Project Management for Construction Chapter 7

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Project Management for Construction Chapter 77. Financing of Constructed Facilities7.1 The Financing ProblemInvestment in a constructed facility represents a cost in the short term that returns benefits only overthe long term use of the facility. Thus, costs occur earlier than the benefits, and owners of facilitiesmust obtain the capital resources to finance the costs of construction. A project cannot proceed withoutadequate financing, and the cost of providing adequate financing can be quite large. For these reasons,attention to project finance is an important aspect of project management. Finance is also a concern tothe other organizations involved in a project such as the general contractor and material suppliers.Unless an owner immediately and completely covers the costs incurred by each participant, theseorganizations face financing problems of their own.At a more general level, project finance is only one aspect of the general problem of corporate finance.If numerous projects are considered and financed together, then the net cash flow requirementsconstitutes the corporate financing problem for capital investment. Whether project finance isperformed at the project or at the corporate level does not alter the basic financing problem.In essence, the project finance problem is to obtain funds to bridge the time between makingexpenditures and obtaining revenues. Based on the conceptual plan, the cost estimate and theconstruction plan, the cash flow of costs and receipts for a project can be estimated. Normally, thiscash flow will involve expenditures in early periods. Covering this negative cash balance in the mostbeneficial or cost effective fashion is the project finance problem. During planning and design,expenditures of the owner are modest, whereas substantial costs are incurred during construction. Onlyafter the facility is complete do revenues begin. In contrast, a contractor would receive periodicpayments from the owner as construction proceeds. However, a contractor also may have a negativecash balance due to delays in payment and retainage of profits or cost reimbursements on the part ofthe owner.Plans considered by owners for facility financing typically have both long and short term aspects. Inthe long term, sources of revenue include sales, grants, and tax revenues. Borrowed funds must beeventually paid back from these other sources. In the short term, a wider variety of financing optionsexist, including borrowing, grants, corporate investment funds, payment delays and others. Many ofthese financing options involve the participation of third parties such as banks or bond underwriters.For private facilities such as office buildings, it is customary to have completely different financingarrangements during the construction period and during the period of facility use. During the latterperiod, mortgage or loan funds can be secured by the value of the facility itself. Thus, differentarrangements of financing options and participants are possible at different stages of a project, so thepractice of financial planning is often complicated.On the other hand, the options for borrowing by contractors to bridge their expenditures and receiptsduring construction are relatively limited. For small or medium size projects, overdrafts from bankaccounts are the most common form of construction financing. Usually, a maximum limit is imposedon an overdraft account by the bank on the basis of expected expenditures and receipts for the duration 210of construction. Contractors who are engaged in large projects often own substantial assets and canmake use of other forms of financing which have lower interest charges than overdrafting.In recent years, there has been growing interest in design-build-operate projects in which ownersprescribe functional requirements and a contractor handles financing. Contractors are repaid over aperiod of time from project revenues or government payments. Eventually, ownership of the facilitiesis transferred to a government entity. An example of this type of project is the Confederation Bridge toPrince Edward Island in Canada.In this chapter, we will first consider facility financing from the owners perspective, with dueconsideration for its interaction with other organizations involved in a project. Later, we discuss theproblems of construction financing which are crucial to the profitability and solvency of constructioncontractors.Back to top7.2 Institutional Arrangements for Facility FinancingFinancing arrangements differ sharply by type of owner and by the type of facility construction. Asone example, many municipal projects are financed in the United States with tax exempt bonds forwhich interest payments to a lender are exempt from income taxes. As a result, tax exempt munici ...