Professional Documents
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Introduction
Construction project cash ow is a sub-set of cash ow for the organisation. It is the inow of cash to the contractor from the client and also the outow of cash to the suppliers, sub-contractors and to direct costs (Kenley, 2003). Cash ow management has long been recognised as an important tool and proper cash ow management is crucial to the survival of a construction company because cash is the most important resource for its day-to-day activities (Peer, 1982; Singh and Lakanathan, 1992). A proper cash ow management is also important as a means to obtain loans, as banks and other money lending institutions are normally much more inclined to lend money to companies that can present periodic cash ow forecasts (Navon, 1995). Previous research by Kaka and Dawood (2000) showed that cash ow proles take different shapes
depending on procurement method employed and construction duration. Cash ow proles for traditional, design and build as well as management contracts were investigated under varying construction duration and Kaka and Dawood (2000) concluded that there is a need to consider cash ow prole in determining the type of procurement method to employ on a construction project. Whilst the insight offered by this study is important to the construction industry, it is also of importance to examine the satisfaction level of contractors to payment terms under different procurement methods. According to Kenley (2003), the client-oriented ow of cash from the client to the contractor generally ows in from the client in periodic payments called progress payments. According to him, building contracts generally provide for such payments for two reasons: To provide a mechanism whereby the contractor may recover money for work in progress, so that the contr-
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H. Odeyinka and A. Kaka are affected, each to a various degree ranging from loss of income to a full-blown insolvency. Even in situations where there are no obstacles in the ow of cash along the chain, there is often a considerable delay before those at lower levels receive payments (Khosrowshahi, 2000). According to the Institute for Construction Training and Development (1992), payment term is something considered very important because it has an effect on the price and also on the efciency of the contractor. According to them, the cardinal principle is that the contractors should not be required to fund the construction; there must be an appropriate ow of funds so that the contractor doesnt have to commit his resources for the funding of the construction. At the same time, the ow of funds will not be such in which the contractor would be tempted, having got more than enough, to slow down. According to Abeysekera (2002), two issues of fundamental importance arise regarding payment procedures: (a) the time lag between expenditure and payments, and (b) cash retentions from progress payments. Regarding time lag between expenditure and payments Abeysekera (2002) highlighted the following comment: Clearly, work rst and then get paid is an ageold practice despite the fact that work is being carried out from the very rst day. However, to receive payment, a substantial amount of work has to be done. This means contractors must nd funds to purchase materials, pay wages, settle dues for services rendered, and for a host of other expenditure. This is extremely demanding as well as costly when contractors are short of funds. The reason for all these articial difculties and cost increases are due to the time lag between payment and expenditure. It is this relatively short time lag between expenditure and payment that drive contractors to the brink of collapse especially when it stretches beyond its elastic range. Regarding retention, Abeysekera (2002) is of the opinion that its practice results in project funds being inadequate to nance the working capital required for construction project. According to Hughes et. al. (2000), retentions are widely believed to act as a performance catalyst and a deterrent against defective work. In the UK, such retentions appear to vary from about 3-5% (Murdoch and Hughes, 2000) whilst in New Zealand, it is much greater varying from about 1.75 10% with the higher percentages applying for smaller values of work (McLaughlin, 2000). These amounts according to Abeysekera (2002) are substantial especially if contractors margins are similar to retention percentage. This implies that contractors would not have sufcient cash until the project is complete. Since the Latham Report
-actor is not funding the project To restrict these payments to set periods (usually of one month) in order to reduce the amount of administration required by all parties. Cash out ows to suppliers, sub-contractors and direct costs is very different to cash inows from the client. These payments according to Kenley (2003) follows the disparate contracts and agreements that exist between the contractor on one hand and sub-contractors and contracted suppliers on the other, and also occur on an as required basis as labour and materials are called up and used during the construction of the project. Whilst these cash inows and outows are recognised and regulated by the standard forms of building contracts under the traditional and design and build contract, contractors level of satisfaction with the payment terms dealing with cash inows and outows is yet to be investigated. This is the concern of this study.
An evaluation of contractors satisfaction with payment terms (1994) there have been numerous calls in the UK to nd alternatives to cash retention (Construction News, 1997; Cook, 1997; Klein, 1997 and Latham, 1997). One reason for dissatisfaction with retention funds is the uncertainty that surrounds the status of a sub-contractors retention in the event of main contractors insolvency (McCartney, 1992). The problem identied here is that if the main contractor goes insolvent during a project, it is very difcult for sub-contractors to obtain the funds held by the main contractor as retention, unless special arrangements have been made (Huxtable, 1992). Different standard forms of building contract under the Joint Contracts Tribunal (JCT) set out contract conditions, some of which attempt to regulate cash inows into the construction business. These include valuation intervals, payment method, time lag between entitlement to receive and actually receiving cash payment and percentage of contract sum retained. The standard forms also set out contract conditions, which regulate the way money ows out of construction business. Examples of these include time lag between being committed to making a payment to sub-contractors and actually paying and time lag between being committed to making a payment to nominated suppliers and actually paying. The JCT 98 (2003) states that valuation interval is to be mutually agreed between the contractor and the employer and if none is stated, it is to be one month. The JCT 98 with Contractors Design (WCD) states that interim payments shall be made by the employer to the contractor in accordance with clauses 30.1 to 30.4 and whichever of the alternatives A or B in Appendix 2 applies to the contract. Alternative A according to the contract conditions refers to stage payments and alternative B refers to periodic payments. According to JCT 98 WCD (2003), where the employer wishes payment to be made in accordance with a series of stages, Appendix 2 contains a table in which a brief description of each stage is to be inserted. And another column in which the appropriate cumulative value of the stages is to be inserted. According to Chappell and Powell-Smith (1999), the cumulative value of the nal stage is to be equal to the contract sum. On the other hand, if the employer wishes payment to be made by periodic payments, this must be stated in Appendix 2 and if no period is stated, the period between applications for payment will be one month (JCT 98 WCD, 2003). According to Chappell and Powell-Smith (1999), whichever of the alternatives is adopted, it is the duty of the contractor to apply to the employer for payment and he also carries out the valuation. The JCT 98 (2003) gives the time lag between is
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suance of interim certicate and entitlement to receive cash payment to be 14 days. This payment time lag is the same under the JCT 98 WCD (2003) but with the difference that the 14-day interval is counted from the date of receipt by the employer of the contractors application for interim payment. According to Chappell and Powell-Smith (1999), there is no provision in the JCT 98 WCD for the quantity surveyor to value work carried out by the contractor and there is no provision for certication by an architect of money due to the contractor. However, the contractor needs to make application for payment of work properly done. Regarding the issue of percentage of contract sum retained, both the JCT 98 (2003) and JCT 98 WCD (2003) made provision for allowance of 5% retention unless a lower rate shall have been agreed. However, whilst the JCT 98 made provision for the use of contractors bond in lieu of retention, the JCT 98 WCD has not incorporated such an alternative. Time lag between when work is carried out by sub-contractors and their entitlement to payment is a payment term that seems to impact contractors cash outow from the construction business. The Nominated sub-contract conditions (NSC/C), known as JCT 98 NSC/C makes provision for the payment time lag to be 17 days from the date of issue of the relevant interim certicate. It makes further provision for payment of interest, which is set at 5% over the base rate of the Bank of England, which is current at the date the payment by the contractor became overdue. Whilst the JCT 98 WCD (2003) recognises the appointment of a named sub-contractor, it is however silent on payment time lag for money due to named sub-contractor from the main contractor. However, both forms of contract stipulate that the client has power to pay nominated subcontractors directly if the contractor fails to pay on time. Moreover, time lag between work carried out by nominated suppliers and entitlement to receiving payment is a payment provision that potentially impacts contractors cash outow from the business. The JCT 98 (2003) entitles a contractor to a discount of 5% on all payments if the contractor makes payment in full within 30 days of the end of the month during which delivery is made. Again, the JCT 98 WCD (2003) has no such provision. Whilst all these identied payment provisions have been recognised as potentially impacting construction cash ow, contractors level of satisfaction with the actual payment terms in practice is yet to be investigated. This then is the concern of this study.
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H. Odeyinka and A. Kaka -ned and this is summarised in Table 2. From the table, it is obvious that 96% of respondents are in senior management position with computed mean experience of 27.82 years and standard deviation of 9.39 years. This background information regarding the respondents indicates that responses provided by them could be relied upon for this study.
Frequency
Percent
30 24 20 26 100
Frequency 24 46 26 4 100
Percent 24 46 26 4 100
An evaluation of contractors satisfaction with payment terms -tors appear to be satised with valuation intervals, time lag between being committed to making a payment to sub-contractors and actually paying, time lag between being committed to making a payment to nominated suppliers and actually paying and payment method. From a closer look at Table 3, it is evident that contractors were unanimous in the expression of their satisfaction regarding valuation intervals and payment method. These are payment terms dealing with cash in-ows into the construction business and the unanimity of opinion expressed by the contractors is an indication that these payment provisions dealing with cash in-ows into construction business are working well. Although, contractors under the traditionally procured contracts expressed satisfaction with time lag between being committed to making a payment to subcontractors and actually paying and time lag between being committed to making a payment to nominated suppliers and actually paying, opinions among the different categories of contractors were statistically different (p<5), using the F-statistic to test the hypothesis that there is no difference of opinion among the different categories of contractors. These two payment terms deal with cash out-ows and the signicant difference of opinion suggests that the method and approach of dealing with these payment terms vary from one category of rm to another. It is evident from Table 3 that whilst time lag between being committed to making a payment to sub-contractors and actually paying ranked 2nd overall, it ranked 1st under the large rm, it ranked 2nd under the medium rm, ranked 4th under the small rm and 3rd under the subcontractors. Odeyinka et. al. (2003) found that UK construction contractors utilise delayed payment to sub-contractors as one of the strategies to fund decit cash ow. However, since medium and large rms have qualied personnel who are knowledgeable in cash ow management, the use of delayed payment to subcontractors to fund decit cash ow is not one of their prime strategies to fund decit cash ow. It is therefore not surprising that their satisfaction level with time lag between being committed to making a payment to nominated sub-contractors and actually paying ranked higher. On the other hand, it could be inferred that time lag between being committed to making a payment to sub-contractors and actually paying as a payment term ranked lower under small rms and subcontractors (rank of 4 and 3 respectively) possibly because the payment to be made, being of some signicance to them, they may want to use it to improve their cash ow position in the short run. As such, it is not surprising that their
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satisfaction level ranked lower under this payment term. An analysis based on rm size shows that while overall, contractors appear to be satised with time lag between being committed to making a payment to sub-contractors and actually paying, time lag between being committed to making a payment to nominated supplier and actually paying and payment method, subcontractors appear to be dissatised with these payment terms. This is not a surprise because subcontractors sit at the bottom of a long contractual payment chain. As such, they suffer the most if client delays payment as contractors usually pay subcontractors after they get paid. Overall, contractors under traditionally procured contracts were dissatised with time lag between entitlement to receive and actually receiving cash payment and percentage of contract sum retained. Contractors dissatisfaction with these twin factors of delayed payment and retention is not a surprise as these are two key issues that are known to be responsible for contractors decit cash ow. According to Abeysekera (2002), given these issues of delayed payment and retention, coupled with the fact that contractors operate at a very low prot margin, it is difcult to expect them to have surplus cash. As such, contractors would be forced to operate with negative cash ows, sometimes over the whole duration of a project. Not surprisingly, they turn to banks and other nancial institutions (i.e. external sources) to meet such shortfalls when internal sources of funds fail to meet such requirements (Brownie and Harris, 1987 and Hamilton and Fox, 1998). Faced with these negative impacts on contractors cash ow, it is not surprising that overall; contractors were dissatised with delayed payments and retentions. Another analysis based on rm size shows that while overall, contractors were dissatised with time lag between entitlement to receive and actually receiving cash payment, the large and medium rms appear to be satised. This is a surprise, given the generally held view that delayed payment impacts negatively on contractors cash ow. A possible explanation may be due to the fact that large and medium rms have established commercial department with qualied personnel that deal with cash ow management. As such, they are expected to have strategies in place for accommodating this delay payment in their cash ow calculations and also to have devised means of funding decit cash ow through other means. Odeyinka et. al., (2003) found that medium and large rms prefer to fund their decit cash ow through company cash reserves, tender unbalancing, etc. On the other hand, it is not surprising that small rms and contractors are dissatised with the de
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Large rms mean 3.83 Medium rms mean Rank 3.10 2 Small rms mean 3.55 Subcontractors mean Rank 3.86 1
5.000
0.005*
Contractual factors Valuation intervals Time lag between being committed to mak-ing a payment to sub-contractors and act-ually paying Time lag between being committed to making a payment to nom. suppliers and actually paying Payment method Time lag between entitlement to receive and actually receiving cash payment Percentage of contract sum retained 3.19 3.06 3 4 3.83 3.42 2 4 3.20 3.09 1 4 3.27 3.27 2 2 2.57 2.71 4 2 5 6 2.29 1.29 5 6 2.90 2.45 5 6 3.00 2.00 5 6 3.17 2.33 5 6 2.83 1.98 3.476 1.322 2.632 2.071
3.30
3.85
3.11
3.20
2.91
2.672
0.061
3 4
2 4 5 6
1 4 5 6
2 1 3 6
3 3 5 6
Contractual factors Valuation intervals Time lag between being committed to mak-ing a payment to sub-contractors and act-ually paying Time lag between being committed to making a payment to nom. suppliers and actually paying Payment method Time lag between entitlement to receive and actually receiving cash payment Percentage of contract sum retained
An evaluation of contractors satisfaction with payment terms layed payment because their sole means of funding the project is through payment received from interim valuations. In many cases, they have to contend with lack of qualied personnel to plan cash ow in advance such that the possibility of delayed payment is already anticipated. This lack of cash ow planning causes undue nancial stress to the contractor, which results in having to fund decit cash ow through borrowed funds. Further analysis based on rm size showed that contractors irrespective of rm size are dissatised with percentage of contract sum retained. This is not surprising because the negative impact of retention on contractors cash ow has widely been criticised. Since the Latham Report (Latham, 1994), which heavily criticised the adverse effect of the use of retention on contractors cash ow, there have been numerous calls in the UK to nd alternatives to cash retention (Cook, 1997; Klein, 1997; Latham, 1997). Again, the fact that the contractor is expected to fund the project while his money is held as retention is not an attractive option among contractors. Further, the length of time the retention sum is held on a contract in which the subcontractors work comes early could be unbearable. Besides, the difculty of securing the release of retention in many cases makes it unattractive. Corroborating this view, National Specialist Contractors Council (2003) in one of its quarterly surveys expressed the opinion of one of its members as follows: Our biggest problem is not with interim payments, which are generally paid, in a reasonable timescale. It is with the nal payment where the main contractor will try to get us to settle on a gure of less than our claim. Retentions are also very difcult to obtain without monumental effort. In short, we as a company will be shrinking in order to lessen our reliance on sub-contract work.
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ASSESSMENT OF CONTRACTORS LEVEL OF SATISFACTION WITH PAYMENT TERMS IN DESIGN AND BUILD CONTRACT
Another analysis was carried out to assess contractors level of satisfaction with payment terms perceived to impact construction cash ow in design and build contract. Table 4 summarises the result of the analysis. From the table, it is evident that overall, contractors were unanimous regarding their satisfaction with valuation intervals, payment method, time lag be tween being committed to making a payment to nominated sub-contractors and actually paying, time lag between being committed to making a payment
to nominated suppliers and actually paying and pay ment method. A cursory look at this list indicates that two of the payment terms, namely, valuation intervals and payment method are payment terms dealing with cash in-ows into the construction business. The fact that contractors were unanimous in the expression of their level of satisfaction regarding these payment terms is an indication that they are working well under the design and build contract. This is not a surprise because the JCT 98 with Contractors Design (WCD) seems to put the contractor in the driving seat regarding valuation intervals and payment method. Clause 30.1.1.1 of JCT 98 with Contractors Design (WCD) for instance states that interim payments shall be made by the employer to the contractor in accordance with clause 30.1 to 30.4 and whichever of alternatives A or B in Appendix 2 is applicable to the contract. Alternative A according to the contract conditions refers to stage payments and alternative B refers to periodic payments. According to Chappell and Powell-Smith (1999), whichever of the alternatives is adopted, it is for the contractor to apply to the employer for payment and he also carries out the valuation. In that regard, as Chappell and PowellSmith (1999) put it, he is in the driving seat. As such, it is not a surprise that overall, contractors are satised with valuation intervals and payment method under the design and build procurement method. Moreover, a further observation of the list of payment terms (Table 4) which contractors appear to be satised with overall, indicates that time lag between being committed to making a payment to subcontractors and actually paying and time lag between being committed to making a payment to nominated suppliers and actually paying are payment terms dealing with cash out-ows from the construction business. Unlike the situation under the traditionally procured contracts, contractors under the design and build contracts were unanimous in their opinion regarding their satisfaction with these payment terms. This is not a surprise because the contractual arrangement under the design and build contract is different from that of traditionally procured contracts. For instance, under the design and build, subcontractors do function as domestic subcontractors, making the main contractor to perceive them as an integral part of their construction outt. On the other hand, the JCT 98 WCD is silent about the issue of nominated supplier. This may be due to the manner in which this is generally interpreted. According to Murdoch and Hughes (2000), a person is only a nominated supplier where the goods or materials to be sup
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H. Odeyinka and A. Kaka procured contract, opinions were signicantly different among the different categories of contractors regarding their level of satisfaction with payment terms dealing with cash out-ows. This suggests that the method and approach employed in dealing with these payment terms vary signicantly from one category of rm to another. This is an issue that will benet from further research. Under the design and build contract, contractors were unanimous in their opinion regarding their satisfaction with valuation intervals and payment method which are payment terms dealing with cash in-ows. This is as expected because the JCT 98 WCD seems to put the contractor in the driving seat regarding these payment terms. Unlike the situation under the traditionally procured contracts, contractors and irrespective of size were unanimous in their opinion under the design and build contracts regarding their satisfaction with time lag between being committed to making a payment to subcontractors and actually paying and time lag between being committed to making a payment to nominated suppliers and actually paying. As these are payment terms dealing with cash out-ows, this suggests that contractors under the design and build procurement method seem to have a similar method and approach of dealing with these payment terms. This again is an issue that will benet from further research, especially when pitched against the nding of Kaka and Dawood (2000) who demonstrated that cash ow proles take different shapes depending on procurement method employed and construction duration. Whilst contractors expressed their satisfaction with the afore listed payment terms under both the traditional and design and build contracts, subcontractors expressed their dissatisfaction on all but valuation intervals. Subcontractors sit at the bottom of a long contractual chain and only get paid after contractors are paid. As such, it is not unexpected that they are dissatised with these payment terms. Besides, in a related study, Odeyinka et. al. (2003) found that delayed payment to subcontractors and suppliers have been identied as some strategies contractors employ to fund their decit cash ow. Having to operate under this payment regime, it is not surprising that subcontractors are dissatised with most of the payment terms. Finally, the study concludes that contractors, irrespective of size as well as subcontractors were unanimous in expressing their dissatisfaction with the twin issues of delayed payment and retentions. These are payment terms that impact cash in-ows into construction business and Abeysekera (2002) has identied them as payment terms responsible for contractors decit cash ow.
plied are the subjects of a prime cost sum. This situation obviously does not arise under the JCT 98 WCD. These major differences in the two procurement methods may explain why contractors were unanimous in the level of their satisfaction to these two payment terms under the design and build procurement method. Although contractors were unanimous in scoring their level of satisfaction with the afore stated payment terms, the subcontractors only expressed satisfaction with valuation intervals but appear dissatised with all other payment terms. This follows the same trend with subcontractors responses under the traditionally procured contracts (Table 3). This is not unexpected because subcontractors under the design and build contracts also get paid only when the main contractor is paid, as such, they suffer the most if client delays payment. Moreover, it is evident from Table 4 that overall; contractors irrespective of size as well as subcontractors were dissatised with time lag between entitlement to receive and actually receiving cash payment (delayed payment) as well as percentage of contract sum retained. This trend is the same with the traditionally procured contracts (Table 3). As such, contractors and subcontractors dissatisfaction with these twin payment terms of delayed payment and retention is not a surprise. This is because these are twin payment terms that are known to be responsible for contractors decit cash ow. Given these twin payment terms, together with the fact that contractors operate at a very low prot margin, it is difcult to expect them to have surplus cash. As such, it is not surprising that overall, contractors as well as subcontractors were dissatised with delayed payment and retentions.
Conclusion
This study has examined contractors level of satisfaction regarding various payment terms thought to impact construction cash ow under both traditionally procured and design and build contracts. The study concludes that overall, contractors seem to be satised under the two procurement systems with valuation intervals, time lag between being committed to making payment to nominated sub-contractors and actually paying, time lag between being committed to making payment to nominated suppliers and actually paying and payment method. Out of these, two payment terms, namely, valuation intervals and payment method deal with cash in-ow into the construction business whilst the other two payment terms deal with cash out-ows from the construction business. However, under the traditionally
An evaluation of contractors satisfaction with payment terms Given these twin payment terms as well as the fact that contractors operate at a very low prot margin, it is difcult to expect them to have surplus cash. It is therefore not surprising that contractors as well as subcontractors were dissatised with delayed payment and retention.
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Recommendations
In view of the fact that contractors and subcontractors are dissatised with delayed payments and retentions, it is suggested that attention may need to be focused on devising new innovative payment systems that will address these issues. Two of such systems that have been suggested by Abeysekera (2002) are transparent accounting and advanced payment (client nanced projects). This obviously is an area that needs further research in order to address this issue of dissatisfaction. In view of the dissatisfaction of the subcontractors to some payment terms that contractors were satised with, it is also suggested that innovative payment systems be devised that will not put the subcontractor at a disadvantage by putting him at the end of a long payment chain. This is because subcontractors are the smallest and most vulnerable. One such innovative payment system that has been proposed is transparent accounting. In all, further research still need to be carried out in order to devise more satisfactory payment systems.
Acknowledgements
The authors wish to acknowledge the constructive comments of the anonymous referees on the rst draft of this paper.
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