Lec 4 Construction Management Construction Project Costs Management

Lec 4 Construction Management Construction Project Costs Management Dr. Attaullah Shah SIVA 1

What is Cost and Project Cost Management? n n n Cost is a resource sacrificed or foregone to achieve a specific objective or something given up in exchange Costs are usually measured in monetary units like dollars Project cost management includes the processes required to ensure that the project is completed within an approved budget

Basic Principles of Cost Management n Most CEOs and boards know a lot more about finance than IT, so IT project managers must speak their language Profits are revenues minus expenses u Life cycle costing is estimating the cost of a project plus the maintenance costs of the products it produces u Cash flow analysis is determining the estimated annual costs and benefits for a project u Benefits and costs can be tangible or intangible, direct or indirect u Sunk cost should not be a criteria in project selection u

Basic Principles of Cost Management n n n Tangible costs or benefits are those costs or benefits that an organization can easily measure in dollars. Intangible costs or benefits are costs or benefits that are difficult to measure in monetary terms. Direct costs are costs that can be directly related to producing the products and services of the project. Indirect costs are costs that are not directly related to the products or services of the project, but are indirectly related to performing the project. Sunk cost is money that has been spent in the past; when deciding what projects to invest in or continue, you should not include sunk costs.

Basic Principles of Cost Management n n Learning curve theory states that when many items are produced repetitively, the unit cost of those items decreases in a regular pattern as more units are produced. Reserves are dollars included in a cost estimate to mitigate cost risk by allowing for future situations that are difficult to predict. u Contingency reserves allow for future situations that may be partially planned for (sometimes called known unknowns) and are included in the project cost baseline. u Management reserves allow for future situations that are unpredictable (sometimes called unknowns).

Types of Construction Costs: q Capital Cost: q Expenses related to the initial establishment of the facility: Land acquisition, including assembly, holding and improvement « Planning and feasibility studies « Architectural and engineering design « Construction, including materials, equipment and labor « Field supervision of construction « Construction financing « Insurance and taxes during construction « Owner's general office overhead « Equipment and furnishings not included in construction « Inspection and testing «

n Operating and Maintenance Cost: u n The operation and maintenance cost in subsequent years over the project life cycle includes the following expenses: « Land rent, if applicable « Operating staff « Labor and material for maintenance and repairs « Periodic renovations « Insurance and taxes « Financing costs « Utilities « Owner's other expenses The magnitude of each of these cost components depends on the nature, size and location of the project as well as the management organization, among many considerations. The owner is interested in achieving the lowest possible overall project cost that is consistent with its investment objectives. 7

Contingencies provisions: In most construction budgets, there is an allowance for contingencies or unexpected costs occurring during construction. This contingency amount may be included within each cost item or be included in a single category of construction contingency u The amount of contingency is based on historical experience and the expected difficulty of a particular construction project u For example, one construction firm makes estimates of the expected cost in five different areas: u Design development changes, « Schedule adjustments, « General administration changes (such as wage rates), « Differing site conditions for those expected, and « Third party requirements imposed during construction, such as new 8 permits. «

Project Cost Management n n Project Cost Management includes the processes involved in planning, estimating, budgeting, and controlling costs so that the project can be completed within the approved budget. Cost Estimating – developing an approximation of the costs of the resources needed to complete project activities. Cost Budgeting – aggregating the estimated costs of individual activities or work packages to establish a cost baseline. Cost Control – influencing the factors that create cost variances and controlling changes to the project budget.

Cost Estimating: Tools and Techniques n n Analogous Estimating: Using the actual cost of previous, similar projects as the basis for estimating the cost of the current project. u Analogous cost estimating uses expert judgment. u Analogous cost estimating is frequently used to estimate costs when there is a limited amount of detailed information about the project u Generally less costly than other techniques u Generally less accurate Determine Resource Cost Rates u For each resource to estimate schedule activity costs. u Standard rates with escalation factors can be included in the contract. u Obtaining data from commercial databases and seller published price lists is another source of cost rates. u Gathering quotes

n Bottom-up Estimating u u u n This technique involves estimating the cost of individual work packages or individual schedule activities with the lowest level of detail. The cost and accuracy of bottom-up cost estimating is typically motivated by the size and complexity of the individual schedule activity or work package. Generally, activities with smaller associated effort increase the accuracy of the schedule activity cost estimates. Parametric Estimating u u u Parametric estimating is a technique that uses a statistical relationship between historical data and other variables (e. g. , square footage in construction This technique can produce higher levels of accuracy depending upon the sophistication, as well as the underlying resource quantity and cost data built into the model. A cost-related example involves multiplying the planned quantity of work to be performed by the historical cost per unit to obtain the estimated cost.

n Project Management Software u n Vendor Bid Analysis u u n Project management software, such as cost estimating software applications, computerized spreadsheets, and simulation and statistical tools, are widely used to assist with cost estimating. Other cost estimating methods include vendor bid analysis and an analysis of what the project should cost. In cases where projects are won under competitive processes, additional cost estimating work can be required of the project team to examine the price of individual deliverables, and derive a cost that supports the final total project cost. Reserve Analysis u Many cost estimators include reserves, also called contingency allowances, as costs in many schedule activity cost estimates. This has the inherent problem of potentially overstating the cost estimate for the schedule activity.

Cost Budgeting: n n Cost budgeting involves aggregating the estimated costs of individual schedule activities or work packages to establish a total cost baseline for measuring project performance. Cost Aggregation u n Reserve Analysis u n Schedule activity cost estimates are aggregated by work packages in accordance with the WBS. Reserve analysis establishes contingency reserves, such as the management contingency reserve, that are allowances for unplanned, but potentially required, changes. Such changes may result from risks identified in the risk register. Funding Limit Reconciliation u Large variations in the periodic expenditure of funds are usually undesirable for organizational operations. Therefore, the expenditure of funds is reconciled with the funding limits set by the customer or performing organization on the disbursement of funds for the project.

Cost Budgeting: Outputs n Cost Baseline u n The cost baseline is a time-phased budget that is used as a basis against which to measure, monitor, and control overall cost performance on the project. Project Funding Requirements u u Funding requirements, total and periodic (e. g. , annual or quarterly), are derived from the cost baseline and can be established to exceed, usually by a margin, to allow for either early progress or cost overruns. Funding usually occurs in incremental amounts that are not continuous, and, therefore, appears as a step function.

n Cost Control u u u u u Project cost control includes: Influencing the factors that create changes to the cost baseline Ensuring requested changes are agreed upon Managing the actual changes when and as they occur Assuring that potential cost overruns do not exceed the authorized funding periodically and in total for the project Monitoring cost performance to detect and understand variances from the cost baseline Recording all appropriate changes accurately against the cost baseline Preventing incorrect, inappropriate, or unapproved changes from being included in the reported cost or resource usage Informing appropriate stakeholders of approved changes Acting to bring expected cost overruns within acceptable limits.

Cost Control Inputs: n n n Cost Baseline Project Funding Requirements Performance Reports Work Performance Information Approved Change Requests Project Management Plan

Cost Control: Tools and Techniques n Cost Change Control System u n A cost change control system, documented in the cost management plan, defines the procedures by which the cost baseline can be changed. Performance Measurement Analysis u u u Performance measurement techniques help to assess the magnitude of any variances that will invariably occur. The earned value technique (EVT) compares the cumulative value of the budgeted cost of work performed (earned) at the original allocated budget amount to both the budgeted cost of work scheduled (planned) and to the actual cost of work performed (actual). This technique is especially useful for cost control, resource management, and production.

Cost Control Tools: n Cost Change Control System u n A cost change control system, documented in the cost management plan, defines the procedures by which the cost baseline can be changed. It includes the forms, documentation, tracking systems, and approval levels necessary for authorizing changes. Performance Measurement Analysis u Performance measurement techniques help to assess the magnitude of any variances that will invariably occur. The earned value technique (EVT) compares the cumulative value of the budgeted cost of work performed (earned) at the original allocated budget amount to both the budgeted cost of work scheduled (planned) and to the actual cost of work performed (actual). This technique is especially useful for cost control, resource management, and production.

EVM: Earned Values Management n n The Earned Value Technique ( EV) involves developing these key values for each schedule activity, work package, or control account: It is a method measuring project performance by comparing the amount of work planned with actually accomplished, in order to determine if cost and schedule performance as planned. Data Element Term Acronyms Scheduled Work Budgeted Cost of Work Scheduled PV Earned Value Budgeted Cost of work performed EV Actuals Actual Cost of Work performed AC Authorized Work Budget at Completion BAC Forecasted Cost Estimate at Completion EAC Work variance Schedule Variance SV Cost Variance CV Completion Variance VAC

Variance Calculations: n Cost variance (CV). u u n CV equals earned value (EV) minus actual cost (AC). The cost variance at the end of the project will be the difference between the budget at completion (BAC) and the actual amount spent. Formula: CV= EV – AC A negative value of CV would mean Cost over run Schedule Variance: u u u SV equals earned value (EV) minus planned (PV). Schedule variance will ultimately equal zero when the project is completed because all of the planned values will have been earned. Formula: SV = EV – PV Negative SV would mean Time over run.

Performance Indices n Cost performance index (CPI). A CPI value less than 1. 0 indicates a cost overrun of the estimates. A CPI value greater than 1. 0 indicates a cost under run of the estimates. u CPI = EV /AC. u CPI is the most commonly used cost-efficiency indicator. u Formula: CPI = EV/AC u n Schedule performance index (SPI). The SPI is used, in addition to the schedule status , to predict the completion date and is sometimes used in conjunction with the CPI to forecast the project completion estimates. SPI equals the ratio of the EV to the PV. u Formula: SPI = EV/PV u

n Estimate At Completion EAC: u n EAC = AC+ETC Estimate to Complete ETC: u ETC equals the revised estimate for the work remaining.

The earned value technique in its various forms is a commonly used method of performance measurement. It integrates project scope, cost (or resource) and schedule measures to help the project management team assess project performance.

Cost and Schedule Forecasting u Exercises: « Exercise #1: Schedule Variance Example. « PV = $ 42000 « EV = $ 38000 « AC = $ 48000 « Budget at Completion BAC = $80000 « SV = EV – PV = $38000 – 42000 = - $4000 « SV % = SV/PV = -4000/42000 = -9. 5 % Hence there is schedule overrun of 9. 5% u Exercise #2: Cost Variance Example. « CV = EV- AC = 38000 – 48000 = - 10000 « CV% = CV/EV = -10000/38000 = -26 % Schedule overrun by 26%

u # 3 Cost Performance Index ( CPI) CPI = EV/AC = 38000/48000 = 0. 79 « Hence $0. 79 worth of work was done for every $ 1 spent. « u #4 Schedule Performance Index: SPI = EV/PV = 38000/42000 = 0. 90 « $ 0. 90 worth of work has been for each done for each $1. 00 worth of work that was planned to be done. « u #5. Estimate at Completion and Variance at Completion EAC = BAC/CPI = 80000/0. 79 = $101265 « VAC = BAC – EAC = 80000 -101265 = - $ 21265. The project will exceed the planned budget by $21265 «

Problems: #1: « « BAC = 40 K EV = 20 K PV = 28 K AC = 26 K Determine: u % of work scheduled u % of budget spent u Cost Variance CV u Scheduled Variance SV

n n Case 1: u PV = 1600 u EV = 1600 u AC = 1600 u Ideal Case where every thing goes as per plan. Case 2: u u u u u PV= 1900 EV= 1500 ACP= 1700 400 worth of work is behind schedule SV = EV- PV = 1500 -1900= -400 SV%= ( SV/PV)x 100 = -21% CV = EV – AC = 1500 – 1700= -200 Cost overrun by 200 CV% = (CV/EV)x 100 = -13% SPI = EV/PV = $0. 79 CPI= EV/AC = $0. 88

u Unit Cost Method of Estimation u If the design technology for a facility has been specified, the project can be decomposed into elements at various levels of detail for the purpose of cost estimation. u The unit cost for each element in the bill of quantities must be assessed in order to compute the total construction cost. This concept is applicable to both design estimates and bid estimates, although different elements may be selected in the decomposition. u For design estimates, the unit cost method is commonly used when the project is decomposed into elements at various levels of a hierarchy as follows:

u Preliminary Estimates. The project is decomposed into major structural systems or production equipment items, e. g. the entire floor of a building or a cooling system for a processing plant. u Detailed Estimates. The project is decomposed into components of various major systems, i. e. , a single floor panel for a building or a heat exchanger for a cooling system. u Engineer's Estimates. The project is decomposed into detailed items of various components as warranted by the available cost data. Examples of detailed items are slabs and beams in a floor panel, or the piping and connections for a heat exchanger.

Computer Aided Cost Estimation n n Some of the common features of computer aided cost estimation software include: Databases for unit cost items such as worker wage rates, equipment rental or material prices. These databases can be used for any cost estimate required. If these rates change, cost estimates can be rapidly re-computed after the databases are updated. Databases of expected productivity for different components types, equipment and construction processes. Import utilities from computer aided design software for automatic quantitytake-off of components. Alternatively, special user interfaces may exist to enter geometric descriptions of components to allow automatic quantity-take -off. Export utilities to send estimates to cost control and scheduling software. This is very helpful to begin the management of costs during construction.

n n Version control to allow simulation of different construction processes or design changes for the purpose of tracking changes in expected costs. Provisions for manual review, over-ride and editing of any cost element resulting from the cost estimation system Flexible reporting formats, including provisions for electronic reporting rather than simply printing cost estimates on paper. Archives of past projects to allow rapid cost-estimate updating or modification for similar designs.

Components of Project Cost Estimates for Major Projects n n n Preliminary Engineering. This is the cost to prepare the construction documents. Right-of-Way. This is the cost to research and acquire right-of-way for the project, including easements. Include right-of-way costs for storm water management, wetland mitigation, and other work outside the roadway prism. External Third Party (e. g. Utilities and Railroad Adjustments). Perhaps the most difficult costs to estimate are those that are associated with third parties, such as utilities and railroads.

Using Software to Assist in Cost Management n n n Spreadsheets are a common tool for resource planning, cost estimating, cost budgeting, and cost control. Many companies use more sophisticated and centralized financial applications software for cost information. Project management software has many cost-related features, especially enterprise PM software.