1 delay mc) + 0.8784 ( d1 delay sc) + 0.7796 inflation rate + c1 ------------------------------------------------ (11)

Note: 1. When delay > d1, (d1 - delay) = 0; and

2. C is ignored because it is not significant with P value > 0.05.

The equation developed above will only be applicable if the following assumptions are made:

1. Proportions of all expenditure are uniform throughout the contract period;

2. The coefficients in the developed equation can only be applied to Infrastructure projects in

India for projects in other places, coefficients shall be developed using data collected from

projects with a similar background; and

3. In most of the cases, the cost of each variable would be unknown during the tendering stage,

so these costs will be provided in terms of percentages of the contract value. The LWC

obtained from the equation is a percentage of the contract value. 8 This has been found out from F- ratio table, considering number of variables for this research are 6 and number of projects taken for the study is 32, source: http://www.danielsoper.com/statcalc/calc15.aspx9 All six coefficients have been calculated as per the Multiple Regression Analysis coefficient calculation, http://www.danielsoper.com/statcalc/calc26.aspx


Notation The following symbols are used in this research paper:

C1 = constant value;

d1 = time from beginning of construction until first payment received;

delay = payment time lag;

ec = percentage of equipment cost of contract value (%)

Inflation rate = average inflation rate during contract period (%)

k = coefficient;

lc = percentage of labor cost of contract value (%)

mc = percentage of material cost of contract value (%)

lwc = percentage of least working capital of contract value (%)

oc = percentage of overhead of contract value (%) and

sc = percentage of subcontractor of contract value (%) Influence of factors on LWC requirement in Indian Infrastructure Projects In order to clarify the relationships between the LWC and the various factors influencing it, multiple

correlation analysis is carried out with the data gathered from the study. The result is the correlation

matrix in Table 1, which shows the correlations between all possible pairs of variables and indicates

the number of cases used to compute them. In each cell of the correlation matrix, that is, at each

intersection of a given row and column, the top number indicates the correlation coefficient.

Requirement of LWC is strongly affected by material cost, followed by Inflation rate, labor cost,

overhead cost, and equipment cost. Equipment, overhead, labor, inflation and material have positive

correlations of 0.803, 0.817, 0.859, 0.919, and 0.948, respectively, with LWC at a significance level of

0.01. An increment of 1% on material would contribute 0.948% to the LWC.

The factor of the subcontractor has a negative correlation of 0.739 with LWC. This shows that the

higher the proportion of jobs awarded to the subcontractor, the lesser LWC is required. Negative

correlations of 0.604 and 0.635 with the variable of overhead and labor costs, respectively, indicate

that if the proportion of jobs awarded to the subcontractor is higher, then the overhead and labor

costs will decrease accordingly. As mentioned above, the factor of the subcontractor has an inverse

effect on the LWC requirement, so that more jobs awarded to the subcontractor will decrease the


cash requirement for the main contractor. Increased subcontractor involvement at a site will definitely

reduce the amount of labor, material, and equipment required by the main contractor. Therefore by

giving additional jobs to subcontractors, the responsibility of the main contractor will be shifted to

supervision work with less attention paid to the cash requirement. Nevertheless, this might produce

other problems such as difficulties during supervision and decreased work quality. Hence the

distribution of jobs to subcontractors should be handled properly to avoid the occurrence of other

problems while reducing the working capital requirement.

Table -1 Correlation Matrix of Factors

Factor Variable LWC Equipment Overhead Labor Inflation Material

Subcontractor

LWC Data correlation Significance (2-trialed)

N

1.000

N/A

32.000

0.803

0.000

32.000

0.817

0.000

32.000

0. 859

0.000

32.000

0.919

0.000

32.000

0.948

0.000

32.000

- 0.739

0.000

32.000

Equipment Data correlation Significance (2-trialed)

N

0.803

0.000

32.000

1.000

N/A

32.000

0.656

0.000

32.000

0.690

0.000

32.000

0.738

0.000

32.000

0.761

0.000

32.000

- 0.504

0.000

32.000

Overhead Data correlation Significance (2-trialed)

N

0.817

0.000

32.000

0.656

0.000

32.000

1.000

N/A

32.000

0.702

0.000

32.000

0.751

0.000

32.000

0.775

0.000

32.000

- 0.604

0.000

32.000

Labor Data correlation Significance (2-trialed)

N

0. 859

0.000

32.000

0.690

0.000

32.000

0.702

0.000

32.000

1.000

N/A

32.000

0.789

0.000

32.000

0.814

0.000

32.000

- 0.635

0.000

32.000

Inflation Data correlation Significance (2-trialed)

N

0.919

0.000

32.000

0.738

0.000

32.000

0.751

0.000

32.000

0.789

0.000

32.000

1.000

N/A

32.000

0.871

0.000

32.000

- 0.679

0.000

32.000

Material

Data correlation

Significance (2-trialed)

N

0.948

0.000

32.000

0.761

0.000

32.000

0.775

0.000

32.000

0.814

0.000

32.000

0.871

0.000

32.000

1.000

N/A

32.000

- 0.701

0.000

32.000

Subcontra

ctor Data correlation

Significance (2-trialed)

N

- 0.739

0.000

32.000

- 0.593

0.000

32.000

- 0.604

0.000

32.000

- 0.635

0.000

32.000

- 0.679

0.000

32.000

- 0.701

0.000

32.000

1.000

N/A

32.000

Note: Correlation is significant at 0.01 level (2-tailed)

Labor and overhead need immediate payment from the contractor to guarantee continuous work

progress. As a result, these two factors have a strong relationship with the LWC requirement. Higher

amounts of overhead and labor, respectively, will increase the working capital requirement. Since


repayments of material and equipment are to be made within certain credit periods, they would not

affect the cash requirement adversely during the initial stage of construction.

The factor of inflation has a positive correlation with the requirement for LWC. A higher inflation rate

will increase the LWC requirement as well as the interest rate charged by banks. The situation

becomes worse when suppliers and subcontractors tighten their terms of payment. Overhead cost

has a strong relationship with other costs. Table 1 show that overhead cost has a positive correlation

of more than 0.650 with all the other costs except for subcontractor cost. The cost requirement for all

other items will affect the overhead cost.

Result Analysis In order to test the validity of the model developed, a series of LWCs were calculated by putting the

data available from various database into the model. These values were then compared to the actual

LWC being used in various construction projects in India. Both actual and predicted values of LWC

have been compared and it was found that the mean actual LWC for the projects studied is 7.93% of

the contract value and has a standard deviation of 2.02%. The LWC predicted for the same projects

by using the model developed is 8.77% of the contract value, with a standard deviation of 2.11%. It is

noted that the mean and standard deviation of the predicted and actual LWC produce only a

difference of less than 0.05%. While this study is among the first to estimate LWC for local practices

in India, several shortcomings can be identified, among them the small volume of data collected and

the lack of availability of required data. These shortcomings could be improved with more data and

more competent database. Due to the constraints of time and resources, the number of projects (32)

only manages to fulfill the requirement for statistical analysis. More variables could be included to

expand the capability of the model and to suit different working conditions.

Conclusion Working capital is an important liquidity indicator and historically it has been a major benchmark for

the profitability of construction contractors in infrastructure projects. A high return on capital employed

is an illusion if it is accompanied by inefficient or fraudulent working capital management. If

receivables or inventory keep going up disproportionately with growth in sales, ever increasing


amount of capital would have to be deployed for financing this working capital requirement. Analysis

of Least working capital (LWC) requirement was done on a sample of 32 infrastructure projects in

India among 16 construction companies. The analysis was done to find out how these infrastructure

project contractors are managing least working capital requirements. When the least working capital

requirement concept is used then it was discovered that working capital management efficiency has

been improved by predicting least working capital requirement during the bidding stage of the

infrastructure projects. It also leads to improvement in profitability of the firms in infrastructure projects

in India in terms of profit margin.

Various historical data on projects with the same contract type in India collected through various

database were analyzed to determine the factors that influence the LWC and the range of these

factors percentages of the overall contract value. In this paper, the data analysis by regression model

with statistical method was used to find out LWC requirement in construction projects. After the

relationship of these factors is determined by using the ANOVA (Analysis of Variance) test, a model is

developed to estimate the LWC. Then the actual LWC and the estimated LWC has been obtained by

using the developed model of these past projects are compared, and the model is proven to have an

accuracy level of up to 9% variance.

The present paper attempts to develop a practical model for Indian construction firms to find out LWC

requirement in construction projects, which should be possessed in any point of time. Main outcome

of this paper is to establish the relationship among the factors responsible for LWC requirements and

presents a simple model that could be used as a guide to estimate the LWC for Infrastructure projects

in India. The estimation in this research is based on percentages of variables of the contract value

based on the historical data that influence the LWC. Then the LWC obtained is expressed in terms of

the percentage of the contract value. The model proposed in this research has been developed to

help the developer or owner of the project to select a qualified contractor with competent financial

background. The user would need at least 30 sets of data (for the development of model using

multiple regression analysis (Enns 1985)) about the LWC and percentages of each cost element to

be plugged into any statistical software to run the multiple regression analysis to get the K values or

the coefficients of the model. Different types of construction work and some other factors such as

location and weather condition would affect the LWC requirement, and these become important

criteria for selecting which historical data to use in the analysis.


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Annexure - I List of Indian Construction Companies studied for Research

1. Ahluwalia Contracts (India) Limited

2. Ashoka Buildcon Limited

3. BL Kashyap & Sons Limited

4. Consolidated Construction Consortium Limited

5. Era Infra Engineering Limited

6. Gammon India Limited

7. Gayatri Projects Limited

8. Hindustan Construction Company Limited

9. IVRCL Infrastructures & Projects Limited

10. Madhucon Projects Limited

11. Nagarjuna Construction Company Limited

12. Patel Engineering Limited

13. Punj Lloyd Limited

14. Sadbhav Engineering Limited

15. Simplex Infrastructure Limited

16. Unity Infra-projects Limited

Conference Paper 3

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