Factors Contributing to Construction Financial Risks in Egypt
Nouran. A. Gad
Lecturer Assistant in Faculty of Engineering at 6 October University
Email: [email protected]
Financial risks are main factor that affect construction in Egypt. Over the past 10 years, the cost of construction building increased drastically. Considering that construction projects are unique having variable duration and cost, the risk management process become very important. This paper focuses on identifying different categories of financial risks in Egyptian construction projects. Identification of these risks has been done through a questionnaire carried out with professionals in construction industry. Initial identification of financial risks has been categorized into three categories: market risk (FMR), credit risk (FCR), and operational risk (FOR). Initial risk analysis of received questionnaires identified the most critical financial risks affecting Egyptian construction projects. This paper discusses the questionnaire development, data collection, data analysis, and prioritizes financial risks based on experts’ opinion.
Construction projects are considered as very complex projects. Therefore the rate of increase prices some kinds of construction materials is volatile over short period of time. Over 10 years ago, and the increase in cost of building in Egypt was predominant factor, where uncertainness come from various sources such as political risks, economic risks, financial risks, physical risks, construction related risks, and environmental risks, The potentiality of a building contractor to exactly predict upcoming construction material prices is critical to the accomplishment of the projects, so one of main causes contributing to this problem is improper risk. The problem is in risk management in the projects and how are the stakeholders applying risk management knowledge in the projects , how to plan , identify , assess risks in the projects so this paper firstly showed a literature review on risks , risk management and financial risks that faced construction projects , Then discussed the nature of the risks in this period drastically changed due to the emergence events of some political and economic variables by risk breakdown structure according focusing on financial risks to show the categories that contributed in Egypt ,the result of this paper contribute to show all factors that consisted Financial risks category on Egyptian construction industry and provide valuable information to guide decision makers in local and international organization which plan to provide construction projects in Egypt to face the financial risks .
Defining Project risk
CITATION Mer09 l 1033 (A Guide to the Project Management Body of Knowledge , Fifth Edition) Project risk is an uncertain event or condition that, if it occurs, has a positive or negative effect on one or more project objectives such as scope, schedule, cost, and quality. A risk may have one or more causes and, if it occurs, it may have one or more impacts.
1.2 Define Risk management
CITATION Mer09 l 1033 (A Guide to the Project Management Body of Knowledge , Fifth Edition)Project Risk Management includes the processes of conducting risk management planning, identification, analysis, response planning, and controlling risk on a project. The objectives of project risk management are to increase the likelihood and impact of positive events, and decrease the likelihood and impact of negative events in the project.
1.3 Define Risk categories
CITATION Mer09 l 1033 (A Guide to the Project Management Body of Knowledge , Fifth Edition) Provide a means for grouping potential causes of risk. Several approaches can be used, for example, a structure based on project objectives by category. A risk breakdown structure (RBS) helps the project team to look at many sources from which project risk may arise in a risk identification exercise. Different RBS structures will be appropriate for different types of projects. An organization can use a previously prepared custom categorization framework, which may take the form of a simple list of categories or may be structured into an RBS.
1.4 Define Risk Management Process
Risk management process are number of variations of risk management process have been proposed. Boehm CITATION Raz01 l 1033 (Raz, (2001))suggested a process consisting of two main phases: risk assessment, which includes identification, analysis and prioritization, and risk control which includes risk management planning, risk resolution and risk monitoring planning, tracking and corrective action. Chapman and Ward CITATION VMR01 l 1033 (Tummala:, 1991 ,2001) identified risk management approach as a multiphase `risk analysis’ which covers identification, evaluation, control and management of risks. CITATION kat98 l 1033 (simmons, 1998)Provided a definition for the risk management as the sum of all proactive management-directed activities, within a program that is intended to acceptably accommodate the possibly failures in elements of the program. “Acceptably” is as judged by the customer in the final analysis, but from a firm’s perspective a failure is anything accomplished in less than a professional manner and/or with less than-adequate result. CITATION AlB90 l 1033 (Al-Bahar, 1990) CITATION Ahm99 l 1033 (Ahmed et al, 1999)Defined the risk management as a formal orderly process for systematically identifying, analyzing, and responding to risk events throughout the life of a project to obtain the optimum or acceptable degree of risk elimination or control. CITATION Mer09 l 1033 (A Guide to the Project Management Body of Knowledge , Fifth Edition)Defined the risks Management process into; The Risk Management Plan (RMP) is the plan for how the risk management will be conducted. This plan is used as a base for future risk management and is also important in communicating the plan to other stakeholders. The plan is based on other project 7 management documentation such as the project charter and the project management plan but should also take into consideration the stakeholders involved. Risk identification is a vital part of risk management. Here risks are identified through various methods such as meetings, brainstorming and scrutinizing project documents. The risks are then assembled into a register which is later used for risk response planning. The risks are analyzed and ranked according to their impact level and probability. The qualitative analysis gives a strong understanding of which risks are most important to focus on. After doing the qualitative analysis, a probability and impact matrix should be produced in order to have a clear picture of the risks and their importance. This is usually done by conducting workshops or interviews so that expert opinions can be gathered. CITATION Mer09 l 1033 (A Guide to the Project Management Body of Knowledge , Fifth Edition). The quantitative analysis builds on the qualitative in that it goes further in the analysis of the most important risks. In the quantitative analysis, the risks are analyzed using various tools such as probability distribution, sensitivity analysis and expected monetary value analysis. The key here is to see the impact the risks have, often in monetary values, but also their probability of occurring. After the quantitative analysis is done, a plan on how to deal with the risks should be set up. There are four basic ways of dealing with risk, Avoid – This response means that the risks are actively removed by taking measures to ensure the risks will not occur or have no impact. Transfer – This response means that the risk is transferred to another stakeholder, such as a subcontractor or client. This is often done on contract level by shifting responsibilities. Mitigate – Mitigating a risk means reducing the impact of the risk and or probability of a risk. Accept – Accepting a risk means to accept the risk and its impact by not actively managing it these responses are only valid for negative risks. Control risks the control includes implementing risk responses, monitoring the project and updating the plans if necessary. The key aspect here is to be ready to treat risks that have already been identified but also to identify new risks.
However, there is a gap between risk management techniques and their practical application by construction contractors. In real projects there is need to identify risks by different methods, types of
Risks associated with construction project and different risk mitigation techniques. According to risk management in construction building, there are several factors affecting the cost of construction includes:
Political risks, economical risks, financial risks, risks related to construction ; design. The most critical risk category that had great effect on projects cost is financial risks.
Define financial risks
CITATION Inv l 1033 (Investopedia, n.d.)’Financial risk is the possibility that shareholders or other financial stakeholders will lose money when they invest in a company that has debt if the company’s cash flow proves inadequate to meet its financial obligations. When a company uses debt financing, its creditors are repaid before shareholders if the company becomes insolventCITATION Lai13 l 1033 (L.M. Khodeir, 2013) Egyptian projects suffered newly identified risk probabilities that came from political and economic factors that occurred between the time period January 2011 and January 2013, leading to difference of the risk management map of Egyptian projects. The top significant risks identified to be put into thought in the risk procedure include: Currency price changes, new tax rates, Lack of fuel, unsecured roads, Official changes, and Workers’ strikes and Fire risk. CITATION DrM13 l 1033 (Dr. M. J.Kolhatkar, 2013)Financial risk have comprehensively be delegated as Bankruptcy of project partner, Fluctuation of inflation rate, Fluctuation of interest rate, Fluctuation of exchange rate, Rise in fuel prices, Insurance risk , Currency exchange risk, Liquidity Risk.CITATION Hes12 l 1033 (Hesham, 2012)Factors influencing steel and cement prices (the major cost supporters of RC) to cost of the production procedure , raw material prices, energy prices, macroeconomic variables, and industry related factors. A Time Series Analysis was led on the material parts of RC in Egypt in the period from 1997 to 2009, that made the research is required to tie in input factors of material costs in view of leading cost indicators and to investigate how the impacts of sudden events can be acknowledged and ideally predicted, if possible. Financial risk are one of the critical risk faced by any construction industry as financial disappointment may prompt to complete closer of the organization leading to huge losses and legal suits. This paper recognized the financial risk into categories and the factors that contributing them
1651150215519000-8003078259Figure SEQ Figure * ARABIC 1- Methodology Strategy for Paper
Figure SEQ Figure * ARABIC 1- Methodology Strategy for Paper
2-1 Risk breakdown structure
CITATION Hil l 1033 (Hillson, 2002)RBS is a hierarchical representation of risks, starting from higher levels and going down to finer level risks. This is similar to the organization of the Work Breakdown Structure (WBS). Is specifically a tool that represents an organized description of any known project risks that are arranged by a number of categories and characteristics .This research identified the three Major categories in financial risks and their subcategories that contribute the financial risks in construction industry.CITATION Mar l 1033 (Market risk definition, 2018) Financial Market risk( FMR ) the possibility of an investor experiencing losses due to factors that affects the overall performance of the financial market in which any stakeholder involved , CITATION Bas13 l 1033 (Basel, September 2000.Retrieved 13 December 2013.)Financial Credit risks (FCR) is the risk of default on a debt that may arise from a borrower failing to make required payments.In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial. In an efficient market, higher levels of credit risk will be associated with higher borrowing costs. CITATION Mic16 l 1033 (Michael Simkovic . Adler, 2016) CITATION Sim11 l 1033 (Simkovic & Kaminetzky, 2011)Because of this, measures of borrowing costs such as yield spreads can be used to infer credit risk levels based on assessments by market participants. CITATION Ope18 l 1033 (Operational risk definition , 2018)Financial Operational risks (FOR) summarizes the risks a company undertakes when it attempts to operate within a given field or industry.
The subcategories in financial risks is faced by making risk break down structure (RBS) .Market risks is categorized into main four subcategories which includes, Interest rates is the amount of interest due per period, as a extent of the amount loaned, deposited or borrowed (called the principal sum). The total interest on an amount loaned or borrowed depends on the principal sum, CITATION Def18 l 1033 (- Definition of interest rate in English by Oxford Dictionaries”., 2018,) It is defined as the proportion of an amount loaned which a lender charges as interest to the borrower, normally expressed as an annual percentage CITATION int18 l 1033 ( “interest rate Meaning in the Cambridge English Dictionary, 8 January 2018) It is the rate a bank or other lender charges to borrow its money, or the rate a bank pays its savers for keeping money in an account.). CITATION Wha l 1033 (What Are Commodities and How Do You Trade Them?, n.d.) CITATION com18 l 1033 (commodity, 2018)A commodity prices is an economic good or service that has full or substantial fungibility that is the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a commodity good is typically determined as a function of its market as a whole: well-established physical commodities have actively traded spot and derivative markets. Most commodities are raw materials, basic resources, CITATION Cur18 l 1033 (Currency risk definition, 2018)Currency risk commonly referred to as exchange-rate risk, arises from the change in price of one currency in relation to another.CITATION wha l 1033 (what is equity risk ?, 2018) Equity risks the financial risk involved in holding equity in a particular investment”. Equity risk often refers to equity in companies through the purchase of stocks, and does not commonly refer to the risk in paying into real estate or building equity in properties. Credit risks (FCR) is categorized into main category, CITATION por18 l 1033 (portfolio risk definition , 2018) Portfolios risks is a chance that the combination of assets or units, within the investments that you own, fail to meet financial objectives. Each investment within a portfolio carries its own risk, with higher potential return typically meaning higher risk. Then the Operational risks (FOR) is categorized into subcategory CITATION Dif18 l 1033 (Difference between product and process risks, 2018) process risk a risk related to the chance that the (execution of the) process (the test process in this case) does not live up to the expectations. As such, process risks are related to process control. Success is threatened by two risk types: risks related to the execution of the internal process and risks related to external threats. Process risk subdivided into 4 main elements such as Infrastructure risks outages such as failure of basic communication linkages can trigger process failure, Information technology risk of the technology errors or security incidents that disrupt or invalid process, Mechanical risk is the breakdown equipment can disrupt the process such as manufacturing or supply chain operator, Process Quality and Human errors in many cases, it is the quality of a process itself that leads to failures. A low quality process may not properly anticipate real world conditions and may break down with changes in the business environment, Errors or oversights can result in low quality or failed processes. For example, if a stock trader incorrectly enters an order the order may execute at the wrong price or quantity, potentially representing a significant loss. It is often possible to reduce human error by designing processes that right43287300are human-friendly and error tolerant.
Figure SEQ Figure * ARABIC 2-1 RBS for Financial risks
2-2Data collection and Measurement
The target population included civil engineering and building construction firms of central countries in Egypt, such as factories, developers, bankers, contractors, governmental officials, the detail of the various stakeholders and total number of questionnaires were collected through interviews.
Total respondent 86 questionnaires
Ages From 30- 45
Experience Greater than 10 years -15
Factories ( cement /steel / batch plants ) 32 respondent
Bankers 29 respondent
Developers & contractors 25 respondent
Table SEQ Table * ARABIC 1- Questionnaire design Respondent
Collect data and analysis by Relative Importance Index Technique for the factors according to expert opinion: It is used determine the relative importance of the various factors that contributed Financials risks. The same method is going to adopted in this papers within various groups (i.e. contractors, developers, bankers and factories of cement and steel). The four-point scale ranged from 1 (very little degree affect) to 4 (very high degree affect) is adopted and transformed to relative importance indices (RII) for each factor as follows:
RII = ?W / (A*N)
Where, W is the weighting given to each factor by the respondents (ranging from 1 to 4), A is the highest weight (i.e. 4 in this case), and N is the total number of respondents. Higher the value of RII, more important was the factor that contribute the Financial Risks.
(Factories – cement / steel / batch plants ) Sum Weight Height value Total Number of Respondent RII
1.1 Interest Rates
Local Taxes & Changes 96 4 32 0.75
Interest Rates & Cost of Finance 79 4 32 0.6171875
Political Interfaces 90 4 32 0.703125
1.2 Currency risks
Exchange Rate of Dollar 128 4 32 1
Floating Pound 120 4 32 0.9375
crises of the dollar shortage 81 4 32 0.6328125
Inflation 96 4 32 0.75
1.3.Commodity Prices Risks
cost of raw material 96 4 32 0.75
Cost of Labors & Equipment 79 4 32 0.6171875
Cost of Transportation & Distribution 64 4 32 0.5
Government Polices & Legislation 89 4 32 0.6953125
Supply & Demand 41 4 32 0.3203125
Cost of Fuel & Power Supply 108 4 32 0.84375
prices of substitutes material 56 4 32 0.4375
prices of complements material 39 4 32 0.3046875
Type of Demand on Real Estate 30 4 32 0.234375
Supply & Demand for Real Estate 0 4 32 0
number of investors 71.5 4 32 0.55859375
investor expectations for higher prices 80 4 32 0.625
different prices between producers 40 4 32 0.3125
capital market 55 4 32 0.4296875
pay on call capital 17 4 32 0.1328125
Liquidity risk & second hand trading. subcontractors ,bank 49 4 32 0.3828125
strong investment competition 47 4 32 0.3671875
(Bankers ) Sum Weight Height value Total Number of Respondent RII
2. Credit risk
2.1 Portfolios risks
liquid working & capital equity 72.5 4 29 0.625
significant under billing 101.5 4 29 0.875
ratios of account receivables to account payable 72.5 4 29 0.625
progress billing and retention receivables 87 4 29 0.75
credit rating and reputation for company & business owners 116 4 29 1
delinquent payroll taxes 101.5 4 29 0.875
related party receivables 72.5 4 29 0.625
cash flow coverage 116 4 29 1
debt equity ratio 116 4 29 1
bonding 72.5 4 29 0.625
Insurance 72.5 4 29 0.625
collective statement from central bank 101.5 4 29 0.875
commercial register 72.5 4 29 0.625
business loans 87 4 29 0.75
financial statement 101.5 4 29 0.875
(Developers / Contractors ) Sum Weight Height value Total Number of Respondent RII
1.Process Risks 1.1 Mechanical failure project implementation in the winter 25 4 25 0.25
Break down Equipment 40 4 25 0.4
1.2 Quality & Safety & Human errors
poor quality of works 80 4 25 0.8
defective product & facilities 73 4 25 0.73
lack of available resources 48 4 25 0.48
low productivity 18 4 25 0.18
labor accidents 28 4 25 0.28
structure failure 48 4 25 0.48
1.3 Information Technology Risks
inaccurate project reporting 70 4 25 0.7
inaccurate geotechnical report 58 4 25 0.58
wrong estimation of cost trade off 73 4 25 0.73
project planned & resource schedule are not aligned 60 4 25 0.6
contention for limited resources 80 4 25 0.8
time overrun 73 4 25 0.73
cost overrun 90 4 25 0.9
1.4 Infrastructure Risks
labor / material / equipment /fluctuation prices 85 4 25 0.85
incomplete documents take off 53 4 25 0.53
subcontractors offers & guaranteed prices 63 4 25 0.63
payment mechanisms 35 4 25 0.35
Revenue / income Risks 45 4 25 0.45
final payment 40 4 25 0.4
claims & disputes between stakeholders 78 4 25 0.78
Type of contract 80 4 25 0.8
Figure SEQ Figure * ARABIC 3- Table of Measurement factors that contributed Financial Risks
2-3 Data analysis
Top 10 factors for each category ranked by Relative Importance Index (RII) technique the relative importance index, RII, was computed for each factor to identify the most significant factors. The factors were ranked based on RII values. From the ranking assigned to each factor that contribute each category, it was possible to identify the most important factors that contribute the financial risks in Egypt construction industry. Base on the ranking, the 10 most important factors by RII were
Figure SEQ Figure * ARABIC 4 – Top 10 factors of Market risks by RII
Figure SEQ Figure * ARABIC 5 – Top 10 Factors Contribute Credit Risks by Risk
Figure SEQ Figure * ARABIC 6- Top 10 Factors Contribute Operational Risks
A deep understanding of relationship between two major topics of Risk management and finance on construction industry in Egypt. The objective of the stakeholders of any project is to achieve the project without any losses or financial risks with high impact faces them. This paper identified , ranked and get the most effective factors that contribute the financial risks such as Exchange rate of dollar , Floating Pound , Cost of fuel and power supply , Credit rating and reputation for company & business owners , Cash flow coverage , Debt equity ratio , Cost overrun , Type of contract , Poor quality of works according to each category .This paper help to provide a model according to these factors with relative importance index to provide a rates of fluctuation prices of the main material in construction industry such as Cement and Steel ,also the factors that contribute each project in specific according to duration , scope of work and experience of the organization .
1-To reduce the financial risks in construction industry by applying Lean on lien rights is the mechanics lien remedy was invented for the explicit purpose of protecting contractors and suppliers against all financial risk on a project. In theory, if mechanics lien rights are properly used, those furnishing labor or material to a construction project could be as secure against non-payment as a bank.
2- Contract and credit agreement should be flexible to change clauses according to site and culture situation as in Egypt
3- Credit checks and monitoring for fitting the labors and material to construction project is fitting on credit that may called trade credit
4- Applying Joint check agreement between contractors and subcontractors
5- Consistency is this final risk reduction method is not only the easiest and cheapest to employ, but it is also the most important
BIBLIOGRAPHY (n.d.). Retrieved from Investopedia: https://www.investopedia.com/terms/f/financialrisk.asp#ixzz5NVWi1lQK
( 8 January 2018). In “interest rate Meaning in the Cambridge English Dictionary. Dictionary.cambridge.org.
– Definition of interest rate in English by Oxford Dictionaries”. (2018,). “interest rate Oxford Dictionaries.
A Guide to the Project Management Body of Knowledge . (Fifth Edition, August 21). 14 Campus Boulevard: 2013 Project Management Institute. Retrieved from http://www.merriam-webster.com/dictionary/Risk
Ahmed et al. (1999). Risk management trends in the Hong Kong construction industry: a comparison of contractors and owners. Construction and Architectural Management, 6/3, pp 225-234.
Al-Bahar, J. a. (1990). Systematic risk management approach for construction projects. . Journal of Construction Engineering and Management, Vol. 116, No. 3, pp. 533-546. .
Basel. (September 2000.Retrieved 13 December 2013.). “Principles for the Management of Credit Risk . Basel Committee on Banking Supervision. BIS.
commodity. (2018, Juli 30). Retrieved from Merrial Webster: https://www.merriam-webster.com/dictionary/commodity
Currency risk definition. (2018). Retrieved from Investopedia: https://www.investopedia.com/terms/c/currencyrisk.asp
Difference between product and process risks. (2018). Retrieved from Tmap: http://www.tmap.net/wiki/difference-between-product-and-process-risks
Dr. M. J.Kolhatkar. (2013). Financial risks in construction projects. International Journal of Application or Innovation in Engineering & Management (IJAIEM).
Hesham, A. (2012). TIME SERIES ANALYSIS FOR THE PREDICTION OF RC MATERIAL COMPONENTS PRICES IN EGYPT. 28th Annual ARCOM Conference. Association of Researchers in Construction ManagementE ,dinburgh, UK.
Hillson, D. D. (2002). the risk breakdown structure ( RBS ) as an aid to effective risk maangement. Preseneted at fifth european project management conference. Canes , France : project management professional solution limited.
L.M. Khodeir. (2013). identifying the latest risk probabilities affectingconstruction projects in Egypt according to political and economic variables. Housing and Building National Research Center.
Market risk definition. (2018). Retrieved from Investopedia: https://www.investopedia.com/terms/m/marketrisk.asp#ixzz5JHk7ALqW
Michael Simkovic . Adler, B. e. (2016). Making Fraudulent Transfer Law More Predictable. in Handbook on Corporate Bankruptcy. Edward Elgar. SSRN 2775920.
Operational risk definition . (2018, may). Retrieved from Investopedia: https://www.investopedia.com/terms/o/operational_risk.asp
PM . (5th Edition ).
PMI. (4th ed). PMBOK. . (Newtown Square, PA: Project Management Institute.
portfolio risk definition . (2018). Retrieved from IG: https://www.ig.com/uk/investments/support/glossary-investment-terms/portfolio-risk-definition
Raz, T. a. ((2001)). Use and Benefits of Tools for Project Risk Management. International Journal of Project Management.
Simkovic, M., & Kaminetzky, B. (. ( 2011). “Leveraged Buyout Bankruptcies, the Problem of Hindsight Bias, and the Credit Default Swap Solution”. Columbia Business Law Review:, 118. SSRN 1632084.
simmons, k. (1998). rights risk . britich journal of special education .
Tummala:, V. M. (1991 ,2001). Assessing and Managing Risks Using the Supply Chain Risk Management Process (SCRMP),” . An International Journal.
What Are Commodities and How Do You Trade Them? (n.d.). Retrieved from the balance : https://www.thebalance.com/what-are-commodities-356089
what is equity risk ? (2018). Retrieved from wise geek: https://www.wisegeek.com/what-is-equity-risk.htm