Introduction to cost management & control in construction projects
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This document discusses cost management and control techniques for construction projects. It defines different types of costs including direct, indirect, fixed, and variable costs. It then explains various project selection techniques such as return on investment, internal rate of return, net present value, benefit-cost ratio, opportunity cost, and payback period. The document provides examples of how to use each technique to select projects. It also discusses future value and present value calculations. Finally, it covers key aspects of project cost management including estimating costs, determining budgets, and controlling costs.
Introduction to cost management & control in construction projects
- 1. INTRODUCTION TO COST MANAGEMENT & CONTROL IN CONSTRUCTION PROJECTS
- 2. TYPE OF COSTS Type of Cost Description Direct Cost Direct cost is directly attributable to the project and spent only on the project work. Indirect Cost Indirect cost is cost that is needed for a project but not restricted to it; it could be used by other projects as well. It is likely there are other groups or activities benefiting from such items, and your project pays its part as well. Fixed Cost Fixed cost is cost that is consistent on a project regardless of how many are used. Variable Cost Variable cost is one that fluctuates with what is produced. The more of something you produce, the more of this type of cost you incur.
- 3. PROJECT SELECTION TECHNIQUES Project Selection Technique Name Also Kno wn As Option to Select Example Return On Investment ROI The biggest number or percentage. Typically the biggest number or percentage among the projects under consideration. $50,000 or 7% Internal Rate of Return IRR Select the biggest percentage. Often used in capital budgeting, interest rate makes the net present value of all cash flow equal zero. 15.5% Net Present Value NPV Select the biggest number (Years are already factored in) $47,000 US Benefit Cost Ratio BCR Select the biggest ratio 3.5:1
- 4. COST BASED PROJECT SELECTION TECHNIQUES (CONT.) Project Selection Technique Name Also Known As Option to Select Example Opportunity Cost The amounts that are not selected Choose Project A ($7,000) over Project B ($5000). The opportunity cost is $5000 to select Project A. Payback Period Select the shortest duration 7 months
- 5. COST BASED PROJECT SELECTION DISCUSSIONS Project Selection Technique Discussion Return On Investment (ROI) Return on Investment (ROI) is a general term. You may calculate it a variety of ways. Typically, you would choose the biggest number or percentage among the projects under consideration. Internal Rate of Return (IRR) Often used in capital budgeting. Interest rate makes the net present value of all cash flow equal zero. In the case of IRR and project selection, select the larger number.
- 6. COST BASED PROJECT SELECTION DISCUSSIONS (CONT.) Project Selection Technique Discussion Net Present Value (NPV) Net Present Value (NPV) is used in capital budgeting where the present value of cash inflows is subtracted for the present value of cash outflows. NPV compares the value of a dollar today versus the value of that same dollar in the future after taking inflation and return into account. I wouldn’t worry about calculating this, you should know how to select a project using it. For example, with Project A have a NPV of $150,000 and 6 months or Project B having a NPV of $295,000 and 1 year, you would select Project B because it has the bigger number AND the years are already factored into the dollar amount.
- 7. COST BASED PROJECT SELECTION DISCUSSIONS (CONT.) Project Selection Technique Discussion Benefit Cost Ratio (BCR) Benefit Cost Ratio (BCR) is the project selection and analysis technique that involves comparing the benefit to the cost of the initiative. The format is 3.65:1 that means that the benefits of the project outweighs the costs 3.65:1. You should not be concerned about profit in this area. That is simply noise; the benefit, cost, and ratio between them are the main components. There could also be a project that has a BCR of less then one (.75:1) for example. This would mean that the project had a benefit of $.75 for ever $1.00 invested. Typically, you would not approve such a project unless there was some underlying factor such as Y2K issues.
- 8. COST BASED PROJECT SELECTION DISCUSSIONS (CONT.) Project Selection Technique Discussion Opportunity Cost Opportunity Cost is associated with taking another opportunity. It is what you give up or leave on the table to take the other opportunity. For example, if you take a $75,000 a year job over a $60,000 a year job, then the opportunity cost of taking the $75,000 is $60,000. Payback Period Payback period is the amount of time needed to earn back the original investment on the project. PMI® suggests that you select the project with the shortest payback period.
- 9. FUTURE VALUE (FV) • Future value is the value of something such as cash or an investment at a specific point in the future. For example, if you had $1,000 now and could get 8% interest over three years, what is the future value? • The formula is shown below with PV = present value, r = interest rate, n = number of periods, and FV = future value.
- 10. PRESENT VALUE Present value is the value of something today that you need to create a certain amount of investment in the future. For example: if you wanted to have $2,500 in three years, what amount of money do you need today to produce this amount if the money was earning 8%?
- 12. WHAT IS COST AND PROJECT COST MANAGEMENT? • 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
- 13. ESTIMATE COSTS • Cost estimates are a prediction that is based on the information known at a given point in time • Cost estimates include the identification and consideration of costing alternatives to initiate and complete the project • Cost estimates are generally expressed in units of some currency • The accuracy of a project estimate will increase as the project progresses through the project life cycle. – For example, a project in the initiation phase may have a rough order of magnitude (ROM) estimate in the range of −25% to +75%. – Later in the project, as more information is known, definitive estimates could narrow the range of accuracy to -5% to +10%.
- 14. ESTIMATE COSTS
- 15. ANALOGOUS ESTIMATES Method Description Scenarios Analogous (Top Down) This estimate is usually a total time or cost estimate that has no significant detail. Advantage: Can be created quickly. Disadvantage: It lacks detail or individual piece estimates. An executive or someone who is subject matter expert (SME) creates a high level estimate based on experience or past project history with the company.
- 16. PARAMETRIC ESTIMATES Method Description Scenarios Parametric Based on existing parameters, this method is usually created by industry standards or past experience. Advantage: It can be done quickly and is usually accurate. A house builder quotes a house for $75.00 per square foot. A carpet installer quotes $2 per square foot for installation.
- 17. BOTTOM UP ESTIMATES Method Description Scenarios Bottom Up This is a detailed estimate that usually involves team input. Advantage: There is detail and accuracy associated with it. Disadvantage: It can take significant time to create and the team can pad the estimates to compensate for unknowns. A project manager and the team work together to create a complete estimate from the bottom (Activity level) up and roll it up to the total estimate.
- 18. ESTIMATE COSTS METHODS: MONTE CARLO Method Description Scenarios Computerized /Monte Carlo This estimate involves using a computerized program to simulate different variables associated with project outcome. Advantages: (1) Accuracy of the estimate; (2) The “what-if” analysis that can be performed Disadvantages: The ramp-up time and costs associated with the setup of the tool. Variables simulated could include the overall time and cost estimates as well as the confidence levels of the estimates. Variables could also include the number of people needed to achieve project goals.
- 20. DETERMINE BUDGET • Determine Budget is the process of aggregating the estimated costs of individual activities or work packages to establish an authorized cost baseline. • The key benefit of this process is that it determines the cost baseline against which project performance can be monitored and controlled. • A project budget includes all the funds authorized to execute the project. • The cost baseline is the approved version of the time-phased project budget, but excludes management reserves.
- 21. DETERMINE BUDGET
- 22. DETERMINE BUDGET Project Funding Requirements – Total funding requirements and periodic funding requirements (e.g., quarterly, annually) are derived from the cost baseline. – The cost baseline will include projected expenditures plus anticipated liabilities. – Funding often occurs in incremental amounts that are not continuous, and may not be evenly distributed – The total funds required are those included in the cost baseline, plus management reserves, if any.
- 23. DETERMINE BUDGET Cost Baseline – The cost baseline is the approved version of the time-phased project budget, excluding any management reserves, which can only be changed through formal change control procedures and is used as a basis for comparison to actual results. – It is developed as a summation of the approved budgets for the different schedule activities.
- 24. DETERMINE BUDGET
- 25. DETERMINE BUDGET
- 26. CONTROL COSTS • Control Costs is the process of monitoring the status of the project to update the project costs and managing changes to the cost baseline. • The key benefit of this process is that it provides the means to recognize variance from the plan in order to take corrective action and minimize risk.
- 27. CONTROL COSTS Project cost control includes: – Influencing the factors that create changes to the authorized cost baseline – Ensuring that all change requests are acted on in a timely manner; – Managing the actual changes when and as they occur – Ensuring that cost expenditures do not exceed the authorized funding by period, by WBS component, by activity, and in total for the project – Monitoring cost performance to isolate and understand variances from the approved cost baseline – Monitoring work performance against funds expended – Preventing unapproved changes from being included in the reported cost or resource usage – Informing appropriate stakeholders of all approved changes and associated cost – Bringing expected cost overruns within acceptable limits
- 28. EARNED VALUE Earned Value Management (EVM) : • Is a project management methodology used to track project performance as well as forecast future performance. EVM integrates the scope baseline, schedule baseline and cost to provide performance measurements. Results can be expressed in dollars and/or percentage. EVM can be used to report current/past project performance, and predict future project performance based on current/past performance. Variance Analysis Forecasting Current/Past Performance Future Performance
- 29. EARNED VALUE
- 31. EARNED VALUE FORMULAS CV Cost Variance EV – AC Where: EV = Earned Value AC = Actual Cost SV Schedule Variance EV – PV Where: EV = Earned Value PV = Planned Value CPI Cost Performance Index EV / AC Where: EV = Earned Value AC = Actual Cost SPI Schedule Performance Index EV / PV Where: EV = Earned Value PV = Planned Value
- 32. EARNED VALUE FORMULAS • EV – AC CV - Cost Variance • The difference between Earned Value and Actual CostEV – AC • Cost Overrun or over budget Negative • Under Budget Positive • On Budget Zero
- 33. EARNED VALUE FORMULAS • EV – PVSV - Schedule Variance • The difference between Earned Value and Planned Value EV – AC • Project performance behind schedule Negative • Project performance ahead schedule Positive • Project Performance on schedule Zero
- 34. EARNED VALUE FORMULAS • EV /PVSPI - Cost Performance Index • The ratio of Earned Value to Planned Value EV/PV • Cost over budget Value < 1 • Cost below budget Value > 1 • On Budget Value= 1
- 35. EARNED VALUE FORMULAS • EV /ACCPI - Cost Performance Index • The ratio of Earned Value to Actual Cost EV/AC • Project performance behind schedule Value < 1 • Project performance ahead schedule Value > 1 • Project Performance on schedule Value= 1
- 37. FORECASTS ESTIMATE AT COMPLETION (EAC) : • Is a periodic evaluation of the project status, used to estimate what is will cost to complete the project based on the performance today (CPI) – usually performed monthly or if significant changes have been identified. ESTIMATE AT COMPLETION (EAC)
- 38. FORECASTS ESTIMATE TO COMPLETE (ETC) : • The estimate to complete (ETC represents the amount needed to finish the project based on the current spending efficiency of the project.) ESTIMATE TO COMPLETE (ETC)
- 39. FORECASTS TO COMPLETE PERFORMANCE INDEX (TCPI) TO COMPLETE PERFORMANCE INDEX (TCPI): • It is an indicator of how performance needs to improve to close the deviation between planned values and actual performance, (efficiency level needed from the remaining resources to meet the cost goals of the project)
- 40. FORECASTS VARIANCE AT COMPLETION (VAC) VARIANCE AT COMPLETION (VAC): • It is the difference between the budget at completion (BAC) and the estimate at completion (EAC). This difference tells how much over or under budget the project finished