In the construction projects, there is usually a time lag between completion of a portion of work and the receipt of payment from owner of the project and thus production (sales) is not converted into cash instantaneously. Therefore working capital is required to meet the financial requirement in daily operations in the project. Often material suppliers and the equipment renting firm also allow a credit period to the construction company. Thus the credit period allowed by material suppliers and equipment renting firm to the construction company and that allowed by the construction company to the owner of the project are to be considered while calculating working capital requirement of the construction company.

The calculation of working capital requirement of a construction company is presented in the following example.

Example -3

The estimated annual revenue of a construction company from a project is Rs.51000000. In the project, the proportions of material cost, labour cost, equipment cost, overhead cost and profit are 37%, 23%, 16%, 14% and 10% of the estimated annual revenue respectively. On an average two months' credit (i.e. average time period between commencement of a portion of work and receipt of payment from owner of the project) is allowed to the owner of the project. The materials are purchased from material suppliers and equipment is hired on rental charges from the equipment renting company. The credit period allowed by material suppliers and equipment renting firm to the construction company is one month. On average, two and half months' supply of materials is kept in stock at all the times. Calculate the working capital requirement of the construction company for the operations in the project.

Solution:

The working capital requirement will be calculated for meting the expenses of material, labour, equipment and overhead.

The annual material cost, labour cost, equipment cost and overhead with the corresponding percentages of annual revenue are Rs.18870000, Rs.11730000, Rs.8160000 and Rs.7140000 respectively.

Materials

Materials held in construction work (i.e. in work in progress) = 2 months

(i.e. average time period between the use of materials in the work and receipt of payment from owner of the project)

Materials in stock = 2.5 months

Credit from suppliers = 1 month

The construction company must have the working capital to meet the expense of 4.5 (i.e. 2 + 2.5) months' materials requirement. However the material suppliers allow 1 month credit to the company. Thus the construction company requires the working capital to meet the expense of 3.5 (i.e. 4.5 - 1) months' materials requirement. The working capital requirement for the materials is calculated as follows;