Factors Affecting Progress Payments in Oil and Gas Industry Projects: Progress Measurement Method and Project Cash Flow

King Fahd University of Petroleum & Minerals

College of Environmental Design

Construction Engineering and Management Department

MASTER OF ENGINEERING REPORT

(CEM 600)

For

Dr. Mohammed Al-Khalil

By

Majed A. Nouraddin

ID No. 936837

Date: May 20, 2004

Factors Affecting Progress Payments

in Oil and Gas Industry Projects:

Progress Measurement Method and

ACKNOWLEDGEMENT

I would like to thank everyone who provide information and assistance in the

preparation of this report.

I would like to thank my supervisor,

Dr. Mohammed Al-Khalil for his

continuous help and guidance.

I would like also to thank all

CEM Professors who taught me during the Master

Degree.

My great thanks and appreciation to my Parents for their continuous support and

encouragement to take my graduate studies, their prayers provided a great support.

My everlasting thanks and great appreciation to my wife and son (Turki) who

supported and sacrificed during my study.

Finally, I would like to thank all my friends and colleagues who supported and

encouraged me during my study.

TABLE OF CONTENTS

SECTIONS

PAGE NOS.

LIST OF TABLES

v

LIST OF FIGURES

vi

REPORT ABSTRACT

vii

CHAPTER 1 INTRODUCTION

1.1

Significance of the Report

1

1.1.1 Progress Measurement

2

1.1.2 Project Cash Flow

3

1.2

Statement of the Problem

3

1.2.1 Progress Measurement

3

1.2.2 Project Cash Flow

4

1.3

Report Structure

5

1.4

Aims and Objectives of Study

7

1.5

Limitations of Study

7

PART I

LITERATURE REVIEW

CHAPTER 2 LITERATURE REVIEW ON PROGRESS MEASUREMENT

2.1

Introduction

9

2.2

Linking Progress Payments to Contractor Performance

10

2.2.1 Schedule of Values

10

2.2.2 Resources Loaded CPM Network

11

2.3

Measuring Work Progress

12

2.3.1 For each Activity and Task

12

2.3.1.1 Unit Completed Method

12

2.3.1.2 Incremental Milestones Method

13

2.3.1.3 Start/ Finish Method

14

2.3.1.4 Opinion Method

14

2.3.1.5 Cost Ratio Method

15

2.3.1.6 Weighted or Equivalent Units Method

15

2.3.2 For Overall Project

16

2.4

Accuracy in Progress Measurement

17

2.5

Earned Value Analysis and Lump Sum Contract

18

2.6

Summary

19

TABLE OF CONTENTS

SECTIONS

PAGE NOS.

CHAPTER 3 LITERATURE REVIEW ON PROJECT CASH FLOW

3.1

Introduction

21

3.2

Major Causes of Business Failure in Construction Industry

22

3.2.1 Insufficient Working Capital

22

3.2.2 Financial Overextension

22

3.2.3 Inadequate Accounting

22

3.2.4 Poor Estimates

23

3.2.5 Poor Management Control

23

3.2.6 Inadequate Investigation of Owner’s Resources

23

3.2.7 Personnel Weakness

23

3.2.8. Personnel Traits

23

3.2.9 Involved in Outside Ventures

24

3.2.10 Industry Hazards

24

3.3

Types of Cash Flow

24

3.3.1 Summary Cash Flow

24

3.3.2 Detailed Cash Flow

25

3.4

Cash Flow from Owner’s Perspective

26

3.5

Reports and Analysis of Project Cash Flow

27

3.6

Summary

29

PART II

RESEARCH METHODOLOGY, DATA ANALYSIS,

CONCLUSIONS AND RECOMMENDATIONS

CHAPTER 4 RESEARCH METHODOLOGY

4.1

Introduction

30

4.2

Data Collection

31

4.2.1 Project Overview

31

4.2.2 Lump Sum Turnkey Contract (LSTK)

31

4.2.3 Required Data

32

4.3

Research Methodology

33

4.3.1 Progress Measurement Method

34

TABLE OF CONTENTS

SECTIONS

PAGE NOS.

4.4

Statistical Inferences about Two Populations

(Matched Samples) Method

36

4.4.1 Procedure

36

4.4.2 Using MS Excel® to conduct a Hypothesis

37

Test about (µ1 –µ2): Matched Samples

CHAPTER 5 DATA ANALYSIS

5.1

Introduction

38

5.2

Progress Measurement

39

5.2.1 Progress Measurement Method specified by Owner

39

5.2.2 Progress Measurement Method used by Contractor

41

5.2.3 Comparison of the Progress Measurement Methods

41

Results

5.2.4 Improving Milestones (0/100) Method

42

5.2.4.1 Provide more breakdowns for activities

42

5.2.4.2 Change the unit of measurement

43

5.2.4.3 Provide more events/milestones

44

5.2.5 Application of the Improved Milestones

(0/100) Method

45

5.2.5.1 Civil Work

45

5.2.5.2 Mechanical Work

49

5.2.5.3 Piping Work

51

5.2.5.4 Electrical Work

54

5.2.5.5 Instrument Work

56

5.2.5.6 Insulation and Painting Works

58

5.2.5.7 Pre-commissioning Work

60

5.2.6 Compression between the Improved Milestones

(0/100) Method and the Original Milestones (0/100)

Method

61

5.2.6.1 Improved Milestones (0/100) Method Data

Calculation

62

5.2.6.2 Comparison of the Progress Measurement

Methods Results

63

TABLE OF CONTENTS

SECTIONS

PAGE NOS.

5.3

Project Cash Flow

66

5.3.1 Method(s)/Technique(s) to Control Project Cash Flow 66

5.3.1.1 Breakdown of Project Cost

66

5.3.1.2 Progress Payment Schedule

67

5.3.1.3 Payment Terms and Conditions

69

5.3.2

Develop Project Cash Flow by Using S-Curve

Method (Case Study)

70

5.3.2.1 Data Required for Projection of Project

Cash Flow

70

5.3.2.2 Projection of Project Cash Flow

74

5.3.3

The Projected Cash Flow against the Actual Cash

Flow

78

5.3.3.1 Statistical Analysis of the Result

79

CHAPTER 6 CONCLUSION

6.1

Introduction

81

6.2

Main Findings

81

6.3

Recommendations

84

REFERENCES 86

APPENDICES

APPENDIX I

:

Construction Progress Assessment Increments

APPENDIX II

:

The

t

Test for Paired Observation

APPENDIX III

:

Disciplines Weight Factors for Construction Work

APPENDIX IV

:

Modified Construction Progress Assessment

Increments

APPENDIX V

:

Progress Calculation Sheets

-v-

LIST OF TABLES

PAGE NOS.

Table 2.1

:

Incremental Milestones Method

12

Table 5.1

:

Cumulative progress figures percentage

62

(%) for 12 Weeks

LIST OF FIGURES

PAGE NOS.

Figure 1.1

:

Report Structure

6

Figure 5.1

:

Project Work Breakdown Structure (WBS)

39

Figure 5.2

:

Milestones (0/100) Method Vs Bill of Quantity 45

Method for Civil Work

Figure 5.3

:

Milestones (0/100) Method Vs Bill of Quantity 51

Method for Piping Work

Figure 5.4

:

Milestones (0/100) Method Vs Bill of Quantity 54

Method for Electrical Work

Figure 5.5

:

Milestones (0/100) Method Vs Bill of Quantity 56

Method for Instrument Work

Figure 5.6

:

The Cumulative Progress Payment Earned

64

for Civil Work

Figure 5.7

:

Difference of the Cumulative Progress Payment 65

Figure 5.8

:

Progress Payment Schedule

73

Figure 5.9

:

Milestones Payment Schedule

74

Figure 5.10

:

Projected Payment Schedule

75

Figure 5.11

:

Project Cash Flow for each Work Category

76

Figure 5.12

:

Overall Project Cash Flow

77

Figure 5.13

:

Projected Cash Flow vs. Actual Cash Flow

78

-vii-

REPORT ABSTRACT

NAME OF THE STUDENT

:

MAJED A. NOURADDIN

TITLE OF THE STUDY

:

FACTORS AFFECTING PROGRESS

PAYMENTS IN OIL AND GAS INDUSTRY

PROJECTS: PROGRESS MEASUREMENT

METHOD AND PROJECT CASH FLOW

FIELD OF THE STUDY

:

CONSTRUCTION ENGINEERING AND

MANAGEMENT: PROGRESS PAYMENTS,

PROGRESS MEASUREMENT METHOD

AND PROJECT CASH FLOW

DATE OF DEGREE

:

JANUARY 21, 2004

Payments to contractor are one of the most important factors necessary for

success of any project. It is essential for project execution and completion.

There are two main factors affecting progress payments in Oil and Gas

industry projects i.e. Progress Measurement Method and Project Cash Flow.

Progress payments are normally linked with contractor performance.

Therefore, progress measurement method used to calculate work accomplished

has large impact on contractor monthly progress payments.

Project cash flow plays a vital role in paying the amount of progress payment

determined by the progress measurement method. Unavailability of fund will

delay/stop the progress payments to contractor.

This research will discuss the affect of Progress Measurement Method and

Project Cash Flow on Progress Payment. Also, it will improve the accuracy of

milestones (0/100) method to ensure that it will provide an acceptable level of

accuracy for both owner and contractor so it can be used as substitute for BOQ

Method. Finally, the research will highlight the method(s)/technique(s) owner

can use for better forecast and control of the project cash flow.

CHAPTER 1

INTRODUCTION

Chapter 1 Introduction

_____________________________________________________________________

Page 1 of 89

C h a p t e r 1

INTRODUCTION

1.1

SIGNIFICANCE OF THE REPORT

Payments to contractor are one of the most important factors necessary

for success of any project. It is essential for project execution and completion.

Contracts normally provide that partial payments of the contract amount shall

be made to contractor for work accomplished to date. This is known as

“Progress Payments” (Hamilton, 2001).

There are two main factors affecting progress payments in Oil and Gas

industry projects i.e. progress measurement method and project cash flow.

Progress payments are normally linked with contractor performance. Therefore,

progress measurement method used to calculate work accomplished has large

impact on determining the amount of progress payments that to be paid to

contractor (Clough and Sears, 1994).

Project cash flow plays a vital role in paying the amount of progress

payment determined by the progress measurement method. Unavailability of

fund will delay/stop the progress payments to contractor (William, 1977).

Chapter 1 Introduction

In summary, project measurement method determines the amount of

progress payment and project cash flow ensures that progress payment is paid

on time.

1.1.1 Progress Measurement

Owner prefers to use a progress measurement method where contractor

claimed progress can be easily verified and checked at work site. Milestones

(0/100) method supports such preference as progress percentage of any work

can be claimed achieved only when specified milestone/event is 100%

completed.

However, contractor prefers to use a progress measurement method that

allows him to report all works done at site. Bill of Quantities (BOQ) method

supports such preference as contractor can claim progress percentage of any

work done at site even though milestone/event is not 100% completed. BOQ

method is very difficult to check and consumes a lot of time to verify. Also, a

certain degree of subjectivity and personal judgment are involved in (Clough

and Sears, 1994).

This research will compare milestones (0/100) method and BOQ method

and then, will improve the milestones (0/100) method to ensure an acceptable

level of accuracy for both owner and contractor.

Chapter 1 Introduction

_____________________________________________________________________

Page 3 of 89

1.1.2 Project Cash Flow

A project cash flow is the forecasting of capital expenditure during the

life of a project. Project cash flow play a vital role in the owner’s financial

planning, which will allow owner to schedule for the injection of funds into the

project (William, 1977).

Owner must wait long time from starting of project until completion

before any return on investment can begin. Owner concerns in project cash

flow are different than contractor. Owner must be assured that sufficient access

to capital is available and remains open all times in order to keep work efforts

flowing efficiently and also, to take advantage of opportunities to accelerate the

work if it will reduce the overall project cost. However, contractor concerns

with the overall cost of the performance of that portion of the overall project

which contractor has contracted to carry out (Sol and Litchfield, 1980).

The research will illustrates some of techniques owner used to control

project cash flow and then, project cash flow will be forecasted by using

S-Curve method. The result will be compared with the actual project cash flow.

1.2

STATEMENT OF THE PROBLEM

1.2.1 Progress Measurement

Owner wouldn’t like to be in a position where contractor be overpaid for

the actual work performed, as first, it cancels the effect of retention, if any, and

second, contractor will get unearned profit as a result of violating the contract.

Chapter 1 Introduction

Overpayment may occurred when contractor claim work as completed in

excess of the amount of work actually done (Fisk, 1997).

In the other hand, contractor wouldn’t like to be in a position where he

will be underpaid for the actual work performed. This will result in shortage of

cash flow which may interrupt the project execution. Underpayment occurred

because of the following (Fisk, 1997):-

i.

Slow payment due to lack of funds arrangement by owner.

ii.

Owner may delay payment to force contractor into expediting

the work.

iii.

Slow processing of contract change orders.

Owner wants to use milestones (0/100) method to prevent overpayment

as contractor will be paid only for the amount of work 100% completed at site.

However, contractor wants to get paid for all works done at site, therefore

contractor prefers to use BOQ method.

1.2.2 Project Cash Flow

Owner wouldn’t like to be in a position where contractor is entitle for

progress payment(s) and owner can not fulfill his contractual obligation.

Failure of controlling the project cash flow will result in partially completed

project and no money which may lead to considerable loses for both owner and

contractor (William, 1977).

Chapter 1 Introduction

_____________________________________________________________________

Page 5 of 89

Therefore, owner needs to use method(s)/technique(s) that will

reinforce his ability to control and forecast the project cash flow.

1.3

REPORT STRUCTURE

Chapter one is an introduction for the report, which underline the

purpose of the report. It includes the significance of the report, the statement of

problem, report structure, aims and objectives of study, and limitations of study.

Part one will be the literature review of factors affecting progress

payments to contractor in general, and progress measurement and project cash

flow in particular. Part one consists of chapters two and three. Chapter two

provides background and literature review on the purpose of progress

measurement method and its affect on progress payment. Chapter three

provides background and literature review on the purpose of project cash flow

and its affect on progress payments.

Part two of this report concentrates on the research methodology,

techniques used for the research, data processing, analysis of the information

gathered and conclusion of the research. Part two consists of chapters four, five

and six. Chapter four discusses the technique used for the research and data

processing. Chapter five is the application and analysis of the report

methodology. It illustrates the data analysis and the study finding. Chapter six

concludes the report and draw out the recommendations.

Chapter 1 Introduction

Finally at the end, the bibliography used for the report and appendices

will be added. Figure 1.1 provides an overview of the report structure.

Chapter 1 Introduction

_____________________________________________________________________

Page 7 of 89

1.4

AIMS AND OBJECTIVES OF STUDY

The major aims and objectives of this report can be summarized in the

following points:

1.

Discuss the affect of Progress Measurement Method and

Project Cash Flow on Progress Payment.

2.

Provide solutions that help in determining the accurate

amount of progress payment and ensuring on time payment to

contractor.

3.

Improve the accuracy of milestones (0/100) method to ensure

that it will provide an acceptable level of accuracy for both

owner and contractor and it can be used as substitute for BOQ

Method.

4.

Develop and discuss the method(s)/technique(s) owner can

use for better forecast and control of the project cash flow.

1.5

LIMITATIONS OF STUDY

The scope of this study is limited to the fallowing:

1.

Oil and gas industry as what is applicable for this industry

may not be applicable for other industries.

2.

Lump Sum Turnkey type of contract. Level of accuracy

Chapter 1 Introduction

Price type of contract required a higher level of accuracy as

contract price is not fixed.

3.

Medium size project that total cost is between 100 – 300

million US dollars. A large size project need more control

scheme and more breakdowns to achieve similar result and

vice versa.

4.

Progress measurement method that will be used to measure

project progress is usually specified by owner in the contract

document. Therefore, this study may be considered as from

owner perspective.

5.

Only progress measurement for construction work will be

discussed in this report. Engineering and Procurement

progress project are almost similar for both milestones (0/100)

and BOQ method.

6.

The research will be focused only on two factors affecting

progress payments to contractor i.e. progress measurement

method and project cash flow.

PART I

CHAPTER 2

LITERATURE REVIEW ON

PROGRESS MEASUREMENT

Chapter 2 Literature Review on Progress Measurement

_____________________________________________________________________

Page 9 of 89

C h a p t e r 2

LITERATURE REVIEW ON PROGRESS

MEASUREMENT METHOD

2.1

INTRODUCTION

Owner is concerned with getting the work completed as per

specification, on or ahead of schedule and on or under budget. Whether or not

these goals are achieved, the daily transactions of the contract must be

supported throughout the project life with auditable documents. Contractor

wants to be paid regularly and on time. The regularity and timeliness of

contractor payments will be depend on the systems and controls adopted by the

project. (Whitticks, 1994)

There is no owner going to pay the full amount of an invoice on

presentation and without verification. There must be an agreed method of

calculating and checking that the work completed or the milestone achieved. It

will be unreasonable for contractor to invoice every day or every time a cubic

meter of concrete is poured or a length of pipe is laid. Progress payment will be

made against milestones achieved, progress per month or on measured progress.

(Whitticks, 1994)

Chapter 2 Literature Review on Progress Measurement

2.2

LINKING PROGRESS PAYMENTS TO CONTRACTOR

PERFORMANCE

A dispute may occur between owner and contractor about the

appropriate payment amount if there is no agreement on how such amount will

be determine. Therefore, progress payments shall be directly tied to the

physical progress of the work accomplished on the project. (Fleming and

Koppelman, 2002) (Fleming and Koppelman, 1995)

Before starting of work, contractor must present a measurable

performance plan against which their performance may be measured to support

payment. Contractor submits to owner a request for payment every month

where he will certify the money have been expended and also include

supporting documentation to demonstrate the physical work has been achieved

in that month. The proposed work plan can be developed by using one of the

following methods (Fleming and Koppelman, 2002) (Fleming and Koppelman,

1995):-

2.2.1 Schedule of Values

Schedule of values approach is the most common approach used in

construction. It is a cost loaded breakout of the contract cost which prepared by

contractor and verified by owner. Once agreement is reached, the proposed

schedule of values is used throughout the project life to calculate physical

performance. The schedule of values will be changed only to incorporate the

authorized changes by owner. Schedule of values has its flaws and potential

Chapter 2 Literature Review on Progress Measurement

_____________________________________________________________________

Page 11 of 89

overestimating the values of the early work tasks and offset the values of the

later tasks, which are correspondingly understated. Frontloading happens

accidentally, inadvertently or intentionally. Such potential risk can be offset by

10% retention value or by delays in making payments. However, there is no

better than risk mitigation by assuring that costs are weighted properly before

approving the schedule of values.

2.2.2 Resources Loaded CPM Network

This approach is a more recent development in the construction industry.

It requires contractor to develop a performance plan that takes a form of critical

path method (CPM) schedule and contains time-phased resources. This

approach provides the following benefits to owner:-

i.

It demonstrates during contractor selection process that contactor is

aware of project scope of work and he has a plan to demonstrate this

fact.

ii.

It demonstrates that contactor is aware and has a plan for all the

required resources.

iii.

Such plans can be used as a project baseline to monitor contractor

Chapter 2 Literature Review on Progress Measurement

2.3

MEASURING WORK PROGRESS

2.3.1 For each Activity and Task

Project is usually divided into several phases. Each phase contain one or

more deliverables. Number of activities and tasks need to be done to provide

the deliverables for the definition, implementation and completion of each

phase. The progress of activities and tasks can be measured using different

methods. These methods are:

i.

Unit Completed Method

ii.

Incremental Milestones

Method

iii.

Start/ Finish Method

iv.

Opinion Method

v.

Cost Ratio Method

vi.

Weighted or Equivalent Units Method

2.3.1.1 Unit Completed Method

Unit Completed Method is applicable to activities and tasks that are

repeatable. The units of measurement that can be used in this method include

linear, square area, cubic etc. The work to be measured may contain single or

multiple tasks. Examples of using this method for single task could be pipe

lying. If 40,000 linear meters of pipe to be laid and 4,000 linear meters of pipe

have been laid, the percent complete is founded by dividing 4,000 linear meters

by 40,000 linear meters to show 10 percent complete. Examples for multiple

Chapter 2 Literature Review on Progress Measurement

_____________________________________________________________________

Page 13 of 89

tasks work could be placing and finishing a reinforced concrete. If 100 cubic

meters of concrete to be poured and 40 cubic meters of concrete have been

poured, the percent complete is founded by dividing 40 cubic meters by 100

cubic meters to show 40 percent complete. (AACE, 2003) (AACE, 2002)

(Hamilton, 2001)

2.3.1.2 Incremental Milestones

Method

Incremental Milestones

Method is applicable to activities and tasks that

must be handled in sequence. For example, installing a pump in an industrial

plant includes the following sequential activities and tasks:

Task/Activity

Incremental Progress

Cumulative Progress

Material Receipt

5

5

Rough Setting

15

20

Level and Grout

30

50

Align and Couple

40

90

Lubricate and Rotate

10

100

Completing any subtask is considered to be the achievement of a

milestone and each incremental milestone completed represents a certain

percentage of the total installation work. The percentage allocated to each

milestone is normally based on the number of workhours estimated to do that

Chapter 2 Literature Review on Progress Measurement

subtask in relation to the total work need to be done. (AACE, 2003) (AACE,

2002) (Hamilton, 2001)

2.3.1.3 Start/ Finish Method

Start/Finish Method is applicable to activities and tasks that are not

readily definable into incremental milestones or those for which the effort/time

required is very difficult to estimate. For such tasks, a percent complete is

arbitrarily assigned to the start of a task and 100 percent is recorded when the

task is completed. For very short duration, the start/finish percentages are

usually 0 percent /100 percent. For short duration, a starting percentage of 50

percent is reasonable and for tasks with a longer duration, 20 to 30 percent

would be probably used. (AACE, 2003) (AACE, 2002) (Hamilton, 2001)

2.3.1.4 Opinion Method

In this method, an expert person usually assigns a percent complete to

the activity/task. This complete percentage is subjective and depends on

personal judgment. The major problem with this approach is that some experts

are optimists and some are pessimists. Therefore, there could be major

differences of opinion in the progress reported for the same or similar task or

activity. This is a subjective approach and should be rusticated to minor tasks

and activities. Examples of task and activities applicable for this approach are

dewatering, temporary facilities and landscaping. (AACE, 2003) (AACE,

2002) (Hamilton, 2001)

Chapter 2 Literature Review on Progress Measurement

_____________________________________________________________________

Page 15 of 89

2.3.1.5 Cost Ratio Method

Cost Ratio Method is applicable to tasks and activities that take a long

period of time or continue as long as the project life. Examples for such tasks

and activities are project management, quality assurance and quality control,

contract administration and project control. The percentage complete at any

time is founded by evaluating the actual cost or workhours expended to that

time divided by the forecast cost or workhours at completion. For example, if

the percent complete for project management need to be found at certain date

given that 5,000 workhours are spent to date and 10,000 workhours are the

total workhours forecast, then project management is 50 percent complete.

(AACE, 2003) (AACE, 2002) (Hamilton, 2001)

2.3.1.6 Weighted or Equivalent Units Method

Weighted or Equivalent Units Method is applicable to activities and

tasks that take a long period of time and composed of two or more overlapping

subtasks. Each subtask measured with a different unit of work measurement.

Structure steel erection is an example for which this method may be applied.

The subtasks for structure steel erection could be run foundation bolts (each),

shim (percent), shakeout (percent), columns (each), beams (each), cross braces

(each), girts and sag rods (bay), plumb and align (percent), connection (each)

and finally punch list (percent). Each subtask for structure steel erection has a

different unit of measurement. To handle this, each subtask is weighted

according to the estimated level of effort (usually workhours) that will be

Chapter 2 Literature Review on Progress Measurement

dedicated to that subtask. As quantities are completed for each subtask, the

quantities are converted into equivalent workhours. (AACE, 2003) (AACE,

2002) (Hamilton, 2001)

2.3.2 For Overall Project

Subsection 2.2.1 discussed the different ways exist for measuring work

progress on a single work item. The next step is to develop a method for

determining overall percent complete for an entire project. The system for

achieving this is called earned value. Also, the following terms can be used

“achieved value”, “accomplished value” or “physical quantity measurement”.

(AACE, 2002)

When developing a control system for any project, the project must be

divided into controllable parts. To control work, work breakdown structure

(WBS) shall be developed. WBS is a deliverables oriented grouping of project

elements that organize and define the total work scope of the project which it

will be used in determining project progress. Each descending level represents

an increasingly detailed definition of the project work. (AACE, 2003) (AACE,

2002) (Haugan, 2001)

Each task in the project shall have its own cost/workhours budget. To

calculate overall project progress, the following formula shall be used:

(AACE, 2002)

Earned workhours or cost for all tasks

Budget workhours or cost for all tasks

Percent Complete =

Chapter 2 Literature Review on Progress Measurement

_____________________________________________________________________

Page 17 of 89

2.4

ACCURACY IN PROGRESS MEASUREMENT

The accuracy of progress measurement depends on two factors:-

i.

Accuracy of the data collected for the work accomplished

ii.

Accuracy of the total scope of work

The accuracy of the data collected can be achieved if the physical

quantities measured for progress are small enough that judgment factors used

do not grossly affect any large quantities. Meeting this end takes time and

effort in the initial setup phase of the progress measurement system. However,

this is rewarded with easy updating of the system. (Toth, 1983)

To accurately reflect the scope of work, the baseline must periodically

be reviewed and forecast. At the initial stage of setup the progress

measurement system, the man-hours from the budget would be the original

baseline. (Toth, 1983)

A study was done in 1989 by Andrew Smith to develop a new progress

measurement method that can achieve the accuracy required in progress

measurement with far less detail than the traditional progress measurement

methods. He claimed that the aim of calculating project progress is only to

enable the scheduler to analyze progress to find out the cause of slowdowns, so

management can handle them on the right time. (Smith, 1989)

His new method was based on the “Law of Compensating errors”. The

law is defined as the statistical tendency of errors in measurement to cancel

Chapter 2 Literature Review on Progress Measurement

each other out. He defined the accuracy of the total as two standard deviations

which will include 95% of all results. He found that the factors affecting the

accuracy of a total number are:-

i.

Number of items in the breakdown

ii.

Accuracy of measurement of each item

iii.

Number of items in the breakdown that are varying in any one

progress period.

2.5

EARNED VALUE ANALYSIS AND LUMP SUM CONTRACT

Under Lump Sum contract, contractor is given progress payment based

on presentation of percentage complete together with the authorized budget for

the completed work. This is earned value at its finest. However, earned value

analysis cannot be completed with the aforesaid information as the actual cost

spent by contractor is missing. Without the actual cost related to earned value

achieved, the cost performance index (CPI) can not be determined. Contractor

will not disclose to owner how much profit he is making on a project. Also,

such information is not important to owner as his concern is to complete the

project on or under the contract price. However, owner should be aware when

contractor is incurring a loss as the bigger the loss the more likelihood the

contractor may not complete the project. (Fleming and Koppelman, 2002)

Chapter 2 Literature Review on Progress Measurement

_____________________________________________________________________

Page 19 of 89

2.6

SUMMARY

This chapter set out to highlight the purpose of progress measurement

and its affect on progress payment in construction industry. The findings of this

chapter can be summarized as follows:-

i.

Progress payments are paid on regular basis, usually in monthly

basis.

ii.

Progress payments must be linked to contractor performance.

iii.

Performance plan must be developed and agreed on before

starting progress payments. Two methods can be used to

develop the performance plan: Schedule of Value method and

Resources Loaded CPM Network method.

iv.

Contractor must submit auditable documents when he applies

for any progress payment along with all supporting documents.

v.

There are five methods to measure progress for individual

activity/task: Unit Completed Method, Incremental Milestones

Method, Start/ Finish Method, Opinion Method, Cost Ratio

Method and Weighted or Equivalent Units Method.

vi.

Overall project progress can be measured by combining the

Chapter 2 Literature Review on Progress Measurement

vii.

The accuracy of progress measurement depends on two factors:

accuracy of the data collected for the work accomplished and

accuracy of the total scope of work.

viii.

Earned value analysis cannot be completed under Lump Sum

contract because cost performance index (CPI) cannot be

determined with the available information. Contractor will not

disclose to owner how much profit he is making on a project.

CHAPTER 3

LITERATURE REVIEW ON

PROJECT CASH FLOW

Chapter 3 Literature Review on Project Cash Flow

C h a p t e r 3

LITERATURE REVIEW ON PROJECT CASH

FLOW

3.1

INTRODUCTION

One of the most important aspects of achieving any project objectives is

cash flow management. A basic control system should be able to consider and

compare the estimated project cost to actual (Fogel, 1997).

Contractor needs an estimate of the frequency of progress payments

from owner that when combined with the forecast of payments to labors,

materials and subcontractors will enable estimate to be made for the cash

requirements. This helps contractor to identify possible financial crisis as well

as interest payments on short term borrowings. Owner will also be concerned

with the availability of cash needed to fulfill his contractual obligations for

progress payments. (Lowe and Lowe, 1988)

Chapter 3 Literature Review on Project Cash Flow

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Page 22 of 89

3.2

MAJOR CAUSES OF BUSINESS FAILURE IN CONSTRUCTION

INDUSTRY

Philip Copare in his article “Cash Flow Management through Front-End

Loading” summarized the major causes of business failure of construction

industry in US as follows (Copare, 1990):-

3.2.1 Insufficient Working Capital

This may happen when contractor does not realize that he must have

sufficient working capital to pay his project expenses such as labor, overhead,

and project startup. When project awarded, contractor will has to finance the

project for about six weeks or more before any payment is made by owner.

Therefore, contractor must utilize his own financial reserve, a line of credit or

other resources until advance payment/progress payments are made by owner.

3.2.2

Financial Overextension

Contractor will continue adding new projects to his workload without

considering his working capacity and available resources. Any delay in

payment with insufficient resources will cause failure.

3.2.3

Inadequate Accounting

This may happen when contractor does not realize the important of

sounds financial records. He will keep all projects funds into one account,

borrow from one project to finance another and not get advantage of material

discounts. Also, he does not sustain accurate cost records for analyzing

construction progress.

Chapter 3 Literature Review on Project Cash Flow

3.2.4

Poor Estimates

Contractor estimates are not accurate due to failure in identify the unit

labor cost for each item of work, the unit cost of material, the cost of

subcontractors, overhead cost and profit will result in low bids without

sufficient funds to do the work or running the business.

3.2.5

Poor Management Control

This may happen when contractor fail to provide and fulfill one or all of

the basic management functions, i.e. planning, organizing, leading, staffing and

controlling.

3.2.6

Inadequate Investigation of Owner’s Resources

This may happen when contractor fail to investigate owner financial

position before project award. Owner may run out of money before project is

completed, which will lead to partially completed project and no money.

3.2.7

Personnel Weakness

Contractor must dedicate many hours to a project in order to reach

successful completion time and cost wise. Some contractors are not willing to

do that to reach these goals.

3.2.8

Personnel Traits

Some contractor cannot deal effectively with owner, subcontractors and

employees. They may have a problem in their personal and public relations.

Chapter 3 Literature Review on Project Cash Flow

_____________________________________________________________________

Page 24 of 89

Therefore, many owners, subcontractors and employees will choose to do

business with other contractors.

3.2.9

Involved in Outside Ventures

Many contractors will speculate in real estate projects by taking an

equity position in the project, thus resulting in insufficient funds to meet

payment requirements.

3.2.10 Industry Hazards

Construction industry is a hazardous business. Contractors increase their

risk every time they undertake new project. Even after many successful

projects, it only takes one bad project to bring a company from success to

failure.

3.3

TYPES OF CASH FLOW

Project cash flow can be furnished in both summary and detailed.

Summary cash flow is representing total expenditure and it is necessary for

long-term planning. Detailed cash flow is necessary for short-term planning

and for the projection of summary cash flow. (William, 1977)

3.3.1

Summary Cash Flow

Summary cash flow is developed during the proposal or the conceptual

phase of the project based on historical records for similar facilities. The data

that required for developing summary cash flow are:-

Chapter 3 Literature Review on Project Cash Flow

i.

Cash flow experience (overall and by component)

ii.

Manpower curves

iii.

Milestone schedule dates and duration

With the availability of the aforesaid data, owner and contractor are in

good position to make the adjustment required for the project and then develop

the project summary cash flow. As project progress, the project summary cash

flow can be revised as more data and decisions are available. The revision can

be made based on impact to the areas concerned, such as:

i.

Delivery of major equipment

ii.

Bulk material installation

iii.

Labor man-hour requirements

iv.

Known design criteria

3.3.2

Detailed Cash Flow

As project progress into detailed design, procurement and construction

phases cash flow can be detailed and developed for the following major items:-

i.

Critical equipment

ii.

Other equipment

iii.

Bulk material

iv.

Labor direct cost

Chapter 3 Literature Review on Project Cash Flow

_____________________________________________________________________

Page 26 of 89

vi.

Design cost

vii.

Contingency

viii.

Escalation

The total of all items must equal to the summary cash flow and hence

tied back to the latest estimate and schedule.

3.4

CASH FLOW FROM OWNER’S PERSPECTIVE

The reasons owner need to forecast project cash flow can be

summarized as follows (Lowe and Lowe, 1988):-

i.

To identify the interest payments on shot-term borrowing

during the project life.

ii.

To ensure that there is enough cash to meet all contractual

obligations during the project life.

iii.

To enable owner to plan and try to optimize his financial

position.

iv.

To enable owner to select the best schedule of the project that

will avoid overspending or significant underspending.

Cash flow limitation can have both positive and negative impact on a

project. On the positive side, experience has shown that any cash flow

limitations imposed on a project automatically creates more management

attention to the project. On the negative side, this means that project can not be

Chapter 3 Literature Review on Project Cash Flow

completed due to funds shortage. Such issue can be avoided by classifying

project activities to critical and non-critical. Activities classified as non-critical

can be shifted to be completed at later stage of the project as soon as budget

allow. However, if budget does not allow and these activities are not required

for operation, it can be delayed after plant start-up. (William, 1977)

On the other side, availability of cash will provide owner the

opportunity to accelerate the work if it will reduce the overall project cost.

(William, 1977)

3.5

REPORTS AND ANALYSIS OF PROJECT CASH FLOW

Reporting of project cash flow is an essential part of any cost control

system. It requires full commitment from the project management team. The

elements of project cash flow are the responsibility of various project

management team members and their accountability for performance must be

imposed. (William, 1977)

A tracking mechanism shall be developed and maintained to provide the

project management with the required data that will improve the decision

making process. (William, 1977)

Chapter 3 Literature Review on Project Cash Flow

_____________________________________________________________________

Page 28 of 89

Often the actual expenditure deviates from the plan with no

corresponding recognition in the schedule. This could be due to:-

i.

An unrealistic schedule

ii.

An unrealistic cost estimate

iii.

An unrealistic cash flow

If the cash flow has been imposed to fit an unrealistic schedule, the

expenditure, above or below the plan, will deviate regularly and should cause

for a reevaluation of the project schedule. Lower than expected cash flow may

indicate a potential schedule delay and on the other hand, expenditure above

Chapter 3 Literature Review on Project Cash Flow

3.6

SUMMARY

This chapter set out to highlight the purpose of project cash flow and its

affect on progress payment in construction industry. The findings of this

chapter can be summarized as follows:-

i.

Inadequate investigation of owner’s resources is one of the

major causes of business failure of construction industry.

ii.

Project cash flow can be furnished in both summary and

detailed. Summary cash flow is representing total expenditure

and it is necessary for long-term planning. Detailed cash flow

is necessary for short-term planning and for the projection of

summary cash flow.

iii.

Owner needs to forecast project cash flow

a.

To identify the interest payments on shot-term borrowing.

b.

To ensure that enough cash are available in order to meet

his contractual obligation.

c.

To plan and try to optimize his financial position.

d.

To select the best schedule for the project.

iv.

Reporting and monitoring project cash flow is an essential part

of any cost control system.

v.

Analyzing project cash flow will improve the decision making

PART II

RESEARCH METHODOLOGY,

DATA ANALYSIS,

CONCLUSIONS AND

RECOMMENDATIONS

CHAPTER 4

Chapter 4 Research Methodology

_____________________________________________________________________

Page 30 of 89

C h a p t e r 4

RESEARCH METHODOLOGY

4.1

INTRODUCTION

The explanatory research presented in chapters 2 and 3, explored the

importance of progress payments in success of any project. It also shows the

significance of progress measurement method and project cash flow as factors

affecting progress payments.

Chapter 2 illustrates that progress payments shall be directly tied to the

physical progress of the work accomplished on the project. Therefore, the

method of measuring the physical progress of the work accomplished will

affect progress payments to contractor. Owner has the right to verify the

physical progress of the work accomplished reported by contractor. However,

this process should not take long time; otherwise payments to contractor will be

delayed. Any delay in progress payments to contractor will jeopardize the

success of the project as contractor will has to fund the project from his own

financial resources. Progress measurement method for any project should be

selected carefully in order to reflect an accurate physical progress measure and

also, it should be easily verifiable.

Chapter 4 Research Methodology

Chapter 3 shows the importance of project cash flow and how

insufficient owner financial resources can cause a business failure in

construction industry. Unavailability of funds may delay or stop progress

payments to contractor. Therefore, projection and control of project cash flow

are essential for any project success and also, it must be included in any project

control system.

4.2

DATA COLLECTION

Required data for this report is collected from a medium size project that

being built in Jubail Industrial City in the Eastern Province of Saudi Arabia.

4.2.1 Project Overview

The scope of the project is to build a new petrochemical plant based on

Lump Sum Turnkey Contract (LSTK). The contract was signed between a

leading Saudi petrochemical company and an international contractor from

Japan. The project duration is 30 months.

4.2.2 Lump Sum Turnkey Contract (LSTK)

This is an arrangement between owner and contractor to perform both

design and construction under a single design build contract. Contractor can

subcontract portion of the project scope of work (usually construction). This

type of contact has gained great acceptance by both owner and contractor as an

optimum delivery method of executing Oil and Gas projects. (Al-Doukhi,

2000)

Chapter 4 Research Methodology

_____________________________________________________________________

Page 32 of 89

4.2.3 Required Data

Two case studies from the above project will be utilized in this report.

First case is about progress measurement method. Owner specified in the

contract that milestones (0/100) method shall be used to measure the physical

progress of the project. However, after several months of reporting the

construction work progress, contractor claimed that milestones (0/100) method

is not reflecting the accurate progress for the project and because of that he is

facing the following problems:

i.

Progress payment is affected by the low progress figures

reported by using milestones (0/100) method. On other hand,

contractor is paying his subcontractors based on BOQ method

and as a result of that he has a negative cash flow.

ii.

Project performance will be always lower than the actual

progress and site condition will not be reflected accurately.

Contractor presents progress figures for both milestones (0/100) method

and BOQ method for the first 13 weeks of the project construction work. This

data will be used in the first part of this research.

Second case is about project cash flow. Actual project cash flow will be

compared with a forecasted project cash flow developed after implementing a

certain methods/techniques required for better forecast and control of project

cash flow. The following information is required to forecast the project cash

flow:

Chapter 4 Research Methodology

i.

The project cost breakdown

ii.

The project duration

iii.

The payment terms of the contract

iv.

The projected expense curve for the project

v.

The projected progress curve for the project

vi.

The actual progress payments for the project

4.3

RESEARCH METHODOLOGY

This report is divided into two sections. The first section is about

progress measurement method and the second is about project cash flow.

Following are commons research steps for both sections:

i.

The research problems were formulated and described in

chapter 1.

ii.

A thorough literature review on the affect of progress

measurement method and project cash flow on progress

payments was conducted. The findings are summarized in

chapters 2 and 3.

iii.

The information required for the literature review was obtained

through available books, published articles, published studies

and the internet.

Chapter 4 Research Methodology

_____________________________________________________________________

Page 34 of 89

iv.

Data required for the research was identified and collected from

a medium size project that being built in Jubail Industrial City

in the Eastern Province of Saudi Arabia.

4.3.1 Progress Measurement Method

The methodology adopted for this section is summarized in the

following steps:

i.

An overview of milestones (0/100) method and BOQ method

will be presented.

ii.

Compare the results of milestones (0/100) method and BOQ

method by using the

t

Test for Paired Observation method to

prove that there is a significant difference between the two

progress measurement methods.

iii.

Improve the accuracy of milestones (0/100) method to ensure

that it will provide an acceptable level of accuracy for both

owner and contractor. This will be done by improving the

progress measurement of each work discipline, e.g. civil,

mechanical, instrument etc…

iv.

Simulate the progress calculation for the same project to

calculate the progress figures for the improved milestones

(0/100) method.

Chapter 4 Research Methodology

v.

Compare and analyze results of the improved milestones

(0/100) method and BOQ method by using the

t

Test for Paired

Observation method to prove that the improved milestones

(0/100) method can be used as a substitute for BOQ method.

vi.

The report will be closed by presenting the conclusion and the

recommendation that will be achieved.

4.3.2 Project Cash Flow

The methodology adopted for this section is summarized in the

following steps:

i.

Develop and discuss the method(s)/technique(s) owner can use

for better forecast and control of the project cash flow.

ii.

Forecast the project cash flow by using the S-curve method.

iii.

Compare and analyze the projected project cash flow with the

actual cash flow by using the

t

Test for Paired Observation

method to prove that the discussed methods and techniques will

help owner in forecasting and controlling project cash flow. .

iv.

The report will be closed by presenting the conclusion and the

Chapter 4 Research Methodology

_____________________________________________________________________

Page 36 of 89

4.4

THE

t

TEST FOR PAIRED OBSERVATION

This method is selected because there are two progress figures reported

for one project for different time period. Another reason for selection of this

statistics technique is the independence condition. This case is in clear violation

of independence condition as the two samples consist of pairs observations

made on the same project.

4.4.1 Procedure

The appropriate procedure to perform this test is as follows (Mendenhall

and Sincich, 1992)(Hamburg and Young, 1994):

D

H

D

H

D

H

D

H

D

H

O

a

O

a

O

a

O

O

O

O

or

<

>

−

≠

−

−

=

−

=

−

)

(

:

)

(

:

)

(

:

)

(

:

)

(

:

2

1

2

1

2

1

2

1

2

1

µ

µ

µ

µ

µ

µ

µ

µ

µ

µ

( )

( )

1

1

&

Where

,

:

Statistic

Test

2

2

2

−

∑

−

=

−

=

=

−

=

∑

∑ −

∑

n

n

n

n

d

d

n

D

d

t

d

d

d

d

S

S

d

d

difference

sample

mean

=

d

difference

sample

of

deviation

standard

=

difference

population

mean

=

D

pairs

in

difference

sample

=

d

pairs

of

number

1

S

d

=

−

=

n

n

df

[

α

]

α

α

t

t

or

t

t

t

t

−

<

<

>

Rejection

Region

:

_/2

:

Region

Rejection

Two-Tailed Test

One-Tailed Test

Chapter 4 Research Methodology

4.4.2 Using MS Excel® to conduct a Hypothesis Test about (

µ

1

–

µ

2

):

Matched Samples

The following steps shall be followed in order to conduct a Hypothesis

Test by using MS Excel® (Williams, 2001):

i.

Step 1 Select the Tools pull-down menu

ii.

Step 2 Choose the Data Analysis option

iii.

Step 3 Choose

t

-Test: Paired Two Sample for Means from the

list of Analysis Tools

iv.

Step 4 When the

t

-Test: Paired Two Sample for Means dialog

box appears:

-

Enter first data range in the

Variable 1 Range

box

-

Enter second data range in the

Variable 2 Range

box

-

Enter

D

o

value in the

Hypothesized Mean

Difference

box

-

Select

Labels

-

Enter a value in the

Alpha

box

-

Select

Output Range

-

Enter E2 (your choice) in the

Output Range

box

CHAPTER 5

DATA ANALYSIS AND

APPLICATION

Chapter 5 Data Analysis and Application

C h a p t e r 5

DATA ANALYSIS AND APPLICATION

5.1

INTRODUCTION

In this chapter, we will examine the two factors that affect progress

payments. Section 5.2 discusses progress measurement. It highlights the

progress measurement method specified by owner as well as the progress

measurement method used by contractor. Comparison between the result of

milestones (0/100) method and BOQ method is presented in subsection 5.2.3.

In subsection 5.2.4, steps of improving milestones (0/100) method is explained.

Application of the Improved Milestones (0/100) Method is presented in

subsection 5.2.5. Finally, Compression between the Improved Milestones

(0/100) Method and the original Milestones (0/100) Method results is discussed

in subsection 5.2.6.

Section 5.3 discusses project cash flow. Methods/techniques owner can

use for better forecast and control of the project cash flow are presented in

subsection 5.3.1. Steps for projection of project cash flow by using S-Curve

Method are explained in subsection 5.3.2. In subsection 5.3.3, comparison

between the projected cash flow and the actual project cash flow is illustrated.