Financial Management in Construction Contracting

Andrew Ross, Peter Williams

• Publisher: Wiley-Blackwell
• Year: 2012
• Print ISBN: 9781405125062
• eBook ISBN: 9781118537961
• Edition: 1
• Topic: Technology & Engineering
• Subtopic: Technology & Engineering Research & Skills
• Index: Technology & Engineering

Financial Management in Construction Contracting
Andrew Ross & Peter Williams

This authoritative text provides a detailed insight into how construction companies manage their finances at both corporate and project level. It guides students and practitioners through the complexities of the financial reporting of construction projects within the constraints of accepted accounting practice. The book is written for non-accountants and from a contractor's perspective and is equally relevant to subcontractors and main contractors.

The authors examine the relationship between the external annual accounts and the internal cost-value reconciliation process. CVR is covered in depth and the authors consider issues such as interim payments, subcontract accounts, contractual claims, final accounts, cash flow management and the reporting of the physical and financial progress of contracts.

A broad perspective of all the financial aspects of contracting is taken along with related legal issues and the authors explain how things operate in the 'real world'. They describe good practice in financial control while at the same time being honest about some of the more questionable practices that can - and do - happen. The approach taken is unique as the financial management of construction projects is considered from the perspective of the contractor's quantity surveyor. The book deals with the real issues that surveyors have to address when using their judgment to report turnover, profitability, cash flow, and work in progress on projects and the financial problems faced by subcontractors are frankly and pragmatically explored.

The payment and notice requirements of the Construction Act are explained in detail and relevant provisions of JCT2011, NEC3, ICC, DOM/1 and other standard contracts and subcontracts are also covered.

Financial Management in Construction Contracting addresses the wide variety of external factors that influence how construction companies operate, including government policy, banking covenants and the financial aspects of supply chain management. Cost reporting systems are described and real-life examples are used to illustrate cost reports, accrual systems and how computerised systems can be employed to provide the QS with information that can be audited.

This is the ideal core text for final year degree and post-graduate students and provides an invaluable reference source for all engaged in the financial management of construction projects.

This book's companion website is at www.wiley.com/go/rossfinancialmanagement and offers invaluable resources for both students and lecturers:

• PowerPoint slides for lectures on each chapter
• Excel worksheets to practice what you learn
• Sample valuations and cashflows

1

Finance in the construction industry

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1.1 Introduction

1.2 The purpose of this book

1.3 Construction contracting

1.4 Work in progress

1.5 Reporting

1.6 Structure of the book

1.7 The construction industry

1.7.1 Industry reports

1.7.2 Industry reform: origins and responses

1.7.3 Housing Grants, Construction and Regeneration Act 1996

1.8 Industry output

1.9 Industry clients

1.9.1 Clients for small buildings

1.9.2 Major clients developing for their own occupation

1.9.3 Property developers

1.9.4 Private house buyers

1.10 Structure of the industry

1.10.1 Size and distribution of firms

1.10.2 Risk culture

1.10.3 Specialist contractors

1.10.4 Payment processes

References

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1.1 Introduction

To anyone walking past a construction site the scene can perhaps be best described as ‘organised chaos’. The site will be fenced off, or there may be a hoarding around the site, and there will invariably be a variety of plant, equipment and scaffolding in ­evidence as well as stacks of bricks, heaps of sand and gravel; there will be partially completed work and work under construction and there will be cabins and site offices too.

Clearly, all of this activity has a monetary value but the means of arriving at this value may not be immediately obvious to the untrained eye. The mechanisms of valuation and financial reporting of completed and partially completed building ­projects under construction are explained in this book, as are the means of ­assessing the value of the work in progress, the valuation of materials on site and the ­determination as to whether a contract is making a profit or loss. The book is also concerned with why the work has to be valued and how such valuations are ­conveyed or ‘reported’ to interested parties outside the contracting organisation.

The scene painted above would be typical of many sites irrespective of whether the contractor is large or small or whether the contract is for building, civil ­engineering, maintenance or any other type of construction work. However, one thing that contractors large and small have in common, whether they are limited companies or unincorporated, is the need, at some point in time, to determine the value of such partially completed contracts. This is necessary so as to enable a set of annual accounts to be prepared for submission to HM Revenue and Customs (HMRC) and, for most companies of any substance, to file their accounts annually at Companies House.

Construction is a multifaceted industry and construction projects are invariably not straightforward. The processes of tendering, contract award, work on site, ­completion and handover are often complex and fraught with difficulties and ­sometimes disputes. There are many influences that bear on the presentation of true picture of the financial position of construction projects, not least the culture of the industry itself.

1.2 The purpose of this book

The purpose of this book is to explain how the financial position on construction contracts is reported, how work in progress is valued, how this information is reported to management and how this is reflected in the annual accounts of the business. The book also explains why things are done as they are and brings into question certain practices that might be considered less than desirable.

To achieve this, it is necessary to understand some basic accounting terminology and practice, how the construction industry and its system of contracts works, how tenders for construction projects are put together and how financial information flows in a construction business.

The book is written for undergraduate and postgraduate students and for ­practitioners working in the construction industry; it is written in a language that this audience will hopefully recognise and understand. It is not written for ­accountants or bankers, although some of the insights revealed in the book may help them to better understand how the industry operates and why. We have tried to avoid accountancy ‘jargon’ and where this has been unavoidable we have tried to explain, in layman’s terms, what it all means.

Above all, the authors believe that the book is an honest representation of ‘how things are’ in the reporting of the financial position of construction ­contracts and make no apologies for being brutally frank about some of the ‘questionable practices’ that the industry suffers from. This is not to say that we endorse such practices – far from it – but good practice cannot flourish without awareness of the bad.

1.3 Construction contracting

The subject matter of this book concerns the financial management of construction projects. To be more specific, the focus is on the ‘contracting’ side of the ­construction industry – that is to say where projects are undertaken by contractors who are engaged by clients (employers) to carry out a building or civil engineering project for a stated price or for a price to be determined on completion. The principles and issues discussed apply equally to main contractors and specialist subcontractors but the financial management of speculative housing developments, carried out by ­contractor-developers, is handled somewhat differently and is not, therefore, ­covered by this text.

All contractors – whether small, medium or large – need to know and understand the financial situation of their projects in order to recognise when things are going wrong and be able to take remedial action before it is too late. However, many ­contractors and subcontractors in the construction industry, especially the smaller ones, are simply not ‘in the loop’ when it comes to the financial aspects of their ^­business. They see a healthy order book, they see cash coming in, they see a healthy bank balance and they assume that all is well. This may be far from the case, ­however, and disaster may be waiting just around the corner. The reason is that what they ‘see’ is not the ‘true’ position and, hopefully, the reasons for this will become clearer as the chapters unfold.

One of the great problems in understanding what goes on financially in ­contracting is that construction contracts of any significant size are complex. The way that ­contracts are priced, the design changes and unexpected events that take place ­during construction, the natural human tendency to argue over money and the endemic financial instability of many of the firms that operate in the construction industry all contribute to the complex nature of the financial aspects of construction projects. Add to this the singular culture of the industry, the problems caused by the separation of design from construction, the complex contractual and procurement arrangements employed and the ‘grey water’ becomes very ‘murky’!

A large part of the work of a contractor’s quantity surveyor is to provide financial data in order to show the financial position of projects under his/her control. This is usual practice in most medium and large sized contractors but much less so in smaller firms and specialist ‘trade’ contractors. The whole idea of contracting is to win contracts and make money and the quantity surveyor acts in a quasi-­accountancy role to provide information for line managers to run projects efficiently and within budget and to capitalise on opportunities to ‘make money’ when the occasion arises.

1.4 Work in progress

Ask any accountant what the main problem is in contracting and the answer will be ‘the valuation of work in progress’. Work in progress is the bête noir of construction accounting and Barrett (1981) pointed out that no area of accounting has produced wider differences in practice than the computation of the amount at which stocks and work in progress are stated in financial accounts.

At any given point, a contracting company will have a number of projects running that are incomplete; this means that there will inevitably be a significant amount of work in progress. On one particula...

Table of contents

• Cover
• Access to Companion Site
• Title page
• Copyright page
• About the Authors
• Preface
• 1 Finance in the construction industry
• 2 Stakeholders and the regulatory environment
• 3 Risk and uncertainty
• 4 Contracts and documentation
• 5 Payments in construction
• 6 Managing the supply chain
• 7 Getting work
• 8 Corporate governance and management
• 9 Company structure
• 10 Service departments
• 11 Financial management
• 12 Project governance
• 13 Budgets
• 14 Resource procurement
• 15 Project risk and control
• 16 Programme and progress
• 17 Valuations and payments
• 18 Cost value reconciliation
• Glossary
• Index