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Asim prasad

  1. 1. Page 1 of 12 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.
  2. 2. Page 2 of 12 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 (C a ,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
  3. 3. Page 3 of 12 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:
  4. 4. Page 4 of 12 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
  5. 5. Page 5 of 12 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
  6. 6. Page 6 of 12 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
  7. 7. Page 7 of 12 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
  8. 8. Page 8 of 12 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
  9. 9. Page 9 of 12 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 Expendi ture till previou s 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-
  10. 10. Page 10 of 12 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:
  11. 11. Page 11 of 12 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
  12. 12. Page 12 of 12 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. ~~~~~~~~~~~**~~~~~~~~~~