Derivation and assessment of interest in cash flow calculations for time-cost optimizations in construction project management

This paper fills a gap in the financial and project management literature of examining how financing fees, particularly interest, are determined accurately for planning and management of cash flows in construction projects. For planning purposes, most models assign costs at the activity level, as individual transactions at their actual date of occurrence as yet unknown. The interplay of cash outflows from numerous purchases, salaries, and payments for materials, labor, and equipment and regular cash inflows from progress payments by the owner to the contractor create a characteristic `sawtooth´ pattern. However, interest calculations for such continuously changing balances traditionally used averaging approximations that deviate from the exact solution. The derivation for such financing fee is presented and its logarithmic expression is compared with the approximations. It is concluded that more detailed research is merited as to how assuming a linearization used in manifold examples of cash flow analysis matches with practice.