W4_INDRA_Compare Shipyard’s Critical Cash Flow Use Payment Scheme

1.            Problem Recognition, Definition and Evaluation

In reference W3 blog posting, we plan to propose new payment scheme for our new project :

Project Name    :           New Building of 10,000 DWT Oil Tanker

Price                 :           US 16,750,000 $

Delivery Time    :           26 Months (117 weeks)

This idea will found some resistance from internal (boss, partner, finance staff) and external (shipyards as bid participants). Here their opinion about this idea :

a.     Payment based on events (milestone) has commonly used in Shipbuilding Practice

b.    Subsistence allowance is needed. After signing contract, shipyard should order steel plate, profile, and some equipment. Shipyards worry it impact to their cash flow (being more negative).

c.     In existing payment scheme, shipbuilding payment is one of the “easiest” jobs for finance department. Because the budget is fix (shipyard cover the over budget risk) and they already know how much money should arranged for every payment when the project approved. The proposed payment scheme gives them more jobs.

Based on their opinion, we will focus on point (b), considering the shipyard cash flow that impact to the progress. Point (a) and (c) are about human habit and mindset, difficult to compare use these variables into quantitative value, and can be changed ofcourse (or change the man….)

Problem Statement

            Which payment scheme gives the best cash flow for shipyard?

2.            Develop of  the Feasible Alternatives

We develop the feasible alternatives as below :

a.     Payment based on Event (Milestone), as our existing payment scheme, it means do not change the scheme and continue what already arranged

b.    Propose Monthly Payment use Earn Value

c.     Propose 2-weekly Payment use Earn Value

3.            Develop the outcomes for each alternative

a.     Existing Payment. In Shipbuilding practice, commonly we use payment based on event (milestone) as below :

Table 1 : Payment Based on Event (Milestone)

Based on the scheme above, we simulate the Shipyard Outcome VS Income as below :

Figure 1 : Existing Payment Scheme

Notes :

-       Shipyard outcome (red line) is including margin (totally same to vessel price). We predict the value of shipyard outcome based on the progress plan. For example :

Main Engine is installed after Keel Laying, but Shipyard should order as soon as possible after Signing Contract because of the delivery time. We accept the progress of Main Engine only 40% when the Engine already shipped, but actually shipyard already pay full to the Maker

-       Shipyard actual income (yellow line) received about 4 weeks after the payment issued because of the internal payment procedure

b.     Propose Monthly Payment use Earn Value

By monthly payment based on the progress, we simulate Shipyard Outcome VS Income as below :

Figure 2: Monthly Payment Scheme

c.     Propose 2-weekly Payment use Earn Value

Same with monthly payment, but arrange the payment every 2 weeks, we simulate Shipyard Outcome VS Income as below :

Figure 3 : 2-Weekly Payment Scheme

4.            Selection of the acceptable criteria.

Based on the problem statement, the criteria is which scheme gives the best cash flow for shipyard.

5.            Analysis and comparison of the alternatives

Based on the simulation, we list the Shipyard’s critical cash flow between each Event as below :

 

Table 2 : Critical Cash Flow Comparison

Data analysis :

a.     Biggest negative cash flow happens in existing payment scheme. It means for milestone payment, Shipyard should allocate 3,777,349 US $ cash to keep the progress on schedule. For monthly payment scheme, shipyard should allocate 3,046,495 US $ cash. For payment every 2 weeks, shipyard should allocate 2,187,390 US $ cash

b.    Although use subsistence allowance, existing milestone payment still gives the biggest negative cash flow between Sign Contract to Steel Cutting. It means subsistence allowance reason is not relevant for the resistance of using earn value

6.            Select the preferred alternative

Based on the simulation, the best alternative is payment every 2 weeks. This scheme need the smallest cash to allocated by shipyard

7.            Performance Monitoring & Post Evaluation of Result

The effectiveness of this payment scheme for progress smooth and shipyard motivation only can be measured based on the actual progress. But based on simulation, this scheme reduce the risk of cash flow problem. Absolutely the first action we should do is make sure all parties this scheme may be working

Reference

i.        A Prototype Description of A Shipbuilder’s Earned Value Management System, Retrieved from: http://www.sparusa.com/Documents/Preview%20Prototype%20EVMS%20Description.pdf

ii.       Building Ships On Time, retrieved from:

          http://www.rand.org/pubs/research_briefs/RB9116/index1.html

iii.      Earned Value Management For Shipbuilding, retrieved from: http://www.sparusa.com/Presentations/PERCEPTION%20Earned%20Value%20Mgmt.pdf