1 1 chapter four 4-managerial process 4.1 estimating project time and costs 4-2 project cash flows...

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4-MANAGERIAL PROCESS

4.1 Estimating project time and costs

4-2 Project cash flows4.3 Performance and payment bonds

4-5 Cost Control. Management tools, accounts, general cost control systems.

5–2

Where We Are NowWhere We Are NowWhere We Are NowWhere We Are Now

5–3

Estimating Projects Estimating Projects Estimating Projects Estimating Projects

• Estimating–The process of forecasting or approximating the time

and cost of completing project deliverables.–The task of balancing expectations of stakeholders

and need for control while the project is implemented.

• Types of Estimates–Top-down (macro) estimates: analogy, group

consensus, or mathematical relationships–Bottom-up (micro) estimates: estimates of elements

of the work breakdown structure

5–4

Why Estimating Time and Cost Are ImportantWhy Estimating Time and Cost Are ImportantWhy Estimating Time and Cost Are ImportantWhy Estimating Time and Cost Are Important

EXHIBIT 5.1

• To support good decisions.

• To schedule work.

• To determine how long the project should take and its cost.

• To determine whether the project is worth doing.

• To develop cash flow needs.

• To determine how well the project is progressing.

• To develop time-phased budgets and establish the project baseline.

5–5

Factors Influencing the Quality of EstimatesFactors Influencing the Quality of EstimatesFactors Influencing the Quality of EstimatesFactors Influencing the Quality of Estimates

Quality of Estimates

Quality of Estimates

ProjectDuration

ProjectDuration

PeoplePeople

Project Structure and Organization

Project Structure and Organization

PaddingEstimates

PaddingEstimates

OrganizationCulture

OrganizationCulture

Other (Nonproject)Factors

Other (Nonproject)Factors

Planning HorizonPlanning Horizon

5–6

Estimating Guidelines for Times, Estimating Guidelines for Times, Costs, and ResourcesCosts, and Resources

Estimating Guidelines for Times, Estimating Guidelines for Times, Costs, and ResourcesCosts, and Resources

1. Have people familiar with the tasks make the estimate.

2. Use several people to make estimates.

3. Base estimates on normal conditions, efficient methods, and a normal level of resources.

4. Use consistent time units in estimating task times.

5. Treat each task as independent, don’t aggregate.

6. Don’t make allowances for contingencies.

7. Adding a risk assessment helps avoid surprises to stakeholders.

5–7

Top-Down versus Bottom-Up EstimatingTop-Down versus Bottom-Up EstimatingTop-Down versus Bottom-Up EstimatingTop-Down versus Bottom-Up Estimating

• Top-Down Estimates–Are usually are derived from someone who uses

experience and/or information to determine the project duration and total cost.

–Are made by top managers who have little knowledge of the processes used to complete the project.

• Bottom-Up Approach–Can serve as a check on cost elements in the WBS

by rolling up the work packages and associated cost accounts to major deliverables at the work package level.

5–8

Top-Down versus Bottom-Up EstimatingTop-Down versus Bottom-Up EstimatingTop-Down versus Bottom-Up EstimatingTop-Down versus Bottom-Up Estimating

TABLE 5.1

Conditions for Preferring Top-Down or Bottom-up Time and Cost Estimates

Condition Macro Estimates Micro Estimates

Strategic decision making X

Cost and time important X

High uncertainty X

Internal, small project X

Fixed-price contract X

Customer wants details X

Unstable scope X

5–9

Estimating Projects: Preferred ApproachEstimating Projects: Preferred ApproachEstimating Projects: Preferred ApproachEstimating Projects: Preferred Approach

• Make rough top-down estimates.

• Develop the WBS/OBS.

• Make bottom-up estimates.

• Develop schedules and budgets.

• Reconcile differences between top-down and bottom-up estimates

5–10

Top-Down Approaches for Estimating Top-Down Approaches for Estimating Project Times and CostsProject Times and Costs

Top-Down Approaches for Estimating Top-Down Approaches for Estimating Project Times and CostsProject Times and Costs

• Consensus methods

• Ratio methods

• Apportion method

• Function point methods for software and system projects

• Learning curves

Project EstimateTimesCosts

5–11

Apportion Method of Allocating Project Costs Apportion Method of Allocating Project Costs Using the Work Breakdown StructureUsing the Work Breakdown Structure

Apportion Method of Allocating Project Costs Apportion Method of Allocating Project Costs Using the Work Breakdown StructureUsing the Work Breakdown Structure

FIGURE 5.1

5–12

Simplified Basic Function Point Count Process Simplified Basic Function Point Count Process for a Prospective Project or Deliverablefor a Prospective Project or Deliverable

Simplified Basic Function Point Count Process Simplified Basic Function Point Count Process for a Prospective Project or Deliverablefor a Prospective Project or Deliverable

TABLE 5.2

5–13

Example: Function Point Count MethodExample: Function Point Count MethodExample: Function Point Count MethodExample: Function Point Count Method

TABLE 5.3

5–14

Bottom-Up Approaches for Estimating Bottom-Up Approaches for Estimating Project Times and CostsProject Times and Costs

Bottom-Up Approaches for Estimating Bottom-Up Approaches for Estimating Project Times and CostsProject Times and Costs

• Template methods

• Parametric procedures applied to specific tasks

• Range estimates for the WBS work packages

• Phase estimating: A hybrid

5–15

Support Cost Estimate WorksheetSupport Cost Estimate WorksheetSupport Cost Estimate WorksheetSupport Cost Estimate Worksheet

FIGURE 5.2

5–16

Phase Estimating over Product Life CyclePhase Estimating over Product Life CyclePhase Estimating over Product Life CyclePhase Estimating over Product Life Cycle

FIGURE 5.3

5–17

Top-Down and Bottom-Up EstimatesTop-Down and Bottom-Up EstimatesTop-Down and Bottom-Up EstimatesTop-Down and Bottom-Up Estimates

FIGURE 5.4

5–18

Level of DetailLevel of DetailLevel of DetailLevel of Detail

• Level of detail is different for different levels of management.

• Level of detail in the WBS varies with the complexity of the project.

• Excessive detail is costly.–Fosters a focus on departmental outcomes

–Creates unproductive paperwork

• Insufficient detail is costly.–Lack of focus on goals

–Wasted effort on nonessential activities

5–19

Types of CostsTypes of CostsTypes of CostsTypes of Costs

• Direct Costs–Costs that are clearly chargeable

to a specific work package.•Labor, materials, equipment, and other

• Direct (Project) Overhead Costs–Costs incurred that are directly tied to an identifiable

project deliverable or work package.•Salary, rents, supplies, specialized machinery

• General and Administrative Overhead Costs–Organization costs indirectly linked to a specific

package that are apportioned to the project

5–20

Contract Bid Summary CostsContract Bid Summary CostsContract Bid Summary CostsContract Bid Summary Costs

FIGURE 5.5

Direct costs $80,000

Direct overhead $20,000

Total direct costs $100,000

G&A overhead (20%) $20,000

Total costs $120,000

Profit (20%) $24,000

Total bid $144,000

5–21

Three Views of CostThree Views of CostThree Views of CostThree Views of Cost

FIGURE 5.6

5–22

Refining EstimatesRefining EstimatesRefining EstimatesRefining Estimates

• Reasons for Adjusting Estimates–Interaction costs are hidden in estimates.

–Normal conditions do not apply.

–Things go wrong on projects.

–Changes in project scope and plans.

• Adjusting Estimates–Time and cost estimates of specific activities are

adjusted as the risks, resources, and situation particulars become more clearly defined.

5–23

Creating a Database for EstimatingCreating a Database for EstimatingCreating a Database for EstimatingCreating a Database for Estimating

FIGURE 5.7

5–24

Key TermsKey TermsKey TermsKey Terms

Apportionment methods

Bottom-up estimates

Contingency funds

Delphi method

Direct costs

Function points

Learning curves

Overhead costs

Padding estimates

Phase estimating

Range estimating

Ratio methods

Template method

Time and cost databases

5–25

WBS FigureWBS FigureWBS FigureWBS Figure

TABLE 5.4

5–26

Learning Curves Unit ValuesLearning Curves Unit ValuesLearning Curves Unit ValuesLearning Curves Unit Values

TABLE A5.1

5–27

Learning Curves Cumulative ValuesLearning Curves Cumulative ValuesLearning Curves Cumulative ValuesLearning Curves Cumulative Values

TABLE A5.2

28

Project Cash Flow Project Cash Flow AnalysisAnalysis

Project Cash Flow Project Cash Flow AnalysisAnalysis

29

Elements of Investment Decision

• Identification of Investment Opportunities

• Generation of Cash Flows

• Measures of Investment Worth

• Project Selection

• Project Implementation

• Project-Control/Post-Audit

Our focus in this chapter is to develop the format of after-tax

cash flow statements.

30

Types of Cash Flow Elements in Project Analysis

Differential or incremental cash flow: cash flow due asset

31

Approach 1

Income Statement Approach

Approach 2

Direct Cash Flow Approach

Operating revenues

Cost of goods sold

Depreciation

Operating expenses

Interest expenses

Taxable income

Income taxes

Net income

+ Depreciation

Operating revenues

- Cost of goods sold

- Operating expenses

- Interest expenses

- Income taxes

Cash flow from operation

Cash Flows from Operating Activities

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A Typical Format used for Presenting Cash Flow Statement

Income statement Revenues Expenses Cost of goods sold Depreciation Debt interest Operating expensesTaxable incomeIncome taxesNet income

Cash flow statement

+ Net income+Depreciation

-Capital investment+ Proceeds from sales of depreciable assets- Gains tax- Investments in working capital+ Working capital recovery

+ Borrowed funds-Repayment of principal Net cash flow

Operatingactivities

Investing activities

Financingactivities

+

+

33

Example 9.1 When Projects Require only Operating and Investing Activities

• Project Nature: Installation of a new computer control system • Financial Data:

– Investment: $125,000– Project life: 5 years– Working capital investment: $23,331– Salvage value: $50,000– Annual labor savings: $100,000– Annual additional expenses:

• Labor: $20,000• Material: $12,000• Overhead: $8,000

– Depreciation Method: 7-year MACRS– Income tax rate: 40%– MARR: 15%

34

Questions

• (a) Develop the project’s cash flows over its project life.

• (b) Is this project justifiable at a MARR of 15%?

• (c) What is the internal rate of return of this project?

35

When Projects Require Working Capital Investments Working capital means

the amount carried in cash, accounts receivable, and inventory that is available to meet day-to-day operating needs.

How to treat working capital investments: just like a capital expenditure except that no depreciation is allowed.

36

• (a) Step 1: Depreciation Calculation– Cost Base = $125,000– Recovery Period = 7-year MACRS

N

MACRS Rate

Depreciation Amount

Allowed Depreciation Amount

1 14.29% $17,863 $17,863

2 24.49% $30,613 $30,613

3 17.49% $21,863 $21,863

4 12.49% $15,613 $15,613

5 8.93% $11,150 $5,575

6 8.92% $11,150 0

7 8.93% $11,150 0

8 4.46% $5,575 0

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(a) Step 2: Gains (Losses) associated with Asset Disposal

• Salvage value = $50,000• Book Value (year 5) = Cost Base – Total Depreciation

= $125,000 - $ 91,525= $ 33,475

• Taxable gains = Salvage Value – Book Value= $50,000 - $ 33,475= $16,525

• Gains taxes = (Taxable Gains)(Tax Rate)= $16,525 (0.40)= $6,610

38

Income Statement

0 1 2 3 4 5

Revenues $100,000

$100,000

$100,000

$100,000

$100,000

Expenses:

Labor 20,000 20,000 20,000 20,000 20,000

Material 12,000 12,000 12,000 12,000 12,000

Overhead 8,000 8,000 8,000 8,000 8,000

Depreciation 17,863 30,613 21,863 15,613 5,581

Taxable Income $42,137 $29,387 $38,137 $44,387 $54,419

Income Taxes (40%) 16,855 11,755 15,255 17,755 21,768

Net Income $25,282 $17,632 $22,882 $26,632 $32,651

Step 3 – Create an Income StatementStep 3 – Create an Income Statement Step 3 – Create an Income StatementStep 3 – Create an Income Statement

39

Step 4 – Develop a Cash Flow Statement

Cash Flow Statement 0 1 2 3 4 5

Operating Activities:

Net Income $25,282 $17,632

$22,882

$26,632

$32,651

Depreciation 17,863 30,613 21,863 15,613 5,581

Investment Activities:

Investment (125,000)

Working capital (23,331) 23,331

Salvage 50,000

Gains Tax (6,613)

Net Cash Flow ($148,331) $43,145 $48,245 $44,745 $42,245 $104,950

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An Excel WorksheetAn Excel WorksheetAn Excel WorksheetAn Excel Worksheet

41

Example 9.1 - Net Cash Flow Table Generated by Traditional Method Using Approach 2

A B C D E F G H I J

Year End

Investment & Salvage Value

Revenue Labor Expenses Materials

Overhead Depreciation Taxable Income

Income Taxes

Net Cash Flow

0 -$125,000

-23,331

-$125,000

1 $100,000 20,000 12,000 8,000 $17,863 42,137 16,855 $43,145

2 100,000 20,000 12,000 8,000 30,613 29,387 11,755 $48,245

3 100,000 20,000 12,000 8,000 21,863 38,137 15,255 $44,745

4 100,000 20,000 12,000 8,000 15,613 44,387 17,755 $42,245

5 100,000 20,000 12,000 8,000 5,581 54,419 21,678 $38,232

50,000*

23,331

16,525 6,613 $43,387

23,331

Information required tocalculate the income taxes

*Salvage value Note thatH = C-D-E-F-GI = 0.4 * HJ= B+C-D-E-F-I

42

Cash Flow Diagram including Working Capital

0 1 2 3 4 5

$23,331Years

$23,331

Working capital recovery cycles

01 2 3 4 5

$43,145$48,245 $44,745

$42,245$81,619

Working capitalrecovery

$23,331

$125,000 Investment in physical assets

$23,331 Investment inworking capital

$23,331

$23,331

43

Question (b):• Is this investment justifiable at

a MARR of 15%?

• PW(15%) = -$148,331 + +$43,145(P/F, 15%, 1) + . . . . + $104,950 (P/F, 15%, 5)

= $31,420 > 0

–Yes, Accept the Project !

0

1 2 3 4 5

$148,331

$43,145

$48,245 $44,745 $42,245

$104,950

Years

44

Question (C): IRR

A B

1 Period Cash Flow

2 0 ($148,331)

3 1 43,145

4 2 48,245

5 3 44,745

6 4 42,245

7 5 104,950

=IRR(B2:B7,0.10)

IRR = 22.55%

45

Rate of Return Analysis (IRR = 22.55%)

n = 0 n =1 n = 2 n = 3 n = 4 n = 5

Beginning

Balance

-$148,331 -$138,635 -$121,652 -$104,339 -$85,622

Return on

Investment

(interest)

-$33,449 -$31,262 -$27,432 -$23,528 -$19,328

Payment -$148,331 $43,145 $48,245 $44,745 $42,245 $104,950

Project

Balance

-$148,331 -$138,635 -$121,652 -$104,339 -$85,622 0

46

When Projects are Financed with When Projects are Financed with Borrowed FundsBorrowed Funds

When Projects are Financed with When Projects are Financed with Borrowed FundsBorrowed Funds

• Key issue: Interest payment is a tax-deductible expense.

• What Needs to Be Done: Once a loan repayment schedule is known, separate the interest payments from the annual installments.

• What about Principal Payments? As the amount of borrowing is NOT viewed as income to the borrower, the repayments of principal are NOT viewed as expenses either– NO tax effect.

47

Loan Repayment Schedule (Example 9.2)

End of

Year

Beginning

Balance

Interest Payment

Principal Payment

Ending

Balance

1 $62,500 $6,250 $10,237 $52,263

2 52,263 5,226 11,261 41,002

3 41,002 4,100 12,387 28,615

4 28,615 2,861 13,626 14,989

5 14,989 1,499 14,988 0

Amount financed: $62,500, or 50% of total capital expenditureFinancing rate: 10% per yearAnnual installment: $16,487 or, A = $62,500(A/P, 10%, 5)

$16,487

48

Additionalentries related

to debt financing

Table 9.4

49

When Projects Results in Negative When Projects Results in Negative Taxable IncomeTaxable Income

When Projects Results in Negative When Projects Results in Negative Taxable IncomeTaxable Income

• Negative taxable income (project loss) means you can reduce your taxable income from regular business operation by the amount of loss, which results in a tax savings.

• Handling Project Loss

Regular Business

Project Combined Operation

Taxable income

Income taxes (35%)

$100M

$35M

(10M)

?

$90M

$31.5M

Tax Savings = $35M - $31.5M = $3.5MOr (10M)(0.35) = -$3.5M

Tax savings

50

Effects of Inflation on Project Cash Effects of Inflation on Project Cash FlowsFlows

Effects of Inflation on Project Cash Effects of Inflation on Project Cash FlowsFlows

Item Effects of Inflation

Depreciation expense

Depreciation expense is charged to taxable income in dollars of declining values; taxable income is overstated, resulting in higher taxes

Note: Depreciation expenses are based on historical costs andalways expressed in actual dollars

51


Salvage value Inflated salvage value combined with book values based on historical costs results in higher taxable gains.

52


Loan repayments

Borrowers repay historical loan amounts with dollars of decreased purchasing power, reducing the debt-financing cost.

53


Working capital requirement

Known as working capital drain, the cost of working capital increases in an inflationary environment.

54


Rate of Return and NPW

Unless revenues are sufficiently increased to keep pace with inflation, tax effects and/or a working capital drain result in lower rate of return or lower NPW.

55

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A B C D E F G H

Example 9.3 Cash Flow Statement for the Automated Machining Center Project

Income StatementInflation Rate 0 1 2 3 4 5

Revenues 5% 105,000$ 110,250$ 115,763$ 121,551$ 127,628$ Expenses: Labor 5% 21,000 22,050 23,153 24,310 25,526 Material 5% 12,600 13,230 13,892 14,586 15,315 Overhead 5% 8,400 8,820 9,261 9,724 10,210 Depreciation 17,863 30,613 21,863 15,613 5,581

Taxable Income 45,137$ 35,537$ 47,595$ 57,317$ 70,996$ Income Taxes (40%) 18,055 14,215 19,038 22,927 28,398

Net Income 27,082$ 21,322$ 28,557$ 34,390$ 42,598$

Cash Flow Statement

Operating Activities: Net Income 27,082 21,322 28,557 34,390 42,598 Depreciation 17,863 30,613 21,863 15,613 5,581 Investment Activities: Investment (125,000) Salvage 5% 63,814 Gains Tax (12,139) Working Capital 5% (23,331) (1,167) (1,225) (1,287) (1,351) 28,361

Net Cash Flow (148,331)$ 43,778$ 50,710$ 49,133$ 48,652$ 128,215$ (in actual dollars)

56

Example 9.4 Cash Flow Statement for AMC Project under Inflation (Multiple Price Indices)

Income StatementInflation Rate 0 1 2 3 4 5

Revenues 6% 106,000$ 112,360$ 119,102$ 126,248$ 133,823$ Expenses: Labor 5% 21,000 22,050 23,153 24,310 25,526 Material 4% 12,480 12,979 13,498 14,038 14,600 Overhead 5% 8,400 8,820 9,261 9,724 10,210 Depreciation 17,863 30,613 21,863 15,613 5,581

Taxable Income 46,257$ 37,898$ 51,327$ 62,562$ 77,906$ Income Taxes (40%) 18,503 15,159 20,531 25,025 31,162

Net Income 27,754$ 22,739$ 30,796$ 37,537$ 46,744$

Cash Flow Statement

Operating Activities: Net Income 27,754 22,739 30,796 37,537 46,744 Depreciation 17,863 30,613 21,863 15,613 5,581 Investment Activities: Investment (125,000) Salvage 3% 57,964 Gains Tax (9,799) Working Capital 5% (23,331) (1,167) (1,225) (1,287) (1,351) 28,361

Net Cash Flow (148,331)$ 44,450$ 52,127$ 51,372$ 51,799$ 128,851$ (in actual dollars)

Example 9.4 Applying Specific Inflation Rates

57

Rate of Return Analysis under InflationRate of Return Analysis under InflationRate of Return Analysis under InflationRate of Return Analysis under Inflation

• Principle:True (real) rate of return should be based on constant dollars.

• If the rate of return is computed based on actual dollars, the real rate of return can be calculated as:

n

Net cash flows in actual dollars

Net cash flows in constant dollars

0

1

2

3

4

-$30,000

13,570

15,860

13,358

13,626

-$30,000

12,336

13,108

10,036

9,307

IRR 31.34% 19.40%

ii

f'

.

..40%

_

1

11

1 0 3134

1 0 101

19

f_

10%

58

Decision CriterionDecision CriterionDecision CriterionDecision Criterion

• If you use 31.34% as your IRR, you should use a market interest rate (or inflation-adjusted MARR) to make an accept and reject decision.

• If you use 19.40% as your IRR, you should use an inflation-free interest rate (inflation-free MARR) to make an accept and reject decision.

59

Input OutputTax Rate(%) = 40 PW(i) = $37,761

MARR(%) = 15 IRR(%) = 33.74%

0 1 2 3 4 5 6Income Statement

Revenues (savings) $38,780 $38,780 $38,780 $38,780 $38,780 $38,780Expenses: Depreciation 9,817 16,825 12,016 8,581 6,135 3,064

Taxable Income $28,963 $21,955 $26,764 $30,199 $32,645 $35,716Income Taxes (40%) 11,585 8,782 10,706 12,080 13,058 14,286

Net Income $17,378 $13,173 $16,059 $18,120 $19,587 $21,430

Cash Flow StatementOperating Activities: Net Income 17,378$ 13,173$ 16,059$ 18,120$ 19,587$ 21,430$ Depreciation 9,817$ 16,825$ 12,016$ 8,581$ 6,135$ 3,064$ Investment Activities: Investment (68,701)$ Salvage 3,500$ Gains Tax 3,505$

Net Cash Flow ($68,701) $27,195 $29,998 $28,074 $26,700 $25,722 $31,499

Surety Surety

BondsBonds

Surety Surety

BondsBondsThe Sensible Choice For Managing Risk

60

Can Surety Bonds Can Surety Bonds Help You?Help You?


• How do you evaluate & manage risk?

• How do you ensure projects are completed on time, on budget, and to contract specifications?

• How do you ensure contractors successfully meet obligations?

5–61



• Bid Bond• Performance Bond• Payment Bond

5–62

Surety Bonds vs. Traditional InsuranceSurety Bonds vs. Traditional InsuranceSurety Bonds vs. Traditional InsuranceSurety Bonds vs. Traditional Insurance

Surety Bonds Insurance3-party 2-party

Risk transfer Risk transfer

Duty to obligee Duty to insured

Regulated by State Insurance Departments

Regulated by State Insurance Departments

Premium fee for prequalification services

Premium actuarially determined

Project specific Usually term specific

Penal sum Policy limits5–63

Contract Surety BondsContract Surety BondsContract Surety BondsContract Surety Bonds


5–64



5–65



5–66

Fundamentals of SuretyFundamentals of SuretyFundamentals of SuretyFundamentals of Surety

Contractor default is preventable

Surety companies & producers prequalify contractors

Surety companies back the bond with their own assets

5–67

The 3 Cs The 3 Cs Of PrequalificationOf Prequalification

The 3 Cs The 3 Cs Of PrequalificationOf Prequalification

Capital

Capacity

Character

Capital

Capacity

Character5–68

Analyzing Financial StrengthAnalyzing Financial StrengthAnalyzing Financial StrengthAnalyzing Financial Strength

CapitalFinancial

statements

Working capital

Work-in-progress

Indemnity

5–69

Evaluating Ability Evaluating Ability To PerformTo Perform

Evaluating Ability Evaluating Ability To PerformTo Perform

CapitalFinancial

statements

Working capital

Work-in-progress

Indemnity

CapacityResumes

Contingency plan

Business plan

Equipment

5–70

Assessing Assessing ReputationReputationAssessing Assessing ReputationReputation

CapitalFinancial

statements

Working capital

Work-in-progress

Indemnity

CapacityResumes

Contingency plan

Business plan – short & long term

Equipment

CharacterReputation

Relationships

References

5–71

Reviewing Business VenturesReviewing Business VenturesReviewing Business VenturesReviewing Business Ventures

Document business commitments that can affect the contractor’s business

– Owning property

– Side ventures

Surety

5–72

Contractor FailureContractor FailureContractor FailureContractor Failure

Number of Years Failed Contractors Were in Business

6-10 Years29%

0-5 Years32%

10+ Years39%

Source: Dun & Bradstreet

5–73

Why Do Contractors Fail?Why Do Contractors Fail?Why Do Contractors Fail?Why Do Contractors Fail?

Failure

MaterialsShortages

OverExpansion

NewOwner

Cost Escalations

SubFailure

Change inScope

Inadequate Management

Failure

5–74

Why Do Contractors Fail?Why Do Contractors Fail?Why Do Contractors Fail?Why Do Contractors Fail?

Work Environment

EconomicDownturn

Death or Illness of Key Employee

OnerousTerms

Inclement Weather

FailureFailure

5–75

ClaimsClaimsClaimsClaims

Surety

ObligeePrincipal

5–76

Expediting Expediting The Claims ProcessThe Claims Process

Expediting Expediting The Claims ProcessThe Claims Process

• Clearly define default in contract

• Submit status reports to surety

• Promptly notify surety of performance or payment problems

• Owner must file formal declaration of default

5–77

Responsibility Responsibility Of The SuretyOf The Surety

Responsibility Responsibility Of The SuretyOf The Surety

• Acknowledge claim

• Investigate claim

• Determine & fulfill obligations

Surety

5–78

Performance Bond ProtectionPerformance Bond ProtectionPerformance Bond ProtectionPerformance Bond Protection

• Re-let the job

• Provide replacement contractor

• Retain original contractor

• Reimburse owner penal sum

Surety

5–79

Payment Bond Payment Bond ProtectionProtection

Payment Bond Payment Bond ProtectionProtection

• Assures payment

• No mechanics’ liens

• Keeps subcontractors on the job

Surety

5–80

Surety Bonds vs. Surety Bonds vs. Letters of CreditLetters of Credit

Surety Bonds vs. Surety Bonds vs. Letters of CreditLetters of Credit

Surety Credit Bank CreditPremium Interest

Expect reimbursement if loss

Repay loan

Principal benefit of surety credit

Borrower has benefit of bank $

5–81

The Value The Value Of Surety BondsOf Surety Bonds


• Bid Bonds• Performance Bonds• Payment Bonds

5–82




5–83




5–84

Cost of Surety BondsCost of Surety BondsCost of Surety BondsCost of Surety Bonds

Project Amount

Approx. Bond Premium

$1 Million $7,700 – $13,500

$5 Million $33,200 – $47,250

$10 Million $56,950 – $81,000

$20 Million $101,950 – $146,000

* Premiums may vary depending on size, type & contractors bonding capacity.

*For a small and emerging contractor, premiums can start around 2.5-3%.

5–85

Premium Calculation ExamplesPremium Calculation ExamplesPremium Calculation ExamplesPremium Calculation Examples

• Established Contractor–$500,000 Contract–Reviewed/Audited Financial Statements–Frequent Bond User–<1.0-1.5% Bond Rate (average – 1.35%)

•<$5,000-7,500

–Likely no other costs involved (collateral, escrow, SBA)

5–86

Premium Calculation ExamplesPremium Calculation ExamplesPremium Calculation ExamplesPremium Calculation Examples

• Emerging Contractor–$500,000 Contract–Limited Financial Info. (Tax Returns/Quickbooks)–Limited Bonding History–1.8-3.0% Flat Rate (average – 2.5%)

•$9,000-12,500

–May not include cost of getting bond (i.e., funds control, collateral, SBA fees)

5–87

How Is Premium Paid?How Is Premium Paid?How Is Premium Paid?How Is Premium Paid?

• Premium is billed BY the contractor TO the owner• Usually paid on first billing, along with:

–Mobilization–General Conditions–Bond

• Cost of bond is included in final contract price• Contractor pays the bond premium to the surety

– Prompt Pay Is Key To A Contractor’s Success!

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The Underlying AgreementThe Underlying AgreementThe Underlying AgreementThe Underlying Agreement

• Look at obligations• Determine risks• Match capable principal to fulfill

agreement

Surety

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1. Owner specifies surety bonds in contract documents

2. Contractor contacts surety bond producer

3. Producer guides contractor through prequalification

4. Contractor obtains bonds & delivers to owner

Bond SpecificationsBond SpecificationsBond SpecificationsBond Specifications

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COST MANAGEMENT

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COST MANAGEMENTCOST MANAGEMENTCOST MANAGEMENTCOST MANAGEMENT

• Includes processes required to ensure that the project is completed within the approved budget.

• Processes involved are:

1- Resource Planning

2- Cost Estimating

3- Cost Budgeting

4- Cost Control5–92

1- Resource Planning1- Resource Planning1- Resource Planning1- Resource Planning

Involves determining what physical resources (people, equipment, materials etc) and what quantities of each should be used to perform project activities.

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Inputs to Resource PlanningInputs to Resource PlanningInputs to Resource PlanningInputs to Resource Planning

1. Work Breakdown Structure:

A deliverable-oriented grouping of project elements that organizes and defines the total scope of the project. It Identifies the project elements that will need resources.

2. Historical Information

3. Scope Statement:

Contains the project justification and the project objectives.

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Inputs to Resource PlanningInputs to Resource PlanningInputs to Resource PlanningInputs to Resource Planning

4. Resource Pool Description:

Knowledge of what resources are potentially available.

5. Organizational Policies:

The policies of the performing organization regarding staffing and the rental or purchase of supplies and equipment.

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Tools and Techniques to Resource PlanningTools and Techniques to Resource PlanningTools and Techniques to Resource PlanningTools and Techniques to Resource Planning

1. Expert Judgment

2. Alternative identifications:

To adopt different approaches for the same problem.

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Outputs from Resource PlanningOutputs from Resource PlanningOutputs from Resource PlanningOutputs from Resource Planning

1. Resource Requirements:

Description of what types of resources are required and in what quantities for each element of the work break down structure.

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Cost EstimatingCost EstimatingCost EstimatingCost Estimating

• Developing an approximation (estimates) of the costs of the resources needed to complete project activities.

• Includes identifying and considering various costing alternatives.

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Cost Estimating and PricingCost Estimating and PricingCost Estimating and PricingCost Estimating and Pricing

• Cost Estimating involves developing an assessment of the likely quantitative result-how much will it cost the performing organization to provide the product or service involved.

• Pricing is a business decision-how much will the performing organization charge for the product or service

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Inputs to Cost EstimatingInputs to Cost EstimatingInputs to Cost EstimatingInputs to Cost Estimating

• Work Breakdown Structure• Resource Requirement• Resource Rates:

scheduled or non-scheduled• Activity Duration Estimates• Historical Information• Chart of Accounts:

Describes the coding structure used by the performing organization to report financial information in its general ledger

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Tools and Techniques for Cost EstimatingTools and Techniques for Cost EstimatingTools and Techniques for Cost EstimatingTools and Techniques for Cost Estimating

Analogous Estimating / Top-down Estimating:

Using the actual cost of a previous, similar project as the basis for estimating the cost

of the current project. It is less costly but less accurate. (Rough-cost Estimate)

Parametric Modeling:

Using project characteristics (parameters) in a mathematical model to predict project

costs.5–101

Tools and Techniques for Cost EstimatingTools and Techniques for Cost EstimatingTools and Techniques for Cost EstimatingTools and Techniques for Cost Estimating

• Bottom-up Estimating:Estimating the cost of individual work items, then summarizing or rolling up

the individual estimates to get a project title. (Detailed Estimate)

• Computerized Tools:Use of computerized tools such as project management software and

spreadsheets to assist with cost estimating.

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Outputs from Cost EstimatingOutputs from Cost EstimatingOutputs from Cost EstimatingOutputs from Cost Estimating

• Cost Estimates• Supporting Details like Scope of work,

Calculation sheet, Assumptions made, Possible range of results, etc.

• Cost Management Plan describing how cost variances will be managed.

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Cost BudgetingCost BudgetingCost BudgetingCost Budgeting

Allocation of overall cost estimates to individual work items in order to establish a cost baseline for measuring project performances.

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Inputs to Cost BudgetingInputs to Cost BudgetingInputs to Cost BudgetingInputs to Cost Budgeting

• Cost Estimates• Work Breakdown Structure• Project Schedule

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Tools and Techniques for Cost BudgetingTools and Techniques for Cost BudgetingTools and Techniques for Cost BudgetingTools and Techniques for Cost Budgeting

Tools and Techniques for developing project Cost Estimates are used to develop budgets for work items as well

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Outputs from Cost BudgetingOutputs from Cost BudgetingOutputs from Cost BudgetingOutputs from Cost Budgeting

• Cost Baseline

A time-phased budget that will be used to measure and monitor cost performance

on the project. It is developed by summing estimated costs by period and is usually displayed in the form of an S-curve.

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Cost ControlCost ControlCost ControlCost Control

Cost Control is concerned with(a) Influencing the factors which create changes to the cost baseline to ensure that changes are beneficial.(b) Determining that the cost baseline has changed(c) Managing the actual changes when and as they occur

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Cost ControlCost ControlCost ControlCost Control

Cost Control includes: Monitoring cost performances to detect variances

from plan. Ensuring that all appropriate changes are

recorded accurately in the cost baseline Preventing incorrect, inappropriate, or

unauthorized changes from being included in the cost baseline.

Informing appropriate stakeholders of authorized changes.

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Inputs to Cost ControlInputs to Cost ControlInputs to Cost ControlInputs to Cost Control

• Cost Baseline• Performance Reports

Provide information about cost performance such as which budgets have been met and which have not. It also alerts the project

team to issues which may cause problems in the future.

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Inputs to Cost ControlInputs to Cost ControlInputs to Cost ControlInputs to Cost Control

• Change Requests

These may occur in many forms-oral or written, direct or indirect, externally or internally initiated, and legally mandated or optional. These may require

increasing the budget or may allow decreasing it.

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Tools and Techniques for Cost ControlTools and Techniques for Cost ControlTools and Techniques for Cost ControlTools and Techniques for Cost Control

• Cost Change Control System

It defines the procedures by which the cost baseline may be changed. It includes the paperwork, tracking systems, and approval levels necessary for authorizing changes.

• Performance Measurement

It helps to assess the magnitude of any variations which do occur.

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Tools and Techniques for Cost ControlTools and Techniques for Cost ControlTools and Techniques for Cost ControlTools and Techniques for Cost Control

• Additional Planning

Perspective changes may require new or revised cost estimates or analysis of

alternate approaches.

• Computerized Tools

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Outputs from Cost ControlOutputs from Cost ControlOutputs from Cost ControlOutputs from Cost Control

• Revised Cost Estimates• Budget Updates• Corrective Action• Estimate at Completion

It is a forecast of total project costs based on project performance.

• Lessons Learned

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OBJECTS OF COST CONTROLOBJECTS OF COST CONTROL OBJECTS OF COST CONTROLOBJECTS OF COST CONTROL

1 – To have a knowledge of the profit and loss of the project throughout the duration of the project.

PROJECT PROFITS1) Client payments.2) Sale of surplus or scrap material and plant3) Payments for plants or labor by others, where, this plant or labor is , from time to time not required for the project.PROJECT LOSSES1) Labor and site office costs2) Plant costs3) Site overheads i.e. site facilities, access roads and office etc4) Cost of tendering including bonds, insurance, etc.5) Material costs.6) Head office overheads proportioned over all current projects.

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OBJECTS OF COST CONTROLOBJECTS OF COST CONTROLOBJECTS OF COST CONTROLOBJECTS OF COST CONTROL

2 – To have a comparison between the actual project performance and that conceived in the original project plan.

Comparison is basically done according to the following bases:

1) According to units of production2) According to line items; e.g., labour, material,

equipment, overheads, ---

3 – Provides feedback data on actual project performance to future project planning

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THANK YOUTHANK YOUTHANK YOUTHANK YOU

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The Owner’s ResponsibilitiesThe Owner’s ResponsibilitiesThe Owner’s ResponsibilitiesThe Owner’s Responsibilities

• Provide working set of plans and specifications

• Establish terms of the agreement

• Ensure full & timely payment

• Maintain adequate insurance

• Pay property taxes

• Communicate

Owner

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1 1 chapter four 4-managerial process 4.1 estimating project time and costs 4-2 project cash flows...

Documents

estimating project times

project deliverables

prospective project

project baseline

estimating task times

project cash flows4

phase estimating

estimating guidelines