Conference Paper 3

1
Working Capital Management in Projects Case Study on Indian Construction Companies

Dr.Hiren Maniar
1

Abstract:

Construction is an essential part of any countrys infrastructure and industrial development. The
Indian construction sector is an integral part of the economy and a conduit for a substantial part of
Indias development investment. Forecasting working capital along with cash requirements is
essential for all construction contractors during the tendering stage since cash flow at the beginning
of the project is a major cause of construction companies failure. In the contracting business,
construction firms are generally more concerned with short-term financial strategies than the long-
term ones. Working capital management is the central issue of all short-term financial concerns.

Unfortunately, estimating least working capital (LWC) is not the mainstream practice of the majority of
contractors in India, who find that the present models for estimating LWC are cumbersome and
seldom give an accurate estimate. Therefore estimates of LWC made during the tendering stage
need to be simplified so they can be prepared quickly with least input. It is important for the developer
or owner to select a qualified contractor with competent financial backing. Main purpose of this
research is to establish the relationship among the factors like inflation, labor wages, material cost,
construction equipment & machineries cost, subcontractor charges, and overhead cost that
contributes to LWC requirements and presents a simple model that could be used as a guide to
estimate LWC for construction projects in India. The estimation is based on percentages of variables
of contract value based on the historical data that influence LWC; the LWC obtained is then
expressed in terms of percentage of contract value.
Key Words: Indian Infrastructure, Construction Projects, Least Working Capital, Factors, Contract
value

Paper Published at PMI (Project Management Institute) India Research & Academic
Conference December 2011 (PMIREC2011)
1
Dr.Hiren Maniar is working as a faculty in finance with L&T Institute of Project Management, Vadodara. He may be
contacted at hm_maniar@rediffmail.com
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Introduction
Every business needs adequate liquid resources in order to maintain day to day cash flows. It
needs enough cash to by wages and salaries as they fall due and to pay creditors if it is to keep its
workforce and ensure its supplies. Maintaining adequate working capital; is not just important in the
short term. Sufficient liquidity must be maintained in order to ensure the survival of business in the
long term as well. Even a profitable business may fail if it does not have adequate cash flows to
meet its liabilities as they fall a due. Therefore when business make investment decisions they must
not only consider the financial outlay involved with acquiring the new machine or the new building
etc, but must also take account of the additional current assets that are usually involved with any
expansion of activity.
Working Capital Management (WCM) is the management of short term financing requirements of a
firm. This includes maintaining optimum balance of working capital components receivables,
inventory and payables and using the cash efficiently for day-to-day operations. Optimization of
working capital balance means minimizing the working capital requirements and realizing maximum
possible revenues. Efficient WCM increases firms free cash flow, which in turn increases the firms
growth opportunities and return to shareholders. Even though firms traditionally are focused on long
term capital budgeting and capital structure, the recent trend is that many companies across different
industries focus on WCM efficiency.

An understanding of working capital is crucial to understanding and analyzing the financial position of
construction contractors. The sureties base their bonding program to a great extent on the amount
and quality of working capital available to the contractor. Many contractors attempt to benchmark their
key ratios to industry standards without understanding what the ratios or benchmarks mean. The
questions posed when examining this subject are:

Why analyze working capital?
What is working capital?
How does it compare to current ratios?
What are the concerns of the surety and the banker?
How much working capital is enough, and how is that determined?
Is there such a thing as too much working capital?
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Is there a consistent manner of computing working capital?

How does a company enhance working capital?

The purpose of this research paper is to provide a basic understanding of the requirement of LWC
(Least working capital) concepts for Indian construction contractors.

Literature Review
Working capital management involves the relationship between a firm's short-term assets and its
short-term liabilities. The goal of working capital management is to ensure that a firm is able to
continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and
upcoming operational expenses. The management of working capital involves managing inventories.
As part of a study of the fortune 500s financial management practices, Gilbert and Reichert (1995)
find that time value of money cash flow analysis is used to select projects in 91 percent of the firms.
Accounts receivable management models are used in 59 percent of these firms, while inventory
management models were used in 60 percent of the companies. Across a limited sample, Weinraub
and Visscher (1998) observe a tendency of construction firms with low levels of current ratios to also
have low levels of current liabilities. Combining accounts receivable and payable into one issue is hill,
Satoris, and Fergusons (1984) finding that payees define date of payment as the date payment is
received, while payers view payment as the postmark date. Additional WCM insight across firms,
industries, and time is needed. Maness and Zietlow (2002, pp. 51, 496) presents two models of value
creation through effective short-term financial management activities.

We can define Least Working Capital (LWC) for a construction project as the minimum cash
requirement for a contractor to complete the construction project within the construction period,
namely the maximum cumulative negative cash flow in the cash flow diagrams (Wilson 1975).

Main aim of this research is to establish the relationships among the factors that contribute to LWC
requirements and to present a simple model that could be used as a guide to estimating LWC for
Infrastructure construction projects in India like roads, bridges, airports, ports etc. Beneficiaries of the
model to be developed are owners or developers involved in the selection of qualified contractors
during the tendering stage. Navon (1996) proposed a relationship between cash flow, cost flow, and
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expense flow. The cost flow is the projection of the projects costs as a function of time. In principle, to
compile the cost flow for a project, the costs of each activity have to be distributed over its duration.
Time lag is not taken into consideration when cost flow is prepared. The money could have been paid
before the activity is performed, that is, used as a down payment or for the services given.
Alternatively, the money may be paid later, upon completion of the credit period. In other words, the
time when a resource is used on the site differs from when it is paid for. This difference is called the
time lag and can be positive or negative, depending on the mode of payment.

Kenley and Wilson (1989) developed a model to forecast the net cash flow of construction projects.
The model is found to have an excellent fit for the data for 80% of the projects analyzed and is useful
for the post-examination of a construction projects net cash flows. This model is very flexible and
capable of adapting to a wide degree of inter-project variability.

Kaka (1996) suggested that further variables be added to enhance the flexibility of the cash flow
produced and proposed a model designed to use more than 50 variables to calculate cash flow for
one individual contract. He also listed five disadvantages of the traditional cash flow model, but the
terms of payment being applied in his model do not suit the terms applied in India.

Application of mathematical models for cost/cash flow forecasting has been discussed by Ashworth
(1997). The data needed for cash flow forecasting with these models are the projects duration, total
cost, and some specific data. Most of the mathematical models are developed for cost flow
forecasting only, while cash flow forecasting mathematical models are based on forecasting the cost
flow first and later translating it into cash flow.

Working Capital Management Concepts

The working capital meets the short term financial requirements of a business enterprise. It is the
investment required for running day to day business. It is the result of the time lag between the
expenditure for the purchase of raw materials and the collection for the sales of finished products.
The components of working capital are inventories, accounts to be paid to suppliers, and payments to
be received from customers after sales. Financing is needed for receivables and inventories net of
payables. The proportions of these components in the working capital change from time to time
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during the trade cycle. The working capital requirements decide the liquidity and profitability of a firm
and hence affect the financing and investing decisions. Lesser requirement of working capital leads to
less need for financing and less cost of capital and hence availability of more cash for shareholders.
However the lesser working capital may lead to lost sales and thus may affect the profitability.

The management of working capital by managing the proportions of the WCM components is
important to the financial health of businesses from all industries. To reduce accounts receivable, a
firm may have strict collections policies and limited sales credits to its customers. This would increase
cash inflow. However the strict collection policies and lesser sales credits would lead to lost sales
thus reducing the profits. Maximizing account payables by having longer credits from the suppliers
also has the chance of getting poor quality materials from supplier that would ultimately affect the
profitability. Minimizing inventory may lead to lost sales by stock-outs. The working capital
management should aim at having balanced; optimal proportions of the WCM components to achieve
maximum profit and cash flow.

Importance of Working Capital Management in the Construction Industry
Traditionally construction business is a low margin business, where the margins can get wiped out
fairly fast if the projects are not executed on time and to requisite quality. Working capital
management is the cornerstone of the construction industry. The working capital requirements flow
from the fact that the contractor has to show considerable progress in project execution before he can
bill his client. And once the bill is raised, the client does get some time before he has to pay up.

Construction contracts are of two types cost plus contract and fixed price contract. In a cost plus
contract, the contractor is reimbursed for permitted costs (permitted as per the construction contract)
plus a percentage of those costs or a fixed fee. These contracts are typically awarded for projects in
which it is very difficult for the owner of the project as well as the contractor to estimate project costs
upfront. This is typically the case for oneoff projects or projects where the scope of work cannot be
defined clearly upfront. In a fixed price contract, the contractor agrees to a fixed contract price and
bears the risk of cost over runs. Typically, these projects are awarded by the owner by inviting a few
chosen contractors to bid for constructing the project, after clearly describing the scope of work, the
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expected performance of the completed project etc. Usually the owner awards the project for
execution to the contractor who bids the lowest price. Needless to say, considering the higher risks to
the contractor than from fixed price contracts, they yield higher margins if the project is executed
flawlessly.
In a fixed price contract, once the contract is awarded, the contract price becomes sacrosanct and
few escalations are allowed. The contractor agrees to pay liquidated damages to the owner for any
delay in project execution. These damages could be structured as penalty per days delay, with or
without an upper cap on the extent of damages. Damages would also have to be paid should the
delivered project fall short on performance grounds. Even at the bidding stage for a project, the
bidders would have to post bid bonds in the form of bank guarantees in favor of the project owner.
This is to assure the owner that the bidder is serious in his bid. If a contractor is awarded the project,
but tries to back out of entering into a firm contract, the project owner can cash in the bid bond. Once
a project is completed, before the contractor gets his final payment, he has to post a performance
guarantee bond in favor of the owner, which the owner can cash in if the project does not perform to
requisite specifications. As a part of their business, contractors have to factor in bank guarantee
expenses for bid bonds and performance bonds. Liquidated damages and performance bonds create
contingent liabilities for construction contractors.
Contractors typically have more receivables than inventory (as work in progress projects are referred
to in some parts of the world). Basically, the work in progress bit is the revenue the company has
booked in its income statement along with associated costs, but has not billed the client for. The
moment the contractor bills the client, the workinprogress head gets converted into receivables.
Because of the way the contractors book revenue on multi-year projects, credit analysts should be
wary when the work in progress head gets large, and possibly bigger than the receivables head. It
could imply that the company is overbooking revenue, which it is in no position to bill on account of
slow execution. Of course, it could be legitimate too if the billing milestones of the contracts
undertaken by the contractor are few and far between, it causes considerable accrual of the work in
progress head in the balance sheet. In that case, the contractor would require considerable amount of
short term debt to fund the big working capital gap. That would cause expending funds for short term
interest payment, which should be fine as long as it is priced into the contract.
The moment a project owner awards a project to a contractor, he pays the contractor a certain
amount as customer advance. This is recognized as a current liability under the head customer
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advances. As the contractor starts executing the project and recognizing revenue, he writes down the
customer advance. This can be an excellent source of financing for the contractors at the early stage
of a project.
Construction, like any other business, requires short term working capital for its existence. When you
start a construction project, you will only have a limited amount of money. This money can be the
savings from your previous project or the upfront money given by the client for this project.
Unfortunately, this money may not be enough to complete the project. You will have to incur
overheads to run your business besides paying salaries to the people who work for you. A major
expense for you will be the procurement of raw materials like cement, structured steel and non-
ferrous metal to get on with the work. These materials can cost much more than what you have and
so it is important to have an alternate source of funding. So, what can one do to meet the
intermediate needs of construction projects? The best solution is to predict factors for considering
and determining working capital requirement for construction projects.
Factors requiring consideration while estimating working capital in construction projects
The average credit period expected to be allowed by suppliers.
Total costs incurred on material, wages.
The length of time for which raw material are to remain in stores before they are issued for
production.
The length of the production cycle (or) work in process.
The length of sales cycle during which finished goods are to be kept waiting for sales.
The average period of credit allowed to customers
The amount of cash required to make advance payment
Factors determining working capital requirements in construction projects
Nature of business
Size of business
Production policy
Manufacturing process
Seasonal variations
Working capital cycle
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Rate of stock turn over

Credit policy
Business cycles
Rate of growth of business
Price level changes
Earning capacity & dividend policy

Case Study on LWC (Least Working Capital) requirement for Indian Construction Companies

Background of Global and Indian Construction Sector

Despite the challenges of the current economic climate, the Indian construction industry has
managed to maintain marginally positive results in the port, civil engineering, and airport and
transport infrastructure sectors. Construction is an integral part of countrys infrastructure and
industrial development. The market size of global construction industry is US $ 7.2 trillion and India
accounts for 7% of market size, raking 3
rd
in the world
2
.As per Global Construction 2020 report, most
of the growth in world will come from Asia (mainly from China and India) and US in next 10 years.
Global Construction sector likely to reach at US $ 12 trillion by 2020. Please refer below figure for
Global Construction Sector growth.

2
Source:Globalconstruction2020report,pleasereferwebsitehttp://www.globalconstruction2020.com/
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Figure-1 Global Construction Sector Growth in 2010

Construction sector in India is second largest after agriculture in terms of employment and accounting
11% of total GDP. Infrastructure segments involve construction projects in different sectors like roads,
rails, ports, irrigation, power etc. The construction industry is primarily driven by Government of India
(GOI) investments on core infrastructure projects and creation of urban infrastructure; industrial
capital expenditure (capex) by corporate sector and development activities of real estate/housing
sector. The sector plays a pivotal role in developing the countrys infrastructure, a pre-requisite for
high levels of economic growth and an area of focus for the GOI. Construction sector accounts for
nearly 45% of the total investment in infrastructure and is expected to be the prime beneficiary of the
surge in infrastructure investment in the near to medium term. The importance that the GOI places on
bridging the countrys acute infrastructure deficit is evident from the two fold increase in the planned
outlay for the infrastructure sector in the 12
th
five year plan. Significant infrastructure investments,
along with revival in industrial Capex (Capital Expenditure) and improvement in real estate scenario,
are likely to catalyse growth for construction companies in India, going forward.
In construction projects, on an average, raw material cost accounts for 30-50% of the total cost major
and subcontracting cost accounts for about 20-40%. Other costs include labor cost, administrative
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expenses and other operating expenses. Since these costs are different for projects in different
segments, cost structure of a particular construction company depends upon its order mix. Major raw
materials consumed by construction industry mainly include cement and steel. So any variation in the
prices of these two basic raw materials has a direct impact on cost of the project and in turn margins
of the companies.

Research Methodology

Most of the previous research pertaining to Working Capital Management in construction projects
focused mainly on project cash flow forecasting. In this research, emphasis is given to determine
LWC (Least Working Capital) requirement in Indian construction projects. Among previous research,
the relationship between cash flow, expense flow, and cost flow developed by Navon (1996) is a good
basis for further study of LWC estimation. Furthermore, this relationship can be adapted to the
construction environment in India.

A new model for LWC estimation for Indian construction projects can be developed by integrating the
knowledge ascertained by Stukhart (1982), Kenley and Wilson (1989), and Navon (1996). The
relationship between cash flow, expense flow, and cost flow developed by Navon (1996) is shown as
below

Expense flow =cost flow +time lag ------------------------------------------------------------------------- (1)

According to Kenley and Wilson (1989), the maximum cumulative negative cash flow is known as the
LWC requirement of the construction project for the main contractor to run the construction project
within the construction period, as follows:

LWC =maximum cumulative negative cash flow. Since the income flow is equal to zero before d
1
3
,
and then the model can be expressed as

LWC =expense flow unit d
1
+overhead until d
1
---------------------------------------------------------- (2)

3
d
1
is time from beginning of construction until first payment received
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Data Collection

A detailed study has been conducted with 16 Indian construction companies
4
with information of 2
projects from 16 construction companies, so that the total number of projects studied was 32, fulfilling
the minimum requirement of 30 projects for model development using multiple regression analysis
(Enns 1985). Most of the projects for 16 construction companies have been executed from 2005 to
2010 and accordingly factors like costs of subcontractor, overhead, material, equipment, and labor
were considered. Data were obtained through various project data base like database, websites and
other sources. The projects selected from these 16 construction companies are involved in
Infrastructure construction projects located in various parts of India. Responses obtained from this
study then formed the basis of the model being developed. Companies involved in this study are EPC
contractors with a paid-up capital of US $ 0.5 million to US $ 20 million
5
.

The type of information gathered included basic information about each project, including the contract
value of the project, duration of the construction activities, and working capital requirements for the
project studied. To enhance the validity of the study, information regarding the background of the
project team and their companies was also collected. In the study mostly Infrastructure Projects like
road, bridge, ports and other construction projects have been studied which are at different locations
in India. For the development of the model, terms of payment (time lag) and percentage of cost
elements (CE) such as costs of subcontractor, overhead, material, equipment, and labor were
collected.

Factors used in the Study of LWC requirement for Indian Construction companies

It was found from various studies that, 76% of Indian construction companies did not estimate the
LWC during the tendering stage, but only prepared the cash flow of projects upon request from their
clients. The contractors refused to estimate the LWC because they first assume they will have
sufficient funds to run the project based on their past experience, and second, they are more
concerned with securing the project than with estimating the required working capital for the project.
This study shows that the main factors that influence LWC in Indian Projects are inflation, labor
4
please refer Annexure I for details of 16 Indian Construction Companies
5
As per the paid-up capital data from various companies websites
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wages, material cost, construction equipment & machineries cost, the subcontractor charges, and
overhead cost.

Inflation Rate (Infl)

The inflation rate is one of the factors that influence the LWC. The increased inflation rate of
the Indian economy from 5.1% in 2005 to 11.5% in 2010
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has increased the burden on local
contractors. Most of the construction material, equipment, and overhead costs have increased
more than 20% according to the 2010 annual financial report. Inflation has influenced the
productivity of construction work because the LWC needs to be increased to meet the
expenses required by the project. Likewise, terms of payment given by suppliers have been
revised during this period to ensure their own smooth cash flow.

Labor Wages (LC)

The term labor is classified into two categories: direct labor and indirect labor. Direct labor is
employed directly by the main contractor, while indirect labor is employed by subcontractors.
Thus, the salaries of direct labor are the contractors responsibility, and this influences the
working capital requirement. This influence is evident in the findings of this study where labor
is one of the main factors that contributed to the LWC requirement. Since labor needs to be
paid at the end of every month, it is an expense that requires immediate cash payment.

Material Cost (MC)

This study ascertained that suppliers terms of payment would affect the total cash requirement
of contractors since the percentage of material cost is very high (more than 50%) when
compared to other cost items. Therefore the impact of material on the working capital
requirement should not be overlooked. Nevertheless, if the credit period given by suppliers is
longer than the duration from the beginning of construction until the first payment is received,
the material cost would not affect the working capital requirement.

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As per RBI report 2010
13
Overhead Cost (OC)

Overhead cost includes all the expenses other than direct costs that need to be spent from the
design stage until completion of a project. It is extremely important to ensure the success of a
construction project. In India, contractors are required to pay a certain amount of money for
insurance, bonds, and other preliminary items to fulfill the tender specifications. These
expenditures will require a large amount of working capital before commencement of any
construction activity. Changes to other cost elements during the construction process will affect
the overhead cost. For example, interruption of material delivery, shortage of labor, or
extension of the use of the plant will increase overhead costs such as supervision, storage of
material, and extra administration.

Subcontracting Charge (SC)

A subcontractor plays a vital role in the construction industry, especially in India, where most
construction activities are awarded to different groups of subcontractors. Generally,
participation of subcontractors in construction projects would decrease the working capital
required for the main contractor as most of the cash required to run the initial work has
become the subcontractors responsibility. If the terms and conditions in the subcontract
require the main contractors to pay their subcontractors after payments are received from
clients, the working capital requirement will be reduced. But this will usually decrease the profit
margin of the main contractor.

Construction Equipment & Machineries Cost (EC)

Equipment and machinery used for construction are usually costly and expensive to move. The
cash requirement for equipment will depend on its ownership. Purchased equipment will need
a higher initial cost compared to hired equipment, and hence is among the factors that
influence the LWC requirement.

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Research Model used for studying LWC Requirement

After identifying the factors that influence LWC requirement in Indian construction projects, the
equation developed earlier can be refined as follows, from Eq. (2):

LWC = 0C
d1
x=0
+ EXP
d1
x=0
----------------------------------------------------------------------------------------- (3)

Assuming that the expenditure (EXP) is uniform throughout the contract period (CP), Eq. (3) can be
simplified as Eq. (4):

LWC =[ 0C
CP
x=0
+ EXP
CP
x=0
]
d1
CP
----------------------------------------------------------------------------------- (4)

At the beginning of any construction activity, expenses can be a submission of labor cost, equipment
cost, material cost, and subcontractor cost to carry out work before the first payment is received.

Expenses (EXP) =labor cost (LC) +Equipment Cost (EC) +Material Cost (MC) +Subcontractor Cost
(SC) ------------------------------------------------------------------------------------------------------------------- (5)

After combining equations (4) & (5), we get

LWC =[ 0C
CP
x=0
+ IC
CP
x=0
+ EC
CP
x=0
+ HC
CP
x=0
+ SC
CP
x=0
]
d1
cp
-------------------------------------- (6)

As cited by Navon (1995), a different time lag for each cost element is important in cash flow
estimation. The same theory applies to LWC estimation. Therefore divergence between d1 and the
time lag of each payment needs to be carefully considered in estimating the cash requirement. Labor
and overhead costs are expenses that need to be paid promptly; hence there is no time lag for these
two costs. However, for equipment, material, and subcontractor costs, certain credit periods are given
to the contractor. These delays will reduce the cash requirement, especially during the initial stage of
construction. By considering these terms of payments, the formula becomes

(LWC) (CP) =d
1
[IC +0C ] +EC( d
1
delay
EC
) +HC( d
1
delay
MC
)
+SC( d
1
delay
SC
) ---------------------------------------------------------------------- (7)
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Both sides of the equation will be multiplied by 100/contract value so that the variables implied by
each element in the equation can be taken as a percentage of the contract value. This is because the
actual cost of each element is not available during the planning stage, and thus the estimated
percentage of these costs makes the estimation of LWC easier.

(LWC) (CP) (100 % Contract sum) ={d
1
[IC +0C ] +EC( d
1
delay
EC
) +HC( d
1

delay
MC
) +SC( d
1
delay
SC
) } (100 % Contract sum) ------------------------------------------ (8)

After the equation has been simplified from Eq. (8) the LWC is expressed in terms of percentage of
the contract value. The inflation rate is added into the equation because it is an important variable
that influences LWC requirement in India, especially for the projects studied, which are Infrastructure
construction projects where the contractors are not compensated for inflation. The inflation rate is
considered in this equation as the predicted average percentage of inflation rate during the
construction period.

(LWC) (CP) =d
1
[IC +0C ] +EC( d
1
delay
EC
) +HC( d
1
delay
MC
)
+SC( d
1
delay
SC
) +inflation rate ---------------------------------------------------- (9)

All the cost variables from the 32 projects studied were analyzed by using multiple regression
analysis via SPSS
7
. The multiple regression analysis is one of the most widely used statistical
methods for analyzing multifactor data and provides a way of empirically identifying how a variable is
affected by other variables. It is also employed for making predictions and judging the strength of
relationships. The lc, oc, ec, and mc are presented in terms of percentage of the contract value; for
example, if the overhead cost of a project is 8% of the contract value, it would be punched in as 8 into
the software program, so that d1 and delay are the time period presented in the scale of weeks, and
C
1
is a constant value without units. When variables are analyzed by using multiple regression
analysis, additional parameters k and C
1
would be introduced; k
x
represents the magnitude of change
on the lwc with an increase of one unit magnitude on variable x, and C
1
is the constant value that
represents the lwc intercept (y-axis) when all the variables are zero (Alreck and Settle 1985).

7
SPSS (Statistical Package for the Social Sciences) software version 10.0
16
(lwc) (CP) =d
1
( k
lc
lc +k
oc
oc ) +k
ec
cc( d
1
delay
ec
) +k
mc
mc( d
1
delay
mc
) +k
sc
sc( d
1

delay
sc
) + k
inf
inflation rate +c
1
---------------------------------------------------------------------- (10)

The output of the multiple regression analysis shows that the F ratio (The F-ratio is used to determine
whether the variances in two independent variables are equal) of the equation is 2,079.167
8
, with a
significant value less than 0.05 and R
2
= 0.998. This shows that the independent variables
(subcontractor, material, inflation, equipment, labor, and overhead) can be confidently used in
estimating the variation in the dependent variable (lwc). Taking into consideration the coefficient of
each variable
9
, the equation is rewritten as follows:

(lmc) (CP) =d
1
( 0.7196 lc +0.6776 oc ) +0.6636 cc( d
1
delay
ec
) +0.8086 mc( d
1
delay
mc
) +0.8784 sc( d
1
delay
sc
) + 0.7796 inflation rate +c
1
------------------------------------------------ (11)

Note:
1. When delay >d1, (d1 - delay) =0; and
2. C is ignored because it is not significant with P value >0.05.

The equation developed above will only be applicable if the following assumptions are made:
1. Proportions of all expenditure are uniform throughout the contract period;
2. The coefficients in the developed equation can only be applied to Infrastructure projects in
India for projects in other places, coefficients shall be developed using data collected from
projects with a similar background; and
3. In most of the cases, the cost of each variable would be unknown during the tendering stage,
so these costs will be provided in terms of percentages of the contract value. The LWC
obtained from the equation is a percentage of the contract value.

8
This has been found out from F- ratio table, considering number of variables for this research are 6 and number of
projects taken for the study is 32, source: http://www.danielsoper.com/statcalc/calc15.aspx
9
All six coefficients have been calculated as per the Multiple Regression Analysis coefficient calculation,
http://www.danielsoper.com/statcalc/calc26.aspx
17
Notation
The following symbols are used in this research paper:
C
1
=constant value;
d
1
=time from beginning of construction until first payment received;
delay =payment time lag;
ec =percentage of equipment cost of contract value (%)
Inflation rate =average inflation rate during contract period (%)
k =coefficient;
lc =percentage of labor cost of contract value (%)
mc =percentage of material cost of contract value (%)
lwc =percentage of least working capital of contract value (%)
oc =percentage of overhead of contract value (%) and
sc =percentage of subcontractor of contract value (%)

Influence of factors on LWC requirement in Indian Infrastructure Projects

In order to clarify the relationships between the LWC and the various factors influencing it, multiple
correlation analysis is carried out with the data gathered from the study. The result is the correlation
matrix in Table 1, which shows the correlations between all possible pairs of variables and indicates
the number of cases used to compute them. In each cell of the correlation matrix, that is, at each
intersection of a given row and column, the top number indicates the correlation coefficient.
Requirement of LWC is strongly affected by material cost, followed by Inflation rate, labor cost,
overhead cost, and equipment cost. Equipment, overhead, labor, inflation and material have positive
correlations of 0.803, 0.817, 0.859, 0.919, and 0.948, respectively, with LWC at a significance level of
0.01. An increment of 1% on material would contribute 0.948% to the LWC.

The factor of the subcontractor has a negative correlation of 0.739 with LWC. This shows that the
higher the proportion of jobs awarded to the subcontractor, the lesser LWC is required. Negative
correlations of 0.604 and 0.635 with the variable of overhead and labor costs, respectively, indicate
that if the proportion of jobs awarded to the subcontractor is higher, then the overhead and labor
costs will decrease accordingly. As mentioned above, the factor of the subcontractor has an inverse
effect on the LWC requirement, so that more jobs awarded to the subcontractor will decrease the
18
cash requirement for the main contractor. Increased subcontractor involvement at a site will definitely
reduce the amount of labor, material, and equipment required by the main contractor. Therefore by
giving additional jobs to subcontractors, the responsibility of the main contractor will be shifted to
supervision work with less attention paid to the cash requirement. Nevertheless, this might produce
other problems such as difficulties during supervision and decreased work quality. Hence the
distribution of jobs to subcontractors should be handled properly to avoid the occurrence of other
problems while reducing the working capital requirement.

Table -1 Correlation Matrix of Factors
Factor Variable LWC Equipment Overhead Labor Inflation Material

Subcontractor
LWC Data correlation
Significance (2-trialed)
N
1.000
N/A
32.000
0.803
0.000
32.000
0.817
0.000
32.000
0. 859
0.000
32.000
0.919
0.000
32.000
0.948
0.000
32.000
- 0.739
0.000
32.000
Equipment Data correlation
N
0.803
0.000
32.000
1.000
N/A
32.000
0.656
0.000
32.000
0.690
0.000
32.000
0.738
0.000
32.000
0.761
0.000
32.000
- 0.504
0.000
32.000
Overhead Data correlation
N
0.817
0.000
32.000
0.656
0.000
32.000
1.000
N/A
32.000
0.702
0.000
32.000
0.751
0.000
32.000
0.775
0.000
32.000
- 0.604
0.000
32.000
Labor Data correlation
N
0. 859
0.000
32.000
0.690
0.000
32.000
0.702
0.000
32.000
1.000
N/A
32.000
0.789
0.000
32.000
0.814
0.000
32.000
- 0.635
0.000
32.000
Inflation Data correlation
N
0.919
0.000
32.000
0.738
0.000
32.000
0.751
0.000
32.000
0.789
0.000
32.000
1.000
N/A
32.000
0.871
0.000
32.000
- 0.679
0.000
32.000
Material

Data correlation
N
0.948
0.000
32.000
0.761
0.000
32.000
0.775
0.000
32.000
0.814
0.000
32.000
0.871
0.000
32.000
1.000
N/A
32.000
- 0.701
0.000
32.000
Subcontra
ctor
Data correlation
N
- 0.739
0.000
32.000
- 0.593
0.000
32.000
- 0.604
0.000
32.000

- 0.635
0.000
32.000
- 0.679
0.000
32.000

- 0.701
0.000
32.000

1.000
N/A
32.000
Note: Correlation is significant at 0.01 level (2-tailed)

Labor and overhead need immediate payment from the contractor to guarantee continuous work
progress. As a result, these two factors have a strong relationship with the LWC requirement. Higher
amounts of overhead and labor, respectively, will increase the working capital requirement. Since
19
repayments of material and equipment are to be made within certain credit periods, they would not
affect the cash requirement adversely during the initial stage of construction.

The factor of inflation has a positive correlation with the requirement for LWC. A higher inflation rate
will increase the LWC requirement as well as the interest rate charged by banks. The situation
becomes worse when suppliers and subcontractors tighten their terms of payment. Overhead cost
has a strong relationship with other costs. Table 1 show that overhead cost has a positive correlation
of more than 0.650 with all the other costs except for subcontractor cost. The cost requirement for all
other items will affect the overhead cost.

Result Analysis

In order to test the validity of the model developed, a series of LWCs were calculated by putting the
data available from various database into the model. These values were then compared to the actual
LWC being used in various construction projects in India. Both actual and predicted values of LWC
have been compared and it was found that the mean actual LWC for the projects studied is 7.93% of
the contract value and has a standard deviation of 2.02%. The LWC predicted for the same projects
by using the model developed is 8.77% of the contract value, with a standard deviation of 2.11%. It is
noted that the mean and standard deviation of the predicted and actual LWC produce only a
difference of less than 0.05%. While this study is among the first to estimate LWC for local practices
in India, several shortcomings can be identified, among them the small volume of data collected and
the lack of availability of required data. These shortcomings could be improved with more data and
more competent database. Due to the constraints of time and resources, the number of projects (32)
only manages to fulfill the requirement for statistical analysis. More variables could be included to
expand the capability of the model and to suit different working conditions.

Conclusion

Working capital is an important liquidity indicator and historically it has been a major benchmark for
the profitability of construction contractors in infrastructure projects. A high return on capital employed
is an illusion if it is accompanied by inefficient or fraudulent working capital management. If
receivables or inventory keep going up disproportionately with growth in sales, ever increasing
20
amount of capital would have to be deployed for financing this working capital requirement. Analysis
of Least working capital (LWC) requirement was done on a sample of 32 infrastructure projects in
India among 16 construction companies. The analysis was done to find out how these infrastructure
project contractors are managing least working capital requirements. When the least working capital
requirement concept is used then it was discovered that working capital management efficiency has
been improved by predicting least working capital requirement during the bidding stage of the
infrastructure projects. It also leads to improvement in profitability of the firms in infrastructure projects
in India in terms of profit margin.

Various historical data on projects with the same contract type in India collected through various
database were analyzed to determine the factors that influence the LWC and the range of these
factors percentages of the overall contract value. In this paper, the data analysis by regression model
with statistical method was used to find out LWC requirement in construction projects. After the
relationship of these factors is determined by using the ANOVA (Analysis of Variance) test, a model is
developed to estimate the LWC. Then the actual LWC and the estimated LWC has been obtained by
using the developed model of these past projects are compared, and the model is proven to have an
accuracy level of up to 9% variance.

The present paper attempts to develop a practical model for Indian construction firms to find out LWC
requirement in construction projects, which should be possessed in any point of time. Main outcome
of this paper is to establish the relationship among the factors responsible for LWC requirements and
presents a simple model that could be used as a guide to estimate the LWC for Infrastructure projects
in India. The estimation in this research is based on percentages of variables of the contract value
based on the historical data that influence the LWC. Then the LWC obtained is expressed in terms of
the percentage of the contract value. The model proposed in this research has been developed to
help the developer or owner of the project to select a qualified contractor with competent financial
background. The user would need at least 30 sets of data (for the development of model using
multiple regression analysis (Enns 1985)) about the LWC and percentages of each cost element to
be plugged into any statistical software to run the multiple regression analysis to get the K values or
the coefficients of the model. Different types of construction work and some other factors such as
location and weather condition would affect the LWC requirement, and these become important
criteria for selecting which historical data to use in the analysis.
21
References

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management, The Journal of American Academy of Business, Vol. 10, No. 1, pp. 149-155.
4. Enns, P. G. (1985). Business statistics, methods and application, Richard D. Irwin.
5. Halpin, D. W., and Woodhead, R. W. (1998). Construction management, Wiley, New York.
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Limited.

22
Annexure - I List of Indian Construction Companies studied for Research

1. Ahluwalia Contracts (India) Limited
2. Ashoka Buildcon Limited
3. BL Kashyap & Sons Limited
4. Consolidated Construction Consortium Limited
5. Era Infra Engineering Limited
6. Gammon India Limited
7. Gayatri Projects Limited
8. Hindustan Construction Company Limited
9. IVRCL Infrastructures & Projects Limited
10. Madhucon Projects Limited
11. Nagarjuna Construction Company Limited
12. Patel Engineering Limited
13. Punj Lloyd Limited
14. Sadbhav Engineering Limited
15. Simplex Infrastructure Limited
16. Unity Infra-projects Limited

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Working Capital Management in Projects Case Study on Indian Construction Companies

Working Capital Management in Projects Case Study on Indian Construction Companies

Is there a consistent manner of computing working capital?

Rate of stock turn over

Figure-1 Global Construction Sector Growth in 2010

Overhead Cost (OC)

Research Model used for studying LWC Requirement

Annexure - I List of Indian Construction Companies studied for Research

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