Project Management - The fourth dimension of cost control

The discipline of project management is primarily focused on managing time and cost throughout the life of a project. This article focuses on one aspect of cost control that is often overlooked in small and large scale projects alike, that is, accurately and objectively measuring the forecast final cost (sometimes called estimate at completion) through the life of a project and why it is important to do so.

The three most common cost values used during a project are "budget", "cost-to-date" and "work-in-progress". These values can be derived by the accounts department without any regard to whether the project is likely to finish under budget or over budget and are completely retrospective in nature.

The project budget, or "working budget", is established at the start of a project and is based on the Project Manager's best estimate of how much it will cost to complete the project. Most importantly, the working budget should be set-up in the same format that the project is planned to be executed. For example, a project may be tendered and awarded based on elemental rates, such as individual tender amounts for columns, slabs and walls, however, these tender amounts will need to be converted to a format suitable for project execution, such as a budget amount for formwork, concrete, steel reinforcing, brickwork etc.

Prior to awarding any works the Project Manager should get the "initial working budget" approved by the Board of Directors then, as the project progresses, the Project Manager may issue a "revised working budget" based on approved design changes or variations from the client. As long as the profit margin is maintained or improved the Board of Directors should be happy to accept the revised working budget as the new baseline for assessing the project's financial performance.

The project cost-to-date is the total value of costs accrued at a fixed point in time, in other words, the total value of invoices received from consultants, suppliers or contractors. The total invoice amount should be reflected in the cost- to-date, regardless of whether the invoice has been paid. Similarly, claims that have been received but not certified should not be reflected in 'the total cost-to-date.

The work-in-progress value (WIP) is the value of actual work completed on the construction site at a fixed point in time. It does not include the value of materials delivered to site that have not be installed or expended, and it does not normally include the value of items fabricated offsite that have not be installed. The WIP value may be used by your client for assessing interim payments or used by the project financier for assessing the value of security that they can lend against.

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What is Forecast Final Cost?

Forecast final cost is the projected total cost for completing a project at a fixed point in project life cycle based on the current status of the project procurement. It is the fourth dimension of cost control and requires the combined input of the project management and contract administration team to give a real - time, pro- active assessment of the projects cost performance. Action can then be taken in advance to mitigate cost over- runs and potential financial problems.

Forecast Final Cost is calculated using the following formula:

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Forecast final cost = total value of works procured + sub contractor / supplier variation orders + value of works not yet procured + cost opportunities - cost risks

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• Total value of works procured = sum of all contracts awarded to suppliers and subcontractors plus the value of any works that will be done by "in-house" employees.
• Sub-contractor / supplier variation orders = sum of all variation orders (additions or omissions) that have been confirmed in writing to consultants, sub-contractors or suppliers including the estimated value of any project managers instructions or architects instructions that have cost implications.
• Value of works not yet procured = the budget value of all suppliers and sub-contract works that have not been awarded or are still be negotiated.
• Cost opportunities = any known opportunities to deliver works under budget based on events that have transpired after the initial working budget was established. For example, steel supply prices may have dropped significantly since the project commenced, therefore there is a cost opportunity to save money on the supply of reinforcing steel. It is critical to base the value of cost opportunities on real objective data from external sources, not simply "gut feel".
• Cost risks = any known costs that were not accounted for in the working budget. For example, the cost of material supplies may have risen sharply before fixed-rate supply contracts have been awarded or there may be works discovered on the construction drawings that were missed during the tender pricing exercise. Again, it is important to be objective in your assessment of these cost risks.

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Based on this formula the project management and contract administration team can calculate the forecast final cost for each item in the working budget. To calculate the total projected gain (or loss) against the working budget we use the following formula.

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Total projected gain/(loss) =  (forecast final cost - revised working budget)

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It is recommended that a spreadsheet is set-up with columns for each of the aforementioned values and rows for each budget amount including all consultants, suppliers and contractors. As the project progresses and more works are procured, the accuracy of the forecast final cost and gain / loss projection will increase. Naturally, losses against some budget amounts will be offset by gains on others.

Based on the objective assessment of forecast final cost and projected gain / loss a Project Manager can take affirmative action to "steer" the project out of troubled water or simply sleep better at night knowing the project is on track for financial success. Some of the ways to avoid potential cost over-runs include re-design, value-engineering, re-specification of materials, re-packing trade works, increasing the field of suppliers and subcontractors, harder negotiation or re-programming construction sequences and durations. Alternatively, project gains / losses will decrease / increase the projects cash-flow requirement to assist in company cash flow planning and ensure there is enough money in the bank to finish the job.

In summary, it is worth the extra time and effort to accurately and objectively measure a project's forecast final cost as we must never forget the age-old saying, "If you can't measure it, you can't manage it".

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This article was published in the Master Builders Journal - Volume 3 -2010