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Sustainable Mathematical Model for Cash Flow Management for Large Infrastructure Projects

Asim Prasad B.Tech IIT Kanpur, Post Graduate Diploma in Project Management, MBA

Chief Manager, GAIL India Ltd., Bhikaji Cama Place New Delhi, India

I. Abstract Large Infrastructure Projects are Capital Intensive, have long gestation periods and requires huge

capital for its successful completion. India being a developing country, large number of

infrastructure projects is being undertaken by the government, semi government and private

agencies to speed up development. These projects cater the basic needs of the populace living in

rural or urban India. Some of these projects require more financial resources than others which

have limited amount of financial resources for the project disposal. Most of these projects are

executed amid challenges in the remote environment which are beyond the control of the project

executing agencies. Such challenges lead to risks which if not identified and managed properly,

results in time and cost overrun.

Seldom is large infrastructure projects executed on equity capital alone. The cost of capital goes

to decide the cost at which the end-user will finally avail services after the project’s commercial

operation starts. Since most of the projects involve both equity and debt, managing cash outflows

efficiently is not only difficult but also an intricate process. This paper discusses a mathematical

model for cash flow management in infrastructure projects which has been applied successfully

for number of projects under concurrent execution. The key features of the methodology are that

it is rolling, flexible, zero based and participatory in nature. The methodology provides a practical

workable solution to precisely predict and manage cash outflows efficiently, thus optimizing the

capital outflow on month to month basis.

Key Words Open System Theory, Operating Environment, Remote Environment, Schedule Physical

Progress, Schedule Financial Progress, Incremental schedule progress

II. Introduction

Projects are conceptualized, formulated and executed to derive tangible and intangible benefits to

meet the needs and expectations of interested parties, especially the customers and end users.

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Projects execution follows the principles of Open System theory (Fig.1) due to which the projects

continuously interacts with the surrounding comprising operating and remote environment.

Projects are characterized by its Uniqueness, Complexity, Dynamism, Diversity, Limited

Resources and Risk profile wherein the value of project output justifies the resource invested.

Projects bring beneficial change not only for the organization but also the society and country at

large. As more and more projects are being executed under stiff deadlines, it becomes essential

for project organizations to adopt such monitoring systems which correctly depict the project

physical and financial progress for assessing the project performance on real time basis.

Mathematically project characteristics are depicted as:

Projects Characteristics = f (Ca,D1

b,D2

c,LR

d,R

e,U

f) (1)

Where,

C: Complexity D1: Dynamism D2: Diversity LR: Limited Resource R: Risk U: Uniqueness

a,b,c,d,e,f are real numbers greater than zero

Remote Environment

Operating Environment

Input

Output

Constraints

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Fig 1: Open System Approach

III. Infrastructure Projects in Indian Context Indian is a developing economy with its populace residing in villages and towns. The citizens are

entitled for such facilities comparable to those available in developed countries which enhance

their living standards. Large numbers of projects are currently undertaken in different sectors

related to infrastructure development. Some of the projects that effects the common populace are

related to water resources, urban development, telecommunications, surface transportation,

railways, power, petroleum, petrochemicals, coal, fertilizer, civil aviation, etc. These projects are

executed either directly by the government agencies or in partnership with private agencies. Once

the project is completed the ownership of commercial operation may be wholly with the

government or in partnership with private agency or wholly with private agency. Under such

commercial operation model, predefined methodology for revenue and profit sharing exists. As

per the report compiled by Ministry of Statistics and Programme Implementation (MoSPI), as on

01.09.2012, 560 numbers of projects in 14 sectors with an original cost of Rs 765,702.99 Crore

were under execution by the central sectors. The latest and anticipated costs of these projects

are Rs 824,894.71 and Rs 883,467.92 Crore respectively. The cumulative expenditure is Rs

412,178.56. Upon commercial operation, these projects will lead to change bringing about

tangible and intangible benefits for the populace and government.

It is seen that, during the course of its execution the projects gets delayed resulting in time and

cost overrun. The cause of such delay is either known or unknown. Even if the cause is known,

the steps undertaken to eliminate the cause of delay or preventive measures adopted to control

such delays are not sufficient enough to completely arrest the delays. Some of the common

reasons for time and cost overrun in infrastructure projects in India are summarized as under:

Time Overrun: Time overrun is defined as difference in actual duration required for project

completion and scheduled duration of project completion considered during project approval. This

duration is measured in days or in months or in years. If the actual duration of project completion

is more than the scheduled duration, the project is delayed. Time overrun occurs due to primary

and secondary reasons. Primary reasons are beyond the control of project executing agencies

and some of them are:

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i. Time taken to obtain various types of statutory permissions from multifarious

government agencies are more compared to prescribed time limits for such

permissions.

ii. Land acquisition / Right of Way acquisition is often delayed

iii. Law and order problems at project site

iv. Insufficient availability of skilled, semiskilled and unskilled labor force during project

execution

v. Geographical surprise at project site

vi. Non availability / poor quality of infrastructure support and linkages leading to project

site

vii. Change in government law / regulations during project execution

viii. Inadequate availability of funds

Secondary reasons are those that can be controlled to some extent by project executing agencies

and some of them are:

i. Delay in financial closure

ii. Delay in appointment of project consultants

iii. Delay in finalization of detailed engineering document

iv. Delay in tendering / ordering

v. Delay in supply of long lead critical materials

vi. Problem in handling contractual issues during project execution

vii. Problems related to industrial relations

Cost Overrun: Cost overrun is defined as the difference between the actual cost at project

completion and cost estimated during project approval. If the actual cost at project completion is

more than the approved project cost, then there is cost overrun or cost escalation. As time is

money so, time overrun leads to cost overrun. Some of the common reasons for cost overrun

under Indian context are:

i. Increase in land cost

ii. Change is project scope

iii. Increase in taxes / duties

iv. Increase in cost of raw materials / project resources/ inflation

v. Devaluation of rupee

vi. Monopolistic situation during ordering

vii. Cartelization by suppliers / vendors

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Time and cost overrun not only leads to increase in the cost of the service, but also leads to extra

financial burden on exchanger apart from causing dent in the reputation of project executing

agency. Pace of economic developments is thus retarded.

IV. Project formulation in large infrastructure projects Infrastructure projects are executed in areas having diversified geography, regional and local

conditions. These are considered during project modeling while the execution methodology,

project detailed plan, risk management plan, work breakdown structure, resource breakdown

structure, risk breakdown structure, responsibility matrix are finalized. The challenge before a

project agency of a large infrastructure project is to precisely identify the risk variables, its

mitigation measure, forecast the incremental physical progress under each work breakdown

structure (WBS) elements and corresponding amount, timing of capital expenditure outflow. Amid

all these, the most important aspect is the cost of service which needs to be optimized through

efficiency in managing these processes while aiming to reduce the interest cost on the capital

employed. Cash flow management for capital expenditure thus becomes very important.

V. Cash flow management Capital expenditure is one of the most important resources required for building an infrastructure

project. Capital comprises both equity and debt. As capital is scarce, it is available at a cost. The

cost of capital is loaded to the project cost. As such it is important to effectively manage the

capital expenditure inflow and outflow. Cash flow management is defined as the process of

managing capital expenditure in infrastructure projects efficiently with the intent to make available

the required amount of fund when needed, but at the same time optimizing the cost of debt and

equity funds. The methodology of cash flow management involves estimating the cost of

different packages, predicting the timing of cash outflow, securing funds on time, controlling and

monitoring the actual cash outflow, identifying deviations in the cash flow plan and modifying the

baseline plan periodically to synchronize it with the incremental physical progresses so that the

actual cash outflow is within permissible deviation limits. This is a continuous and intricate

process as it requires thorough knowledge of schedule and actual progress, commercial

purchase and work order conditions, schedule for raising vendor, contractor bills, anticipated

amount against each bill and processing time before payment release. Irrespective of the nature

of infrastructure project, this is a standard methodology that can be applied to any type of

infrastructure project.

Cash flow management needs to be managed in such a manner that it adapts to the changing

environment quickly. It also needs to be ensured that sufficient funds are readily available to

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make payments against bills received, without adversely affecting the delivery of goods and

services.

VI. Steps in Cash Flow Management Cash flow management is an integral part of project management. It’s a systematic, long-drawn

and continuous process that starts immediately after the project business case has been

prepared. The cash flow management planning must start once the project charter is handed over

to the project manager. The plan is prepared by synchronizing it with the overall scheduled

physical progress plan. Experience reveals that the overall percentage planned cash outflow lags

the overall percentage scheduled physical progress. This is due to the fact that payments are

made only after completion of work or delivery of material or service by contractors and vendors.

Estimating the net fund flow till the commissioning of the project prior to start of commercial

operation of the project with accuracy is important as it affects the shareholders’ profits

subsequently during the project’s commercial operation. Based on experience, the steps required

for efficient cash flow management for large infrastructure projects are detailed below.

1. Identification of cost heads: Large infrastructure projects involve various cost heads

comprising direct cost, indirect cost, hard cost and soft cost. The project cost estimated at

the time of project investment approval is the cost considered in the Detailed Feasibility

Report (DFR). This forms the basis for ascertaining deviations at the time of project

completion.

2. Estimation of cost against each item in the cost head (Table-1) : During the project

investment approval, costs inclusive of taxes and duties, are allocated against each item

under the cost head based on past experience of executing similar projects, market

estimates and cost database. It may so happen that cost of some items are in foreign

currency also. With changes in market conditions, a 20 percent deviation from DFR is

considered reasonable for estimation purpose. Some of the items under cost heads

commonly encountered in infrastructure projects are:

i. Land, survey and statutory permissions

ii. Procurement packages such as raw materials, equipment, and machinery

iii. Work packages for different types of specialized contract works

iv. Project management consultancy and third-party inspection services

v. Owners’ management expenses such as wages, salary, lodging and boarding of

workers, setting up offices and establishing communication networks

vi. Contingency or management reserve for managing known and unknown risks

Comment [Thakur1]: Pls explain

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vii. Inflation, interest, margin money for working capital, foreign exchange variation

Table-1

Sl. Cost head Total DFR Cost: TCi

1. Land, survey and statutory permissions TC1

2. Procurent packages (P1,P2….Pj) TC2

3. Work Packages(W1,W2….Wk) TC3

4. Owners Management Expenses TC4

5. Contingency TC5

6. Inflation, Interest on Debt , Margin Money for Working Capital TC6

Total Project Approved DFR Cost(Baseline-0 at Time T0) TACB0

Mathematically,

TACB0 = TCi where i=1 to n; n= total number of cost heads; (2)

The total approved DFR cost=TAC, is a function of time and is dependent on market forces.

3. Calculation of the cash outflow based on DFR cost and anticipated project

schedule for each item(Table-2): Infrastructure projects normally takes 3-5 years to

complete. At the time of project investment approval, the project physical progress

schedule is prepared. This schedule is based on a forecast of how much progress the

project is likely to achieve in each month till its completion. The project manager then

forecasts expenditure against each item considering DFR estimate, based on the

estimated project progress schedule, bills schedule by vendors/contractors, time taken to

process these bills and anticipated bill amounts. The project manager now has the

incremental and total planned expenditure for each month. He/she can also ascertain the

cumulative cash flow in each month as a fraction of approved project cost.

Table-2

Sl. Cost head Total

Cost: TCi Month -1 Month-N

1. Land, survey and statutory permissions TC1 TC11 TC1N

2. Procurement packages (P1,P2….Pj) TC2 TC21 TC2N

3. Work Packages(W1,W2….Wk) TC3 TC31 TC3N

4. Owners Management Expenses TC4 TC41 TC4N

5. Contingency TC5 TC51 TC5N

6. Inflation, Interest on Debt , Margin Money for Working Capital

TC6 TC61 TC6N

Total Project Approved DFR Cost(Baseline-0 at Time TACB0 TCM1 TCM-N

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T0)

% Cash Outflow [Basaeline-0] - TCM1/ TACB0

TCM-N/ TACB0

Mathematically,

TACB0 = TCMm where m=1 to N; N= total number of months for project cash outflow (3)

The cash outflow so calculated is the baseline-0 cost outflow based on estimated DFR cost.

4. Calculation of the cash outflow for each item based on actual ordered value and

planned incremental scheduled progress (Table-3): The actual order value differs

from the DFR estimates since orders are placed at a date later than planned. Delays are

common because high value procurement involves lengthy processes with multiple

stakeholders. Hence, it is important to record the actual order value against each item.

Next step in this step is to calculate the planned expenditure against each item and the

total incremental planned expenditure for each month. This method helps in deriving the

cash flow. As the time gap between DFR preparation and ordering is considerable, the

time horizon for this cash flow is indicated by T1. This time horizon starts from the

placement of 1st order and ends when all orders have been placed. The steps are

repeated till all orders are placed.

Expenditure against contingency, inflation, interest, margin money for working capital,

foreign exchange variation is recorded during project capitalization on actual basis.

Table-3

Sl. Cost head Total Order value TOCi

Month -1 Month-N

1. Land, survey and statutory permissions TOC1 TOC11 TC1N

2. Procurement packages (P1,P2….Pj) TOC2 TOC21 TC2N

3. Work Packages(W1,W2….Wk) TOC3 TOC31 TC3N

4. Owners Management Expenses TOC4 TOC41 TC4N

5. Contingency TOC5 TOC51 TC5N

6. Inflation, Interest on Debt , Margin Money for Working Capital

TOC6 TOC61 TC6N

Total Project Ordered Cost(Baseline-1 at Time T1) TOCB1 TOCM1 T0CM-N

% Cash Outflow [Basaeline-1] - TOCM1/ TACB1

T0CM-N/ TACB1

Comment [Thakur2]: Again, don’t think we can accommodate another graph/table

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Mathematically,

TOCB1 = TOCMm where m=1 to N; N= total number of months for project cash outflow;(4)

The cash outflow so calculated is the baseline-1 cost outflow based on order value.

5. Recalculate the cash outflow during project execution based on balance

expenditure and actual physical progress [Table-4]: Infrastructure projects encounter

hurdles due to political, economic, social, technical, legal, and environmental factors.

Therefore, the actual percentage progress varies from the scheduled percentage

progress, which directly affects the actual expenditure outflow. The actual expenditure of a

delayed project will be lesser than the planned expenditure.

In order to ascertain the planned cash outflow of successor months, the balance

expenditure at the end of the current month for all items is calculated. This balance

expenditure is the difference between the actual order value and sum of the payments

made for the items till the previous month. Based on the current progress, commercial

order conditions, the balance expenditure is distributed in the subsequent months. This

way, the forecasted cash outflow is calculated.

This method results in realistic cash outflow against each item for all subsequent months.

For orders placed on fixed cost basis, this monthly process stops when the order value is

exhausted, meaning the entire committed expenditure has been made. However, incase

the actual expenditure overshoots the DFR estimated cost, it means that the project

encounters cost overrun.

Table-4

Sl. Cost head Total Order

value TOCi Y=Cumu

lative Expenditure till previous month

Z=X-Y =Balance

Expenditure till previous

month

1. Land, survey and statutory permissions TOC1 TCE1 Z1=TOC1-TCE1

2. Procurement packages (P1,P2….Pj) TOC2 TCE2 Z2=TOC2-TCE2

3. Work Packages(W1,W2….Wk) TOC3 TCE3 Z3=TOC3-TCE3

4. Owners Management Expenses TOC4 TCE4 Z4=TOC4-

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TCE4

5. Contingency TOC5 TCE5 Z5=TOC5-TCE5

6. Inflation, Interest on Debt , Margin Money for Working Capital

TOC6 TCE6 Z6=TOC6-TCE6

Total Project Ordered Cost TOCB1 TCE Z=TOCB1 -TCE

% Cash Outflow [Basaeline-2] - TCE/ TOCB1

(TOCB1 –TCE)/

TOCB1

The cash outflow so calculated is the baseline-2 cost outflow based on balance expenditure. As

the project progress, on month to month basis the balance expenditure and revised cash flow

are calculated. This continuous process improves the accuracy level of prediction w.r.t.

anticipated expenditure required in subsequent months. Refer Fig 2.

6. Prepare contingency plan to minimize deviations: The actual overall progress of large

infrastructure projects in India is seldom ahead of schedule. The project team needs to

prepare contingency plans for work breakdown structure elements where actual progress

is behind schedule. However, project execution involves scarce resources and the project

manager may not always be at liberty to execute contingency plans. Project delays also

result in cost overrun. While preparing contingency plans, the project manager needs to

conduct a decision tree analysis to ascertain the cost of not implementing the contingency

plan or implementing it partially, due to scarcity of resources.

7. Continuously monitor the actual cash outflow: Monitor the actual cash outflow

continuously with the release of payments against running bills. This is a real-time

process, and requires systems to monitor the progress electronically and update the

project manager on aspects like availability of funds for capital expenditure, cost of such

funds, balance payment against each item on cost head, look ahead cash flow plan for

succeeding months, and percentage financial progress made in each cost head along with

overall percentage financial progress. The financial percentage progress report will give

the project manager a clear idea of whether there will be cost overrun in the project.

VII. Key features of the model

This methodology has been implemented with a reasonable degree of accuracy while executing

cross-country natural gas pipeline infrastructure projects. The methodology can be used for any

type of infrastructure projects as this is generic in nature. The key features of this methodology are

as under:

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i. Time Period: Under this methodology the cash flow is continuously updated so the time

frames remains stable but the period changes. So it is rolling.

ii. Forecast Values: The Cash Outflows are adjusted according to the variance between

scheduled and actual physical progress on real time basis. So it is flexible.

iii. Forecasting Process: The Cash flow begins from ground up considering the previous

month cumulative actual values as the baseline. So it is zero based.

iv. Setting Goals: All those responsible to achieve the actual targets are included. So it is

participatory.

VIII. Conclusion Infrastructure projects are largely executed with borrowed funds and precise forecast of cash

outflows on a monthly basis is important. That way only the incremental amount required for

expenditure in the successive months is borrowed. The above methodology also helps to prepare

capital expenditure budget estimates for the project during execution. Companies that execute

infrastructure projects of varying size and complexity can also ascertain the cash flow of the

organization’s entire project portfolio.

Cash flow management is as much an art as it is about knowledge and skill. As the project

matures, the project manager needs to leverage the knowledge gained in the preceding months

with regards to cash outflows. A proactive approach works well. Globally, projects see a higher

level of involvement by senior management when it comes to capital allocation decisions,

performance tracking, and risk management. The involvement of suppliers and contracts during

periodic cash flow planning helps to make the cash flow management plan more robust and

versatile. Project leaders need to ensure that monitoring of the cash flow management strategy

takes place through the project lifecycle and not just during the design and planning phases.

Fig-2 : Cumulative % Cash Flow Curve

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Asim Prasad

Mr. Asim Prasad is a graduate in Mechanical Engineering from Indian Institute of Technology,

Kanpur, India. Presently he is working as Chief Manager at GAIL India Limited, Corporate Office,

New Delhi. He has nearly 19 years of varied experience in the natural gas value chain comprising

the Operation and Maintenance of natural gas pipeline / compressor stations; Project

Management of Liquefied and Natural Gas Pipelines; Gas Marketing etc.

Mr. Prasad has been involved in the execution of several prestigious projects of GAIL namely the

Jamnagar Loni LPG Pipeline Project (Rs 1200 Crore), DahejVijaipur Pipeline Project (Rs 2936

Crore), DahejPanvelDabhol Pipeline Project (Rs 1900 Crore) etc. He was one of the project team

members for the GAILs prestigious Dahej-Vijaipur Pipeline project, which received Silver Medal

for Excellence in Project Management in the Mega Project Category from International

Project Management Association, Germany in Oct 2006. Likewise theDahejPanvelDabhol

Pipeline Project also achieved the highest status of finalist in the awards category of Project

Excellence in Mega Sized Projects from International Project Management Association, Germany

in Helsinki in June 2009 where Mr. Prasad was one of the project team members. In Sep 2011,

the Vijaipur-DadriBawana Pipeline project (Rs 3500 Crore) won the PMI India Project of the Year

Award , where Mr Prasad was the project team member, head of Project Management Office and

authored the award application.

Mr Prasad has presented and published papers in conferences / seminars of national

/international repute. During his professional career, Mr. Prasad completed Post Graduate

Diploma in Project Management and Masters in Business Administration. He obtained

Certification in Project Management, Certification in Project Risk Management from Institute of

Project Management Certification and Certification in Complex Project Management. Mr. Prasad

holds membership of number of professional institutes including PMI, USA.

The present assignment of Mr. Prasad incorporates Last Mile Consumer Connectivity for natural

gas customers, Customer Market Development and Market Penetration along Operational

(10,600 Kms) and Upcomming (4500 kms) natural gas pipeline projects having an approved cost

of Rs 25000 Crore approx. under execution in GAIL.

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