Cash moves at a different pace than activities.
Maybe that seems obvious, or maybe you’re not sure what I’m talking about; but it’s an important distinction to understand in construction project management.
Cash Flow in Project Management
When I first started working in project management, I had envisioned a job where I would spend my days walking around the construction jobsite carrying a big stick (not really) and telling people what to do. That appealed to me because I like organizing things and I get a kick of satisfaction when I see things moving along smoothly. To be honest, I’m actually better at organizing others than I am at organizing myself. You’d only have to take one peek at the disaster in my garage to see that in action. Anyway, the reality of my project management career has been that I’ve spent very little time at the actual jobsite, and most of my time with my face buried into schedules, budgets, cost projections, contracts and approving timesheets. Working with a smaller company managing big-ish projects, I had to learn quickly how to be a lot of things: a scheduler, cost controller, supply chain manager and the boss of a crew of people, all at the same time.
If someone would’ve told me back then that “cash moves at a different pace than activities”, I would have stared blankly back at them thinking, “ya, so what?” Because I didn’t really understand the full implications of that. Budget, committed, actual, incurred, accrual, invoiced – I kept seeing words like this, but I considered them to be the domain of accounting and not project management. Oh, how wrong I was.
Spend Forecast vs. Cash Flow
To understand the difference between a Spend Forecast versus Cash Flow, it’s important to first understand how costs are incurred on a project versus how cash actually exchanges hands. When a budget is created for a project, that budget is time-phased to the schedule to synchronize time with cost. This enables cost engineers and the like to plan for when costs are anticipated to be incurred. Just because cost has been incurred however, doesn’t mean that the money has actually been spent. At the moment an activity is completed, the cost for that activity is recognized on the project (incur) and is considered a liability (accrual) until it’s eventually invoiced and paid for.
For example, let’s say you order 100 bags of cement to be delivered to the jobsite for next week. The bags arrive as requested and the delivery guy hands over a packing slip or receiving document to the jobsite receiver. At the moment the bags are delivered, you haven’t actually paid for them yet, but you now have them in good order and you’re obligated to pay for them. Two weeks after that, you receive an invoice from the cement company to pay for the delivery.
5 Stages of Project Cost
With that example, you can see how cost appears on projects in various states as it transitions from being an initially budgeted cost, all the way to being completed and paid for.
Budget: You initially planned for 100 bags of cement when first creating the project plan.
Committed: You create and issue a purchase order to the cement company to deliver the bags. This is considered a “commitment” because you’re engaged in a contract for the delivery of materials, services or equipment.
Incurred: Cost is incurred on the project at the point of receipt. No cash has exchanged hands, but there is now a recognized liability (accrual) to pay. From a “project spend” point of view, this money’s been spent. From a “cash flow” point of view, it has not.
Invoiced: Cost is considered invoiced once an invoice is received from the vendor. This may happen at the time of delivery, or may happen at a later date. Until it’s invoiced, the incurred-not-invoiced cost is considered an accrual.
Paid: Depending on payment terms, an invoiced cost may not have to actually be paid for some number of days (i.e. 30 days).
Given the above descriptions of project cost, a spend forecast is a timeline of planned incurred costs. A cash flow forecast, on the other hand, is a timeline of forecasted paid costs. That’s the difference.
Producing a Cash Flow Forecast
To finish off this discussion, I’ll briefly touch on how it is we derive the information to be able to produce a cash flow forecast. The spend forecast should hopefully be clear – it’s effectively a time-phased budget broken out by WBS and/or project cost codes. In order to a produce cash flow forecast, we need to first input payment milestones into vendor contracts. Each vendor contract or purchase order – whether it’s a service contract or supply of materials – will have a Terms section that defines the dates and amounts of payment with any associated payment conditions. It’s these payment terms that provide the data to produce a forecasted cash flow timeline curve. You can additionally include payroll information and other internal costs in that timeline to complete the full picture.