11b. Managing Construction Budget
11b. Managing Construction Budget
Project Cost Management includes the processes involved in planning, estimating, budgeting,
financing, funding, managing, and controlling costs so that the project can be completed within
the approved budget. The Project Cost Management processes are:
Plan Cost Management—The process of defining how the project costs will be
estimated, budgeted, managed, monitored, and controlled.
Estimate Costs—The process of developing an approximation of the monetary
resources needed to complete project work.
Determine Budget—The process of aggregating the estimated costs of individual
activities or work packages to establish an authorized cost baseline.
Control Costs—The process of monitoring the status of the project to update the project
costs and manage changes to the cost baseline.
It is to be noted that in smaller projects, cost estimating and cost budgeting are tightly linked
and can be viewed as a single process that can be performed by a single person over a relatively
short period of time. For medium to large sized projects, these two are distinct processes.
In this course, cost control will be our area of focus. There are several different reasons
contractors use cost control methods on construction projects. Cost control can range from a
simple col- lection of costs for labour, material, equipment, and subcontractors, organized in
projects or subprojects, to detailed compilation and analysis for every work activity. The
overhead cost of cost control increases as the detailed collection and expected reporting detail
increases. Therefore, contractors need to determine how much information they want from their
cost systems, according to their managers and the needs of their risk partners, such as banks
and bonding companies, and compare this to the staff costs to compile this information. Cost
control involves construction expertise from construction engineers or project controls
specialists, as well as accounting staff.
In a simple cost control system, the labour, material, equipment, and subcontract costs are
compared to the estimated cost for the project or subprojects to determine if the project
achieved the target cost. By adding the appropriate amount of indirect overhead, usually by
using a percent- age of the costs, the contractor can determine if the project was profitable; that
is, revenue exceeded the total of direct and indirect costs. The con- tractor wants to compare
the actual profit with the anticipated profit to determine if the estimating and operations
systems are synchronized.
Before getting into the details of cost control systems, it is important to understand the
importance of a cost management plan. It is a plan that sets out the format & establishes the
criteria for planning, structuring, estimating, budgeting & controlling project costs. For projects
of considerable size and scope, cost management plan plays a vital role in outlining the
processes and techniques to maintain and control the cost of the project during the execution
stage. The basic components of a good cost management plan according to Project
Management Institute (PMI) are detailed as below:
Units of measure. Each unit used in measurements (such as staff hours, staff days, or
weeks for time measures; meters, litres, tons, kilometres, or cubic yards for quantity
measures; or lump sum in currency form) is defined for each of the resources.
Level of precision. This is the degree to which cost estimates will be rounded up or
down (e.g., US$995.59 to US$1,000), based on the scope of the activities and
magnitude of the project.
Level of accuracy. The acceptable range (e.g., ±10%) used in determining realistic cost
estimates is specified, and may include an amount for contingencies.
Organizational procedures links. The work breakdown structure (WBS) (Section 5.4)
provides the framework for the cost management plan, allowing for consistency with
the estimates, budgets, and control of costs. The WBS component used for the project
cost accounting is called the control account. Each control account is assigned a unique
code or account number(s) that links directly to the performing organization’s
accounting system.
Control thresholds. Variance thresholds for monitoring cost performance may be
specified to indicate an agreed-upon amount of variation to be allowed before some
action needs to be taken. Thresholds are typically expressed as percentage deviations
from the baseline plan.
Rules of performance measurement. Earned value management (EVM) rules of
performance measurement are set. For example, the cost management plan may:
o Define the points in the WBS at which measurement of control accounts will be
performed;
o Establish the EVM techniques (e.g., weighted milestones, fixed-formula,
percent complete, etc.) to be employed; and
o Specify tracking methodologies and the EVM computation equations for
calculating projected estimate at completion (EAC) forecasts to provide a
validity check on the bottom-up EAC.
Reporting formats. The formats and frequency for the various cost reports are defined.
Additional details. Additional details about cost management activities include but are
not limited to:
o Description of strategic funding choices,
o Procedure to account for fluctuations in currency exchange rates, and
o Procedure for project cost recording.
Cost control, despite its simple name, means a lot of different things to different people. Some
often-heard synonyms are cost engineering, cost reporting, value engineering, and cost
reduction. None of them alone is equivalent to cost control. Let's define a few of the synonyms
in order to understand the differences in meanings.
Cost engineering is a generic term that covers the total field of cost estimating, budgeting, and
cost control. It is too general a term to use for real cost containment.
Cost reporting consists of gathering the cost data and reporting the actual versus planned results
without mentioning the operative word control.
Value engineering gets closer to cost control because it looks at ways to reduce costs on specific
items or activities. However, it does not look at the total project picture or check the daily
performance; it focuses only on specific items in the design, procurement, or construction area.
Cost reduction also gets closer to cost control, and would be fine if it included cost reporting.
The result would then be evaluation and containment of costs on a complete project.
As it turns out, true cost control for capital projects involves all of the above activities at various
times. According to Ritz, cost control means the purposeful control of all project costs in
every way possible. That means that every member of the project team has a part to play in
reducing and controlling costs. The project and construction managers are the leaders of the
cost-containment program, and they must constantly reinforce that philosophy throughout the
life of the project!
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 the cost
baseline is maintained throughout the project. This process is performed throughout the project.
The inputs, tools and techniques, and outputs of this process are depicted below.
Project Funding Requirement: Periodic supply of funds for project that includes expenditures
and contingency reserves. The project funding requirements include projected expenditures
plus anticipated liabilities.
Work performance Information: Project progress update. Work performance data contains
data on project status such as which costs have been authorized, incurred, invoiced, and paid.
Organizational Process Assets: Cost control rules & policies at organization level, monitoring
& reporting techniques specified.
The details of Earned Value Analysis and its parameters can be studied separately (Ref.
PMBoK 5th Edition & any project management textbook).
EACs are typically based on the actual costs incurred for work completed, plus an estimate to
complete (ETC) the remaining work. It is incumbent on the project team to predict what it may
encounter to perform the ETC, based on its experience to date. Earned value analysis works
well in conjunction with manual forecasts of the required EAC costs. The most common EAC
forecasting approach is a manual, bottom-up summation by the project manager and project
team.
The project manager’s bottom-up EAC method builds upon the actual costs and experience
incurred for the work completed, and requires a new estimate to complete the remaining project
work. Equation: EAC = AC + Bottom-up ETC.
Performance Reviews: It is the process of comparing cost performance over time and to check
overrunning or underrunning of budget. Performance Reviews are supplemented by –
Labour Reports
Work Performance Reports
Equipment Operation and Maintenance Cost Reports
Sundry Expenses Reports
Material Purchase Reports
Overheads Expenditure Reports
Sundry Expenses Reports
Departmental Expenses Reports etc.
All the cost related data are aggregated and compiled according to the cost codes designed in
the budgetary provision.
Variance Analysis: It is the process to determine the cause and degree of cost variance to
decide upon corrective/preventive action. Technically, variance analysis follows cost
performance review in the workflow.
Variance analyses can be performed by comparing planned cost against actual cost (compiled
in the cost performance review stage) to identify variances between the cost baseline and actual
project performance.
Further analysis can be performed to determine the cause and degree of variance relative to the
schedule baseline and any corrective or preventive actions needed. Cost performance
measurements are used to assess the magnitude of variation to the original cost baseline.
An important aspect of project cost control includes determining the cause and degree of
variance relative to the cost baseline and deciding whether corrective or preventive action is
required. The percentage range of acceptable variances will tend to decrease as more work is
accomplished.
Budget Forecasts: Financial forecasts like EAC and BAC are communicated to stakeholders
for further decisions. The forecast is updated every month or periodical interval. The forecasts
help in determining the course of action to retain the project in its course and avoiding cost
overrun.
Organizational Process Updates: Root Cause analysis, corrective action formulations and
record of lessons learned are performed.
Change Requests: Request to change the overall cost monitoring and control plan of the project
if required. Analysis of project performance may result in a change request to the cost and
schedule baselines or other components of the project management plan. Change requests are
processed for review and disposition through the Perform Integrated Change Control process.
In construction projects, change requests are also called Change Orders or Variation Claims.
The viability of Change Orders depends on the mutual agreements between the parties involved
in the execution of the contract. Such change orders get regularly recorded and updated after
each cycle of cost control.
Project Management Plan Updates: Each cost control cycle may result in change in cost
performance baseline & cost management plan if required. Sometimes performance baseline
also changes to accommodate the change in costs.
Project Document Updates: Many project documents like productivity norms, cost estimate &
basis of estimates, lessons learnt report and risk register get updated after each cost control
cycle. Project documents need updating if the cost impacts are irreversible and the implications
of such changes are accepted by all the primary stakeholders involved in execution of the
project.
1.6. Cost Control Techniques other than Earned Value Analysis
Apart from earned value analysis, there are few more cost-control techniques that organizations
use to track, monitor and control their project expenses. Two most common techniques are –
1. S-Curve Approach
2. Unit Cost Approach
Once the contracts have been awarded, it is relatively easier to estimate the ‘bill value’ for each
activity on a detailed bar chart. By analysing the nature of each activity, one can estimate the
way in which this value will be distributed on, say, a monthly basis. These amounts will then
be summed to give the total estimated monthly value, and the figure plotted on a graphic form
as shown in the figure below. Now, a second curve (shown as dotted line) can be drawn based
on the work that is actually performed.
It is clear from Figure 16.9 that the amount that should have been billed as on the day of
monitoring has not been done, and that is the reason the second curve is running below the first
curve. This is an ‘under spend’ situation. Similarly, the second curve is also showing a shift
towards the right. This shows an ‘overall delay’ indicating that the project is running behind
schedule. Thus, the financial value may be used as a single general measure of the progress of
a project.
Once the project starts, every month the cost baseline needs to be checked for variance and
forecasts need to be performed to obtain the revised estimate of the project. It is very unlikely
that a project will perform exactly according to the plan. In such circumstance, planning
managers calculate the revised forecast of the project’s cost after each cost-control cycle. If
one cumulatively adds the costs for the original plan, revised plan and the actual cost incurred
till date, then three distinct S-curves can be obtained – the Actual Cost Curve, the Revised Cost,
Curve and the Budgeted Cost Curve.
budget.
The ACE of an item could be exactly matching the bid rate or sales prices (estimated ‘no profit,
no loss’ scenario), lower than the bid rate (estimated profit scenario), or higher than the bid rate
(estimated loss scenario). The ACE becomes the standard of comparison in future monitoring
endeavours—any excessive expenditure over the ACE is treated as a warning sign and the
control measures are promptly applied.
The three basic steps of Unit Cost approach are shown in the diagram below.
1.6.2.1. Setting up the cost code
The cost code system is established as per standard cost management plan. The same is
discussed in the project budgeting chapter.
Provision for Expenses: This includes foreseeable loss and expenses to be incurred in
closing down of the projects. The delayed recoveries by clients for materials issued to the
contractor, electricity and water supplied, etc., are also to be considered. Similarly,
provision should also be made for the expenses that have been incurred though their exact
cost is not known (for example, customs duty for imported items, commission to clearing
agency, etc.) at the time of preparing the report.
Deferred Expenses: For some activities, the initial investment required would be very high.
The investment is made for completing the entire activity. For instance, if the activity is
only 10 per cent complete, it would be unfair to book the total investment for the activity
in the cost statement. In such cases, only a part of the expenses, preferably on a pro rata
basis, is shown in the cost statement and the remaining amount is taken as deferred expense,
which is adjusted afterwards in proportion to the progress of activity.
Adding up the total cost for each of the cost codes gives the total project cost for the month and
up to the month. This information is passed on to the planning engineer for further processing.
1.6.2.3. Preparation of Project Cost Report
Planning engineer prepares this report normally on a monthly basis after getting the cost
statement from the accountant. For preparing the report, the planning engineer works out the
variance in cost for each of the cost codes.
Estimate to date: This is found as follows - Calculate the quantity done to date. Let it be Qd.
Take cost to date data for this cost code from the cost statement. Let it be Cd. Compute the unit
cost to date. This is denoted by Ed. Hence,
Estimate for balance quantity: Calculate remaining quantity to be done (Qb). Estimate the cost
likely to be incurred (Cb). Compute the estimated unit cost for the balance quantity (Eb). This
is given as,
Revised estimate for revised quantity: The revised estimate for a cost code is computed by first
adding the quantities Qd and Qb. The revised total cost is the sum of Cd and Cb. The revised
unit cost (Er) is calculated by dividing the revised total cost, Cr, by the revised total quantities,
Qr. Expressed mathematically as,
Original estimate for original quantity: Original estimate, Eo, is the estimated cost for a
particular cost code. This is computed by dividing the original estimated cost (Co) by original
quantities (Qo). This is expressed mathematically as,
The variance (V) for each of the cost code is the difference of Eo and Er. That is variance,
Sometimes, another metric called “original estimate for revised quantity” is also used to
analyze the variance. Effectively, the original cost in a cost code (Co)is divided by the revised
total quantity in the same cost code (Qr).
The process is repeated for all the cost codes of the project to arrive at the total project cost at
the time of monitoring. This information tells us whether the total project is over-running the
budgeted cost or under-running the budgeted cost. The typical format of a project cost report
is given in the figure below:
A small example of a boundary wall project (Ref. Jha, K N 2015) is given below to illustrate
the concept of unit cost approach.
The Project Cost Report at the end of the month of July [Project Starts on 1 June, 2008 and
Finishes on 2 August, 2008]:
Note:
The revised contract price has to be arrived at based on revised quantities and agreed rates as
per the contract. All escalations payable by the client and other claims as and when raised have
to be included in the revised contract value. The revised contract value for the revised quantities
minus revised cost estimates gives the estimated site contribution (profit) at the end of the
project as on date.
Observe that instead of original estimate for original quantities, original estimate for revised
quantities is used. Here the quantity is taken from the revised quantity but cost is calculated
based on original cost plus some provisions of expenditure that is not considered in the original
plans and project updates as on date.