Construction companies are exposed to aluminium, steel, bricks, bitumen, cement and glass. Most of these semi-finished products are produced in an energy intensive process. Higher costs of natural gas, coal and electricity will lead to higher costs for the construction sector. Construction risk management should include commodity price forecasting techniques to improve cashflow forecasts.
Transparency improves construction risk management
Transparency of the cost structure enables the contractor to hedge commodity costs with physical or financial contracts. Production costs of glass for example can consist of 25 to 35% of energy costs depending on price movements on the energy market. Glass contracts can be indexed to natural gas or oil to create transparency for the construction companies. Production of cement and bricks is also a highly energy intensive production process. Creating cost transparancy will lead to a clear cost structure preferable with liquid commodity indexes that can be hedged on financial markets. This is a clear example of construction risk management.
But even with transparent contracts we recognize that estimating potential costs of a new building is a complex task. First step is to calculate the required volumes of reinforcing bars, aluminium, float glass, concrete, bitumen, copper wire to have a proper insight in required volumes .Next step is to combine expected volumes with potential commodity prices. In the KYOS portfolio system all commodity costs of a construction project can be simulated to estimate potential cashflows. This process will add immediate value during the tender and project phase to keep risks as low as possible. This is construction risk management pur sang.
Cost savings – KYOS portfolio & risk management system
Excel has proven to be a pitfall for many companies in terms of costs, mistakes, hidden risks and potential fraud. ERP systems like SAP look backwards in stead off to the future and cannot perform the required risk management calculations. The KYOS portfolio & risk management system captures years of experience in managing risks of commodity contracts and market price volatility, leading to effective commodity hedging strategies.
Managing cashflow variance – KYOS portfolio & risk management system
The higher and more frequent market prices move up or down the higher its volatility. Volatility is often expressed in a percentage and can be calculated for e.g. interest rates, currencies (FX) and commodities. A highly volatile market price is not per definition a bad situation but you probably feel more comfortable with less volatile costs. Steel has shown an average volatility above 20% in recent 5 years. This is more than double the volatility of EURUSD in the same period. Calculating the volatility should be an integrated part of your construction risk management strategy.
Automated market price analytics are combined with your project positions. It will provide you with clear insight in the current cashflow and potential cashflow variance versus project expectations. You will have a better insight in project cashflows and the associated risks. This is a clear added value as you have the ability to adjust your strategy during the project.
Fixed or floating prices – Construction risk management
As your supplier may not be that flexible in terms of transparent pricing, managing market price risks is crucial. Most contracts in the construction market do not have transparent pricing agreements yet. Procurement needs to find a balance between fixed prices and sometimes rapidly changing market prices The KYOS portfolio & risk management system will help you to find your “risk and reward” optimum by simulating multiple cashflow variances. It will provide you with clear insight in the potential cashflows of a construction project given any variance between fixed and floating prices.
Better managing your cashflow variances will lower your required working capital.
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