Combined Cost Module v2 PDF
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Curtin University
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This document provides an introduction to project cost management, covering concepts of cost planning and cost control. It discusses the trade-off between time, cost, and quality, and how costs are managed within the project life cycle. The document focuses on the key aspects of managing costs during various project phases.
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Module 1 Introduction to Project Cost Management Table of Contents Introduction...........................................................................................
Module 1 Introduction to Project Cost Management Table of Contents Introduction......................................................................................................... Error! Bookmark not defined. Learning Outcomes................................................................................................. Error! Bookmark not defined. Module Topics....................................................................................................... Error! Bookmark not defined. Concepts of Project Cost Management.................................................................. Error! Bookmark not defined. The Tradeoff Between Time, Cost and Quality............................................................................................. 3 Managing Costs During the Project Life Cycle.............................................................................................. 5 Authority and Responsibility for Project Costs............................................................................................. 6 Required Reading................................................................................................... Error! Bookmark not defined. Additional Resources............................................................................................... Error! Bookmark not defined. Summary................................................................................................................................................. 7 References........................................................................................................... Error! Bookmark not defined. © Curtin University Page 1 of 104 The two major stages in project cost management; Cost planning: (involving resource planning, cost estimating and cost budgeting) often used for project feasibility and selection when starting up and/or initiating a project; and Cost control: used during the project implementation, at stage boundaries and when closing a project. Cost planning is the process by which project costs are calculated (estimating), applied to a timeline (budgeting) and then formed into a “cost plan” which will be used as a measure of cost and progress performance during the implementation of a project. Cost control takes the cost plan and uses it as a means of monitoring performance against the cost objective. Humphreys (2005, 117) defines cost control as...the application of procedures to monitor expenditures and performance against progress of projects or manufacturing operations; to measure variance from authorized budgets and allow effective action to be taken to achieve minimum costs. (AACE International cited in Humphreys 2005, 117) It is important to note that cost control differs from cost accounting in that cost control “predicts the final outcome of a project” whereas cost accounting “is the historical recording of disbursements and costs and expenditures to establish the precise and actual cost status of a project to date” (Humphreys 2005, 117). Cost control is clearly dependent upon the quality of the cost planning process. Kerzner (2017, 502) suggests:...failure of a cost control system to accurately describe the true status of a project does not necessarily imply that the cost control system is at fault. Any cost control system is only as good as the original plan against which performance will be measured. It is more common for the plan to be at fault than the control system. (Kerzner 2017, 502) There are 2 types of costs associated with any project: Direct costs These are the costs that are directly attributable to a project, such as salaries, travel and buying or renting equipment for the explicit use of the project (Rad 2002). They will include the costs of materials and the direct operating labour costs (Humphreys & Wellman 1996). In a project to make a film, for instance, the actor’s wages would be a direct cost. Indirect costs These are all costs other than direct costs. They cannot readily be attributed to a specific activity or project element. They are typically “project overheads” and cover items such as the project manager, head office administration and insurance. Indirect costs are often time- related, and not related to the amount of work achieved. For instance, the insurance for the film crew would be constant throughout the project and not related to the amount of filming undertaken in any one day. The costing or apportioning of indirect costs is often made by the organisations financial team and not the project manager. However, when estimating the cost of the project the project manager must trace all these imposts on his or her project to ensure the estimate is comprehensive. © Curtin University Page 2 of 104 Figure 1: Factors to consider in Cost Estimate (Humphreys 1991, 81) Local transport planning – the development of local transport plans, usually to guide the development of transport within a local government area. The Tradeoff Between Time, Cost and Quality Every project has 3 main focus areas that will determine its success or failure; Time, Cost and Quality. In other words, is the project executed according: To the time allowed; Within budget; and To the quality specified by the client (hopefully all 3 have been calculated or specified accurately). The three project objectives of time, cost and performance are “interrelated and must be addressed simultaneously; exclusive emphasis on any one is likely to detract from the others” (Nicholas 1990). Furthermore they are frequently in conflict with one another “at any point in project execution these seemingly simplistic objectives are not normally compatible” (Olde & Peralta 1989). Therefore it is critical that these objectives are clearly prioritised when trade-offs between them become necessary – “For a project to be successful, top management must establish a meaningful balance between schedule, cost and quality” (Heidenreich 1988). Generally there is an optimum time period to execute a project in will result in the lowest cost. Try to do a project too quickly and costs increase due to overtime (work related costs), do a project too slowly and costs increase due to an increase in overheads (time related costs). This tradeoff between time and cost is made by top management who may be prepared to accept a higher total cost if the project is finished early and therefore generates income sooner. See table below: © Curtin University Page 3 of 104 Figure 2: Cost and Time Relationship (Turner 1993) Usually the higher the quality specification for a project the higher the cost and the longer it takes. The decision on the level of quality required is determined by the type of project (i.e. in Aeronautics) the materials available and the client’s requirements. It is part of the project managers role to advise the client on the appropriate level of quality required and the optimum time to implement the project. The ultimate TCQ tradeoff is at the center of the TCQ triangle (below) where all have equal importance. This is unlikely and projects may move between the 3 at any stage of a project. Figure 3: Martin Barnes’s original triangle of objectives (Lock 2007, 21) © Curtin University Page 4 of 104 Managing Costs During the Project Life Cycle iLecture Begin this topic by watching part 3 of the recording, again you can view the Module 1 recording via the iLectures link on Blackboard. Project cost management is required at all phases of the typical project life cycle. Typically, the Concept phase will involve such cost management processes as conceptual estimates for alternative feasibility studies; the Development phase will include definitive cost estimates for the project and the setting of budgets and cash flows; the Implementation phase will predominantly entail cost controlling; the Termination phase will involve settlement of final accounts, and a review and audit of the cost management process The following diagram describes the project life cycle – costs are incurred during all stage on the Project Life Cycle and must be calculated and planned for as accurately as possible. The concept stage and planning stages can be 10% - 15 % of the final project cost. Executing (or implementation) stage of the project which is where the majority of the work and expenditure occurs can account for 80 % of total project costs. Project transfer or finish (which may include commissioning) will consume the remainder of the cost costs. Figure 4: Project Life Cycle – Four basic Phases (Wideman 2017) The Cost of Making Changes Typically, the cost of making changes increases greatly as the project progresses (see below). A good Project Manager will educate the project team and client to the negative effects on cost of making changes late in the project (in general the later the change is made the more costly the change becomes) The Project Manager must encourage the development of a comprehensive scope of work’s that fully reflects the Clients requirements during the early phases of the project life cycle so as to minimise future changes and consequential cost increases. © Curtin University Page 5 of 104 Figure 5: Phases of Project Life Cycle (Wideman 2018) Discussion Board Exercise 1.3 What PCM activities are likely to be undertaken in each of the following phases? Concept Development Execute Termination (or finish) You are encouraged to read and respond to your colleagues’ posts as well. In all projects there will be unders and overs i.e. activities that cost less than planned and activities that cost more than planned. A reasonable client/sponsor will be satisfied if the overall spending is within the planned budget – however all the actual costs identified must be used as the planned costs in future budgets. This use of historical data will make future estimates and budgets more accurate. Authority and Responsibility for Project Costs Authority and responsibility for cost management should lie totally with one person (e.g. project manager, cost manager), Usually however various cost items are allocated to different members of the project team. Any person given the responsibility for cost management must also have the concomitant authority to enable the effective management of costs. Often Project Managers are given a project to manage only once the final decision has been made to proceed and implement the project. In this case the Project Manager has had no input into the costing of the project © Curtin University Page 6 of 104 This can lead to cost change requests during to project to allow for variations to the project caused by under specification, technical changes and client scope changes. It is important that the organisation has a structure cost change process in place to tack the request, costing, approval and implementation of any changes. One thing is certain – changes will be requested and occur on any project. The cost of these changes is generally allowed for in a contingency sum which is part of the total project cost. The contingency sum is usually 5 – 10 % of the total project sum – this will be further dealt with in a later Topic. Summary This week’s module focused on a number of key topics in regard to an Introduction to Project Cost Management: Project Cost management is about calculating the costs to complete a project – and understanding that the more planning and accurate cost estimating the more likely the project will be successful; Understanding the Project Life Cycle and the cost of changes during the PLC; The tradeoff between TCQ – and finding a good balance between the 3 focus areas; and Project Managers often have no input into the initial cost estimating which can lead to cost conflicts during project execution. © Curtin University Page 7 of 104 Module 2 Cost Budgeting Table of Contents Introduction......................................................................................................... Error! Bookmark not defined. Learning Outcomes................................................................................................. Error! Bookmark not defined. Module Topics....................................................................................................... Error! Bookmark not defined. Cost Budgets - A Control Tool................................................................................................................. 9 Inputs and Outputs in Cost Budgeting....................................................................................................... 10 Top-down v Bottom-up Cost Budgeting..................................................................................................... 12 Project v Operational Cost Budgeting....................................................................................................... 13 Required Reading...................................................................................................................................... 14 Additional Resources.................................................................................................................................. 14 Summary................................................................................................................................................ 14 References........................................................................................................... Error! Bookmark not defined. © Curtin University Page 8 of 104 Cost Budgets - A Control Tool The budget must provide for all project costs, both direct and indirect, and also include such items as contingencies, allowances, and escalation. The budget provides: Basis for the formal approval and allocation of funds to the project; The allocation of funds across the Project Life Cycle; and Baseline for measuring and controlling the cost performance of the project. The budget must be realistic and based on an accurate estimate otherwise monitoring planned costs against actual costs will uncover many overs and unders and not be useful as tool to forecast the projects final cost. Figure 1: Example of PM conference budget (Created by author) The budget provides a means for controlling the project's costs: The main function of a good budget is to monitor the costs of a project while it is in progress, and to avoid cost overruns. (Haynes 1990) Budgeting is part of the planning function, and also serves as a control mechanism giving the basis from which actual performance can be compared, measured, explained, and corrected... The budget should be viewed and used as a program for planned expenditures. (Easton & Day 1981) From these quotes you would have realised that a budget like the one above is essential to plan when the costs from the estimate will be incurred and as a tool to compare the planned costs from the estimate with the actual costs as they are incurred during the Project Life Cycle. Roman (1986) highlights the important status of the project budget as a cost control tool - "a major responsibility of the project manager is developing and adhering to a budget for the project. Often he or she will be rated a success or failure as a project manager according to whether the project comes in under budget, on budget, or over budget.” © Curtin University Page 9 of 104 If the project budget is exceeded this could result in: Externally procured (i.e. an external Contractor or supplier is contracted to complete all or part of the Project) legal disputes and financial loss to either or both the external contractor/supplier and the client organisation; or Internally sourced - depletion of the organisation's funds and wealth as additional funding is required to complete the project. I find the best way to develop an estimate that will become a budget is by creating a “shopping list” of items you need to complete the Project and pricing these items. The more information in the form or designs and specifications you have available the more detailed your shopping list will be and the more accurate the estimate/budget. Exercise: Develop a “shopping list” for a overseas holiday for 2 to Italy. Include all indirect and direct costs. Inputs and Outputs in Cost Budgeting In order to produce a budget appropriate to the stage in the Project Life Cycle the following inputs are required (PMI 2000): Cost Estimate A budget is derived from an estimate of the project's costs: “The budgets are derived from estimates prepared using all of the design and cost information available at the time.” (Peles 1989) Nicholas (1990) explains the difference between estimates and budgets: “The similarity between budgets and estimates is that both state what it will cost to do something. The difference is that the estimate comes first and is the basis for the budget. An estimate may have to be refined many times, but once it is approved it becomes the budget.” The budget takes the cost calculated for the item of work in the estimate and schedules that cost against when the item is expected to occur (see budget above). Estimates are continuously updated as more information becomes available through the Project Life Cycle. The budget is also refined as the estimates are developed from conceptual estimates through to definitive estimates. “The budgeting process includes extensive reviews and revisions of the cost estimates, to arrive at the final budget figures” (Pells 1993). If the early estimates/budgets are used during Project Implementation they won’t be useful as an effective basis for cost control - “the primary requirement of cost control is a trackable budget, which should be developed from a detailed estimate” (Anderson, Neil & Hyvonen 1991). If the Project progresses to detailed planning and design and therefore implementation (remember not all Projects are implemented – it would depend on market conditions and financial feasibilities) cost must be calculated which will provide a more accurate estimate/budget that can be used to monitor costs during implementation. Work Breakdown Structure A work breakdown structure is like a very large complex “shopping list” that breaks the project down into logical, convenient and manageable small work elements is the Work Breakdown Structure (WBS) (figure 2). The WBS is a “deliverable-orientated grouping of project elements which organises and defines the total scope of the project” (PMI 2000). The WBS subdivides the project into levels of logic and work similarity until at its lowest level a work package is identified that is costed; this is represented below to 2 levels. 2.4 would be further broken down to what might be a work package like: 2.4.2.3.5 – Floor finishes to Office where all labour, plant and material related costs would be estimated. All work package costs would be aggregated to estimate the final cost of the Superconducting Super Collider Project. © Curtin University Page 10 of 104 Figure 2: Top three level of a project breakdown structure for a large, high-technology project (Archibald 1992, 206) Not all Projects have a WBS developed – in some cases with small or simple projects a “shopping list is adequate.” The WBS makes a project easier to control and helps identify the exact areas where actual costs are deviating from budget. Once a project has been divided into WBS elements, a code or numbering system is assigned to the cost data for cost monitoring, control, reports, and forecasting purposes. Each project element is assigned a unique cost account number to assure effective accounting and budgetary control of project costs. How to develop a WBS is dealt with in detail in another MPM unit Discussion Board – Exercise 2.1 Develop and estimate the costs of a work package “3 Nights in 4 Star Hotel in Rome.” You are encouraged to read and respond to your colleagues’ posts as well. Project Schedule (Generally a Bar Chart as shown below) Figure 3: Example Project Schedule (Created by Author) © Curtin University Page 11 of 104 The conversion of an estimate into a budget also entails allocating the budgetary amounts over the project's timeframe - “It is not only the top budget limits that are important, but also the rate at which expenditure is scheduled to take place” (Lock 1996). Harrison (1981) points out that "the difference between an estimate and a budget is that an estimate is the more or less simple tabulation of estimated costs for the work involved in a project... (whilst) the budget is a time-phased, detailed financial plan” Hence the budget requires a project schedule as this shows the duration, start and finish dates for the project elements, and therefore permits the allocation of cost budgets to the appropriate time periods (PMI 2000). Most scheduling software (e.g. MS Project) allows you to apportion costs to the activities which generate a budget. Risk Management Plan This is used to define the levels of risk in the project and can help identify the amount of contingency to be included in the project estimate. The higher the project risks due to market uncertainty, poor scope definition contractor uncertainty the higher will be the contingency sum – which is an amount added to the estimate/budget to allow for unknowns. With a relatively low risk project the contingency sum is usually around 5% of Project Value which increases as Project risk increases ( contingencies will be dealt with further later in this Cost Management). Below is a typical Risk Register of risks identified by the Project Team – the higher the risks the higher the contingency sum. Table 3: Example Risk Register (Created by author) Top-down v Bottom-up Cost Budgeting Meredith & Mantel (1995) identify two alternative methods for gathering data and formulating a project budget: Top-down Budgeting This approach involves obtaining judgements and experience from senior management who use historical data on similar projects. The senior managers estimate the overall project cost to an accuracy of +- 20% and pass it to lower level managers who breakdown the project cost into specific work packages. The budget is broken down into successively finer detail usually by way of a WBS or “shopping list” © Curtin University Page 12 of 104 depending on size and complexity of Project. This method is most commonly adopted as senior management generally makes the decisions on what projects to proceed with and what level of estimating is required. Disadvantages: Lower level managers can feel forced to accept budget allocations which they feel are insufficient for the assigned tasks as the costs have been estimated by senior management based on historical data; and It generates intense competition, conflict and negative relationships between lower level managers who frequently seek greater budgetary allocations for their particular area from a limited overall project budget. Advantages: The overall project budget “can often be developed quite accurately, though a few individual elements may be significantly in error”; The experience and judgement of upper management “is presumed to factor all such elements into the overall estimate”; It permits upper management to control the activities of lower-level organisational units; and Top management will have bought into the budget through their input. Bottom-up Budgeting In this budgetary method the budget for each element is derived by consulting the relevant people in the organisation. These elemental budgets are aggregated to give the total direct costs of the project, In other words the staff that actually do the work develop the estimate. Disadvantages: Omission can occur as "it is far more difficult to develop a complete list of tasks when constructing that list (of all elements) from the bottom up than from the top down" this is because a number of people are working on the estimate and co- ordinating their efforts if often neglected; and Lower-Managers overstate their budgetary needs as they believe that upper management will cut all budgets by some percentage. – It is very natural for project staff to include “a bit of fat” into the cost. If everybody does this the overall costs increase which may make the project financially unfeasible and the project does not proceed. Advantages: Greater accuracy because the elemental budgets are prepared by those with the specialised knowledge; Creates participative management and offers good managerial training; and Lower-Managers more likely to accept final budget allocations. Project v Operational Cost Budgeting Projects have a determined start and end date and therefore have a defined budget period. This could be short term i.e. under 12 months or long term i.e. over 5 years. If the budget period is long term, the organisation will have to commit funding over more than 1 financial year and the funding is often included in the Capital Expenditure section of the organisations financial plan. The capital budget amount is based on the detailed project budget. Operating budgets are required to keep the organisation running on a day to day basis and usually include items for salaries (some of these may be apportioned to the project to cost the staff working on the project), utilities, rent, transport costs and maintenance etc. These budgets are often based on the previous year’s budget allocation plus an allowance for inflation and any growth in organisation. Project and operating budgets must be integrated to ensure that operating costs are allowed for in the organisations budget when the project is completed. Discussion Board – Exercise 2.3 Develop a budget for the trip to Italy based on your shopping list and a bar chart. You are encouraged to read and respond to your colleagues’ posts as well. © Curtin University Page 13 of 104 Required Reading No further reading required, however it would be advantageous for students to read a selection books and articles used as references below. Additional Resources The following resource is not available via your Leganto Reading List, however, should you wish to locate them online, they will also be useful in learning about and understanding this topic: Harrin, Elizabeth. 2017. “Easy Steps to Create a Project Budget.” The Balance, November 12. Doll, Shelley. 2002. “Creating your project budget: Where to begin?” TechRepublic, May 17. Summary This week’s module focused on a number of key topics in regards to Project and operational Budgeting: The cost estimate is applied to the project time schedule to develop the project budget; The budget can only be used to accurately monitor costs If the estimate is based on a well-developed project scope; Bottom up estimating is more accurate than top down – however top down is usually adopted as it is driven by senior management; and Organisations must integrate Project specific (Capital) and operating budgets within their annual financial planning. © Curtin University Page 14 of 104 Module 3 Cash Flow Management Table of Contents Introduction............................................................................................................................................ 16 Learning Outcomes................................................................................................. Error! Bookmark not defined. Module Topics....................................................................................................... Error! Bookmark not defined. Cash Flow Management and Representation............................................................................................... 16 Cash Flow Forecasting......................................................................................................................... 19 Working Capital Forecasting and Monitoring............................................................................................... 20 Cash Flow Inputs................................................................................................................................ 21 Required Reading...................................................................................................................................... 22 Summary................................................................................................................................................ 22 References........................................................................................................... Error! Bookmark not defined. © Curtin University Page 15 of 104 Introduction Cash Flow Management and Representation Definition of Cash Flow Management Most cost accounting, economics and cost engineering textbooks include reference to cash flow analysis as it is an important part of cost control in any enterprise and/or project. Cash flows are used throughout business and in project management as a means of reporting income and expenditure. Pilcher (1994) describes a cash flow as indicating “…movements of cash, either into or out of the project account,” and explains that “…income or receipts are known as positive cash flows and expenditure or payments are known as negative cash flows”. In his definition of cash flows, Speed (1997) adds one other major component of a cash flow; time. He describes a cash flow as the “…the schedule of payments over a time period that an owner has to make in order to build a typical project.” Activities Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Actual Total Profit Speaker 1 - Fee $ 2,000.00 $ 2,000.00 $ 6,000.00 $ 10,000.00 Speaker 1 - Flights $ 6,057.62 $ 6,057.62 Speaker 1 - Accommodation $ 74.46 $ 670.14 $ 744.60 Key Note Speaker Costs Speaker 1 - Travel Insurance $ 33.53 $ 33.53 Speaker 2 - Fee $ 2,000.00 $ 3,000.00 $ 5,000.00 $ 10,000.00 Speaker 2 - Flights $ 12,339.42 $ 12,339.42 Speaker 2 - Accommodation $ 74.46 $ 670.14 $ 744.60 Speaker 2 - Travel Insurance $ 33.53 $ 33.53 Speaker 3 - Fee $ 2,000.00 $ 3,000.00 $ 5,000.00 $ 10,000.00 Speaker 3 - Flights $ 8,797.32 $ 8,797.32 Speaker 3 - Accommodation $ 74.46 $ 670.14 $ 744.60 Speaker 3 - Travel Insurance $ 33.53 $ 33.53 Conference - Day 1 $ 2,400.00 $ 4,800.00 $ 4,800.00 $ 12,000.00 Conference - Day 2 & 3 $ 5,250.00 $ 10,500.00 $ 10,500.00 $ 26,250.00 Venue, Dinner & other Costs Dinner / Awards Night $ 6,100.00 $ 11,200.00 $ 11,200.00 $ 28,500.00 MC #1 Three Days $ 300.00 $ 450.00 $ 750.00 $ 1,500.00 MC # 2 Day 2 & 3 $ 200.00 $ 200.00 $ 600.00 $ 1,000.00 Motivational Speaker (dinner) $ 1,000.00 $ 1,500.00 $ 2,500.00 $ 5,000.00 Band/ Entertainment $ 1,000.00 $ 1,600.00 $ 2,400.00 $ 5,000.00 Major Prizes $ 1,500.00 $ 1,500.00 Wine (Minor prizes & gifts) $ 840.00 $ 840.00 Wine (Consumption) $ 1,140.00 $ 1,140.00 Technical Equipment $ 200.00 $ 800.00 $ 1,000.00 Car Rental $ 805.32 $ 805.32 Exhibition Signage, advertising pamphlets, brochures $ 1,200.00 $ 600.00 $ 600.00 $ 600.00 $ 3,000.00 Costs Exhibition Space $ 2,500.00 $ 2,500.00 $ 5,000.00 Project Manager $ 960.00 $ 960.00 $ 960.00 $ 1,860.00 $ 1,860.00 $ 6,600.00 Marketing Manager $ 700.00 $ 700.00 $ 700.00 $ 1,400.00 $ 1,400.00 $ 2,100.00 $ 7,000.00 Overhead Costs Event Manager $ 600.00 $ 600.00 $ 600.00 $ 1,200.00 $ 1,200.00 $ 1,800.00 $ 6,000.00 PA/ Secretary $ 728.00 $ 728.00 $ 728.00 $ 1,496.00 $ 1,496.00 $ 2,104.00 $ 7,280.00 Marketing & Event Assistant $ 568.00 $ 568.00 $ 568.00 $ 1,272.00 $ 1,272.00 $ 1,272.00 $ 5,520.00 Office Rental Costs $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 1,041.67 $ 12,500.04 Loan Fees $ 1,184.00 $ 1,184.00 Related Loan Loan repayments $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 2,500.00 $ 30,000.00 Loan interest $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 95.25 $ 1,143.00 Contingency 20% Contingency $ 22,929.11 $ 22,929.11 $ 57,284.73 $ 30,831.28 $ 6,947.93 $ 3,636.92 $ 7,192.92 $ 4,236.92 $ 3,636.92 $ 7,792.92 $ 3,636.92 $ 11,464.92 $ 51,614.92 $ 63,942.92 $ 252,220.22 Activities Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Actual Total Received Loan $ 20,000.00 $ 20,000.00 MasterClass - Day 1 (Member) $ 6,176.00 $ 6,176.00 $ 6,176.00 $ 6,176.00 $ 24,704.00 MasterClass - Day 1 (Non-Member) $ 5,425.00 $ 5,425.00 $ 5,425.00 $ 5,425.00 $ 21,700.00 Early Bird - Conference Days 2 & 3 (Member) $ 7,000.00 $ 7,000.00 $ 7,000.00 $ 7,000.00 $ 28,000.00 Standard - Conference Dyas 2 & 3 (Member) $ 17,875.00 $ 17,875.00 $ 17,875.00 $ 17,875.00 $ 71,500.00 Standard - Conference Dyas 2 & 3 (Non Member) $ 8,571.42 $ 8,571.42 $ 8,571.42 $ 8,571.42 $ 8,571.42 $ 8,571.42 $ 8,571.42 $ 59,999.94 Dinner & Awards Night (Member) $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 56,000.00 Dinner & Awards Night (Non Member) $ 1,875.00 $ 1,875.00 $ 1,875.00 $ 1,875.00 $ 1,875.00 $ 1,875.00 $ 1,875.00 $ 13,125.00 Corporate Tables - 8 people per table $ 1,200.00 $ 1,200.00 $ 1,200.00 $ 1,200.00 $ 1,200.00 $ 1,200.00 $ 1,200.00 $ 8,400.00 Sponsorship (8 companies) $ 6,222.22 $ 6,222.22 $ 6,222.22 $ 18,666.66 $ 20,000.00 $ 24,875.00 $ 24,875.00 $ 24,875.00 $ 24,875.00 $ 19,646.42 $ 19,646.42 $ 37,469.64 $ 37,469.64 $ 37,469.64 $ 31,247.42 $ 19,646.42 $ 322,095.60 Profit $ 69,875.38 28% Figure 1: An example of a project budget showing cash out and a separate cash in forecast for a typical Project Management Conference (Created by author) The “shopping list” activities: the estimate total is $ 252 220.22c. © Curtin University Page 16 of 104 Figure 2: Activities total (Author adapted from students work) The forecasted revenues are: Figure 3: Forecasted revenues (Author adapted from students work) Combining the cash out with the cash in’s as they occur as per the budget in figure 1 produces a “saw tooth” cash flow graph (see below). © Curtin University Page 17 of 104 Figure 4: ‘Saw Tooth’ cash flow chart (Author adapted from students work) Discussion Board – Exercise 3.1 Re-draw the cash flow above using the actual revenue amounts shown in the table below. Comment on the Discussion Board the effect the different revenues had on the Project Cash Flow budget. Actual Revenue Total New Actual Total 30,000 35 000 20,700 18 000 21,700 22 000 30,000 35 000 71,500 65 000 60,000 50 000 56,000 15 000 13,825 9 000 11,550 14 000 8,400 8,400 16,000 16,000 © Curtin University Page 18 of 104 339,675 287,400 Cash Flow Forecasting Cash flow forecasting is used by Organisations to determine their annual operating finances and for projects. Both cash flows need to be separate and integrated to ensure the organisation has enough funds on hand to support both its normal business and the project. Organisational Cash Flow A typical cash flow statement for the annual operating finances could look like this: Figure 5: A typical cash flow statement for the annual operating finances (Principlesofaccounting.com 2018) In this case the Organisation has purchased land which has been a drain on there cash reserves. Discussion Board – Exercise 3.2 How could the organisation have avoided the depletion of their cash reserves? Share your answers and thoughts on the Discussion Board. The diagram below indicates the 3 major sections of an organisations cash flow statement. © Curtin University Page 19 of 104 Figure 6: The three sections of the cash flow statement (Little 2010) Project Financing would form part of the investing section of the cash flow. Please note this topic and course is not trying to make you financial experts (some of you may already be) but is attempting to give a basic overview of cash flow in organisations. Project Cash Flow Cash Flow forecasting in a project environment can be over more than one financial year and is developed for the entire project life cycle. Topic 1 above showed how a cash flow diagram is developed from the project budget which then has the expected project revenues and when they occur included. The costs and revenues are combined to determine the cash flow graph. The project cash flow will be negatively influenced by revenues being smaller than expected or being received later than expected. The project cash flow will be positively influenced by costs being lower than expected and occurring later in the project life cycle. Discussion Board – Exercise 3.3 Redraw the saw tooth cash flow (from figure 4) with all costs being incurred 1 month earlier and all revenue’s being received 1 month later. Analyse the new cash flow and comment on Discussion Board the effect that paying costs early and receiving revenue late has had on the project cash flow requirements. Working Capital Forecasting and Monitoring Organisational Working Capital An organisation needs working capital to ensure that it is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. If an organisation runs out of working capital it will not be able to operate on a daily basis and will be heading for bankruptcy. Project Working Capital A project’s working capital requirements are determined by the cash flow graph – in the saw tooth cash flow graph the areas represented below the X axis (or $0) are the project working capital requirements – see below: © Curtin University Page 20 of 104 Figure 7: Example of project working capital requirements (Author adapted from students work) The Conference project has a limited working capital requirement as the cash flow is under the $0 line for only 3 months and with a maximum working capital requirement of around $ 30 000. The project manager will have to ensure that this working capital requirement can be accommodated within the organisations working capital or seek additional project financing. Discussion Board – Exercise 3.5 Determine the maximum project working capital requirement for the saw tooth exercise you did earlier in the module. Not all projects generate early revenue. For example, a project to develop and sell a 15-story apartment building will only generate revenue following financial settlement by the purchaser on completion of the entire apartment block. The working capital requirement would be high and must be calculated to allow the developer to arrange sufficient internal or external financing to complete the project. The planned cash flow must be carefully monitored through the Project Life Cycle on a fortnightly basis to ensure that the costs are accruing and being paid as planned and the revenues are flowing in as planned. Should this not occur as planned, additional working capital may be required which may take the form of additional financing which can take time to organise. If the project runs out of working capital and is unable to cover its costs i.e. contractor/supplier payments the project may be halted. The costs of re-mobilising the project team would be excessive and must be avoided if at all possible. Cash Flow Inputs The inputs required to establish a cash flow depend on the type of cash flow under consideration. However, for a typical project cash flow, any or all of the following inputs would be required: 1. The budget This will be based on the work breakdown structure (WBS) and the cost estimate for each activity 2. The project schedule The project schedule will be used to identify when each activity in the cost estimate will be undertaken and give the cash flow its time component. 3. Records of actual expenditure These will show both direct and indirect expenses. According to Humphreys (1991) “…to setup the cash flow for a project, we need to establish all the in- and out-of-pocket amounts”. The accounts department will need to ensure that all relevant cost data is collected and allocated to the appropriate WBS activity so that actual and planned performance can be compared and monitored. 4. Estimated costs to complete the project works These costs would be for those works or items that have not yet been procured but are required to complete the project. Methods for estimating these costs are covered in the Teaching Notes for Earned Value Analysis. 5. Tax, inflation and depreciation assessments © Curtin University Page 21 of 104 The effects of tax as a cost and as a rebate (tax concession) must be considered in the cash flow. The cost manager preparing the cash flow must be familiar with the regulations for tax so that its effect can be adequately considered. Similarly, inflation of future costs and the depreciation of existing capital stock must all be understood and considered. 6. The nature of the project and its conditions 7. According to Speed (1997) “Cash flow is strongly influenced by the type of contract used”. Where the supplier has to finance the project themselves, they will include finance charges in the project cost and cash flow, whereas a supplier being paid on cost reimbursement principles will not need to include finance charges in the cash flow. Required Reading No further reading required, however it would be advantageous for students to read a selection books and articles listed as references below, as well as look at the content in the useful website boxes and in the YouTube videos throughout the module. Summary This week’s module focused on a number of key topics in regard to Cash Flows and Working Capital: The project budget along with planned project revenue is used to plot the project cash flow; Any variation to costs and when paid will influence the project cash flow: Any variation to revenue and when received will influence the project cash flow; Different types of projects have different cash flows – dependent largely on when revenues are expected; and Project working capital requirements calculated from the cash flow diagram and must either be internally financed by the parent organization or externally funded through loans. © Curtin University Page 22 of 104 Modules 4 and 5 Cost Estimating Methods and Important Aspects Table of Contents Introduction......................................................................................................... Error! Bookmark not defined. Learning Outcomes................................................................................................. Error! Bookmark not defined. Module Topics....................................................................................................... Error! Bookmark not defined. Components and Types of Estimates........................................................................................................ 24 Inputs and Factors Influencing Accuracy................................................................................................... 27 Estimate Classification........................................................................................................................ 28 Allowing for Contingencies and Inflation................................................................................................... 29 Required Reading................................................................................................... Error! Bookmark not defined. Summary................................................................................................................................................ 32 References........................................................................................................... Error! Bookmark not defined. © Curtin University Page 23 of 104 Components and Types of Estimates Definition of an Estimate Figure 1: Definition of ‘Estimate’ (Thefreedictionary.com 2018) From the above you can gather that a project estimate cannot be expected to be 100% accurate. This is due to the complexity of the project and its many components. The accuracy of the estimate increases with the improved definition of the scope of the project. Even with detailed planning and a very defined project scope the estimate may not be the actual final cost as scope changes, escalation and finance charges may decrease/increase the final actual cost of the project. The Components of an Estimate Contractors estimate (tender) The cost estimate will consist of a combination of the following: Labour - This is the cost of people employed to execute project tasks. The hourly cost consists of two components: payment direct to person; and additional on-costs. e.g. payroll tax, superannuation, workers compensation. Materials - Materials are consumed in delivering a project’s product. The materials may be incorporated in the project’s final product (e.g., bricks). Materials are usually obtained from manufacturers and suppliers. The cost of supply commonly includes for delivery and unloading. Equipment - Equipment refers to items used for project tasks which are not consumed so that they can be used on other subsequent projects (e.g., crane, computers). The cost will depend on whether the equipment is owned or hired and will include not only the capital or hire cost but also operating costs such as energy, maintenance, etc. Subcontract - When project elements are performed by a firm external to the organisation preparing the estimate, then a contract is entered into between the two parties. The cost of this work would include those components mentioned previously. i.e. labour, material and equipment. © Curtin University Page 24 of 104 Fees - These include costs for insurance and licence agreements Organisational Overheads - These are the costs incurred by an organisation such as general office staff, office rent, and advertising. A contractor who is preparing an estimate for submission of a tender needs to include a cost for organisational overheads, as tenders are the only means by which such costs are recouped. Profit & Risk - If the estimate is being formulated as a basis for a tender then allowances for profit and risk are part of the estimate. Client Estimate The client must allow for the costs related to the concept and feasibility stages, detailed planning and design, implementation (often from the contractor’s tender above) and commissioning. The implementation stage is usually the highest proportion of the cost estimate – usually 70 – 80% of total project costs. The Project from a Clients perspective can have many components. For example, an estimate can consist of:...costs for administering the project, the cost that its contractor(s) charge for the work performed, and the fees of any consultants, engineers, and suppliers that the owner hires. Also included in the owner's cost estimate must be... provisions for interim and permanent financing, and the numerous elements of life-cycle costs associated with ownership, such as operating and maintenance costs. (AACE 1992, 1-1) Types of Estimates Order-of-magnitude estimates These are not very accurate and are used early in the Project Life Cycle when there is little information available (scope, plans etc) and an investment decision has not been made. As a result, the client wants a quick answer that does not cost much money to produce and may only have an accuracy of +- 50%. If the order-of magnitude estimate looks OK the project sponsor may decide to take it to the feasibility stage where a more accurate budget estimate is required. Order-of-magnitude estimates are alternatively described as 'ball park', '‘preliminary’, ‘proposal’, ‘conceptual', ‘guesstimate’ or 'screening'. The order-of-magnitude estimate “is no more than an educated guess” (Wideman 1995, 4-5). It "is the earliest of estimates and is made to enable the user to decide which way (and whether) to go with a project" (Clark & Lorenzoni 1985, 27). It provides a quick, simple and inexpensive means for determining an approximate predicted cost of a project, requiring an estimating effort of 1 to 150 hours (AACE 1997). It is used when very little information is available, with a level of definition of 0% to 2% of full project definition (AACE 1997, F.3). Consequently, it can give a false sense of accuracy. Order-of-magnitude estimates virtually always use historical information such as cost curves and other parametric techniques such as $/m2, $/m, $/unit. This will be further discussed in a subsequent Module. Order-of-magnitude estimates can be used for (AACE 1992); (AACE 1997, 9.5): Estimating the probable costs of a program budget; Evaluating the general feasibility of a project; Evaluating cost consequences of proposed design modifications; Establishing a preliminary budget for control purposes during the design phase; and Screening a number of alternative projects for further detailed analysis. © Curtin University Page 25 of 104 Budget estimates These are used when a more detailed feasibility for a project is being developed. The estimate must be more accurate that an order of magnitude as a basic scope with sketch designs and specifications are developed which increases the accuracy of the costings and estimate which may cost up to 1 % of total project costs. If the results of the feasibility study are positive the project would proceed to the detailed planning and design stage which can cost 5 – 7% of total project cost. Budget estimates are also called 'design development', ‘feasibility’, ‘top-down’ 'appropriation' or 'control' estimates. Budget estimates are primarily used for setting a preliminary budget and/or funding approval. So they are:...normally prepared after the project owner has completed his concept planning work... and is now in a position where normally he will require management approval to proceed in developing the project further...(and) he needs to give management some idea of the cost of the specific project so that management can allocate or budget money in the future. (Clark & Lorenzoni 1985, 31) Budget estimates can also be used for screening the project at a more developed stage and for confirming economic viability. Budget estimates are prepared after some preliminary information has been produced which further details the project scope. The amount of design work (i.e. level of project definition) needed for budget estimating is typically between 5-10% (Patrascu 1988). It is suggested that budget estimates are normally expected to be accurate within +30% /-15% (AACE 1992). Budget estimates are more accurate than order-of- magnitude estimates as they are based on more information. However, "the accuracy and usefulness of a budget estimate depends, to a large extent, on the amount and quality of information available" (AACE 1992). Depending on the level of project definition, budget estimating is typically based on more accurate parametric calculations i.e. m2, units etc but may include some deterministic estimating (i.e. cost on a labour/material/plant basis). Definitive estimates Definitive estimates are only possible to develop once the detailed scope of the project is defined through drawings and specifications. The costing of this definitive estimate is often performed for the client by an external cost consultant/cost estimator (in construction industry a Quantity Surveyor) as the organisation may not have an internal staff member capable of costing the estimate to the detail required. This definitive estimate is often called a pre-tender estimate if the implementation stage of the project is being outsourced to an external contractor. The tender results will hopefully be within +- 5% of the pre-tender estimate which should allow the project to proceed without seeking additional funding. Additional funding could make the project unfeasible and be shelved until market conditions improve or scope changes are introduced to reduce the overall project cost. Definitive estimates are also called 'check', 'tender' estimates. Definitive estimates are "used for bid proposals, bid evaluations, contract changes, extra work, and legal claims" (PMI 1987). They are based on an extensive amount of detailed information (e.g. site data, plans, elevations, detail sections, full specification) with the level of project definition available between 30% and 100% (AACE 1997). Accuracy is expected as the estimate "must represent the best forecast of the final cost... since it is the last in the line of estimates for the project" (Patrascu 1988, 92). The expected degree of accuracy for definitive estimates can range between +- 5% (Kerzner 1998) +10% (Patrascu 1988). The greater accuracy of definitive estimates is a result of a greater input, both in terms of information available and time allocated to prepare the estimate. Each item in the project is developed to such detail to allow a relatively accurate estimate to be produced. Definitive estimates typically use deterministic bottom-up estimating. The level of effort can range from 500 hours to over 10,000 hours (AACE 1997). © Curtin University Page 26 of 104 Discussion Board – Exercise 4.1 List the main cost components of an estimate for the following projects? 1. Development of a new computer game (not the factory production of the game); 2. A research and development project to produce a new vaccine for flu; and 3. Building yourself a family home. Inputs and Factors Influencing Accuracy Estimate Inputs and Sources The accuracy of a project estimate depends largely on the amount of information available to the estimator i.e. how detailed and defined the project scope is and the amount of historical cost data available. The experience and expertise of the estimator is also a big factor. Cost estimating requires the following inputs: Project Documents - Any available project documentation must be studied and understood. Such documents include: scope statement, specification, drawings, and contract. The more accurate, detailed and defined the project documentation is the more accurate the estimate is likely to be. Work Breakdown Structure (WBS) - The WBS will identify the project elements and each can have a cost associated with it – “All project costs should be clearly identified (activities, goods and services) and cost estimations should consider relevant sources of information and be linked to the work breakdown structure”(ISO 1997). The type, quantity and cost of resources for each element can then be determined and then the element costed. So the WBS “will help the estimator to organise direct cost data” (Heinze 1996, 79). The WBS ensures that all identified work has been estimated (PMI 2000). According to Kimmons (1990), early estimates should be prepared based on the appropriate level of the WBS. The earlier estimate will be tied only to the upper levels of the WBS, while the definitive estimate will be tied into work packages and activities. Historical Information - Sources of cost information includes: in-house cost records (e.g. unit cost of labour, overheads); types and quantity of resources from similar projects; commercially published cost information (e.g. cost books, trade literature); government figures; university research. (ISO 1997) states that “cost estimates from past experience should be checked to ensure that they are correct for present conditions”. Some industries have good historical data available such as construction – the IT industry suffers from poor historical data as, according to Rad (2002), software projects do not enjoy the luxury of having good historic data, particularly since many software and system development projects are regarded as vastly different from those in the historical database. Organisational Policies - The policies of the organisation preparing the estimate (e.g. preferred estimating methods, resource costs, rent or buy, etc.) must be heeded. Project team skills and knowledge - The skills and knowledge of the project team, such as consultants, subcontractors, suppliers and manufacturers, can be utilised to formulate a cost estimate. Sources of estimating data Estimating requires access to some form of historic data. “The availability of historical data is paramount in the development and use of estimating models as well as in the general process of estimating. Historical data provide a basis for a more reliable estimate during the early stages and for more detailed and realistic plans during the detailed planning stages” (Rad 2002, 44). If no historical data is available due to the uniqueness of the project the client will have to include a large contingency sum in the estimate or enter into an agreement with a specialled supplier/contractor based on a cost plus contractual arrangement. The danger of this is that the client will not be able to accurately forecast the final project cost until the project is almost complete. Data to develop an estimate may be derived from any of the following sources: © Curtin University Page 27 of 104 Supplier’s quotations; Contractors and sub-contractors’ quotes; Trade literature; Technical literature; Textbooks; Company historical data; Standard costs; and Computer software packages systems. Estimate Classification Estimates are classified by Senior Executives depending on where in the project life cycle they are and the overall importance to the organisation. The estimate class determines the degree of accuracy required and the level of effort that must be committed to the estimate to achieve the accuracy required. In the table below a Class 1 estimate class has a high degree of accuracy +-3 % which would require a 100% definition of the clients’ requirements. A Class 1 estimate would be developed by the client prior to tendering on a large scale complex project. Contractors/suppliers bidding for work would develop Class 1 estimates for their bid if they are really motivated to win the work. Often motivated by a competitive market, a new client etc. Remember not all projects progress through the Project Life Cycle and are implemented, some don’t make it through the concept stage when a Class 5 estimate is appropriate. If the organisation approves the project through the concept and feasibility to detailed design and planning then the estimate could progress from a Class 5 to a Class 1. Some projects may be implemented after a Class 2 estimate due to time and resource constraints or the nature of the project is such that senior management have enough confidence of profitability and cost based on a Class 2 estimate. Figure 1: Cost Estimate Classification Matrix for Process Industries (AACE 2016, 3) © Curtin University Page 28 of 104 Allowing for Contingencies and Inflation Contingency sums A contingency sum is an allowance in the project total cost estimate to allow for unforeseen events and is defined as:...an amount of money added to the estimate to allow for changes that experience shows will likely be required. (AACE 1992)...(contingencies are) allowances added to an estimate to represent the best judgement of undefined or uncertain items of work which it is considered should be provided for.... Contingencies are 'areas of space' in an estimate which help a project manager to meet the project cost, time and performance objectives, as they face exposure to project risk and uncertainty. (Thompson & Perry 1992, 25)...an estimator’s allowance for the cost of unknowns, changes to make things work or estimating error. (Wideman 1995) Typically, client contingency sums are included to cover the following: Incomplete Scope Definition - Contingency is a means of allowing for incomplete scope definition i.e. if the estimate was a Class 2 or 3, the greater uncertainty of the final project price would require a larger contingency sum to ensure the client arranges sufficient funding to complete the project, the client may be willing to accept the uncertainty and therefore the large contingency sum to get the product to market quicker. Inaccuracy of Estimating Methods & Data - (Clark & Lorenzoni 1985, 127) note that "no estimating method or cost data... is perfect and... inadequacies here historically result in an estimate biased on the low side". Therefore, a contingency should be added to the estimate to cover for these inadequacies. Identified risks - Contingencies may be created for specifically identified risks. For example, a client may be aware that the equipment required as part of a manufacturing plant project may experience a large cost increase and would like to make an allowance to cover this if it eventuates. Unknown Unknowns - A contingency reserve should be set up to allow for unidentified risks. "It is important to identify contingency allowances associated with all significant individual risks, plus a residual allowance for other unidentified risks" (Chapman 1994). However, this excludes unforeseeable major events (see below). Any contingency remaining once the project Is complete reverts back to the client. Some Project Managers who have closely monitored project costs during implementation realise towards the end of the project that the contingency sum might not be completely consumed spend the funds on nice to have additions to the project. The client’s approval must be sought and granted before this can occur! Contractor contingency sums Provide for scope error interpretations during preparation of the tender price (estimate), inaccuracy in quantification, abnormal construction and commissioning problems, pricing variation, inaccuracy in the estimate, liabilities in the contract, unforeseen regulations, safety requirements, equipment breakdowns, weather interruptions, labour productivity, technological change (Heinze 1996); (Moselhi 1997); (Kharbanda & Stallworthy 1988); (Patrascu 1988) The higher the contingency the higher the tender price which may make the contractors tender bid uncompetitive. Below is a table showing typical contingency sums vary depending on the type of estimate, type of work and state of technological development. © Curtin University Page 29 of 104 Figure 2: Typical contingency sums vary depending on the type of estimate, type of work and state of technological development (created by author) and these percentages are not to be used – you will need to research the applicable % contingencies based on your projects circumstances. Allowances for Escalation The client should include an amount in the total project cost to allow for inflation, especially during periods of high inflation and low competition between suppliers/contractors due to high market activity. A short-term project contract i.e. under 1 year may not require an escalation allowance, however it is essential with any longer-term contract i.e. over 2 years to include an escalation allowance. Escalation is an allowance for future changes in costs and/or prices and is a generally a result of a combination of three factors: 1. The general inflationary movement of costs, invariably upwards; 2. Specific market factors. (e.g. during times of high business activity, the escalation rate increases); and 3. A shortage of materials due to economic activity or “acts of god” i.e. floods etc. The global economy at the moment is in a prolonged period on low or no inflation (sometimes even negative inflation) and as a result escalation is not as big a factor as previously. It also means that clients can develop a more detailed project scope over a longer period of time without any inflationary concerns. This has an add on effect of a smaller contingency sum required as the scope definition is improved – low inflation is a win – win. © Curtin University Page 30 of 104 Discussion Board – Exercise 4.4 Determine what allowance you should make for price escalation if you plan in 3 years’ time to buy a: House; Car; and a Television. Calculating escalation There are two main time periods for which an allowance for cost escalation is required: From the Past - Escalating historical costs used in an estimate to the present date to be used in a current estimate. This is a relatively easy process, typically requiring the application of cost indices which provide an historical representation of cost escalation. These indices are supplied by Professional Industry bodies such as the Australian Institute of Quantity Surveyors Into the Future - Allowing for the escalation of costs from the date of the estimate up to the completion of the project. This is a more difficult task as it requires the prediction of future cost movements. Put simply, this can be achieved by the following process: Multiply the annual escalation rate (derived, for example, from agencies who provide forecast of future economic patterns) by the time period for escalation to give the total escalation rate; and then Multiply this escalation rate by the present estimated costs to arrive at the total escalation costs Total escalation costs are added to the present estimate to arrive at the predicted final project cost. For example: To calculate the final cost of a $ 10 000 000 project in todays $$ as of December 2017 with an average annual inflation rate of 3 % (currently around 1.5 % in Australia) and a project implementation time of 24 months: 3 % X 2 years = 6 % X $ 10 000 000 = $ 600 000 escalation allowance The most common way to calculate the escalation allowance is through the use of indices published by Professional bodies. Below is the Australian Institute of Quantity Surveyors. If the project is in the construction industry in WA the inflation allowance could be calculated like this: $ 10 000 000 X June 2019 indice/ December 2017 $ 10 000 000 X 186.2/176.3 = $ 561 542 – reasonably close to the above estimate based on annual inflation. Discussion Board – Exercise 4.5 Using the indices table below calculate the % escalation between: January 2005 and October 2007; April 2008 and December 2011; and March 2013 and March 2016. Discuss what you think influenced the % escalation’s you have calculated. Table 3: Australian Institute of Quantity Surveyors CCIF (AIQS 2000) © Curtin University Page 31 of 104 Summary This week’s module focused on a number of key principals in regard to Estimate Classification, escalation and contingency sums: The estimate can only be as accurate as the data inputted and the skill of the estimator; Senior management will generally determine the amount of effort to be used to achieve the relevant estimate accuracy required; The further along the Project Life Cycle the greater the scope definition and the more accurate the estimate; Projected cost increases are allowed for in during the project by means of escalation allowance that should reflect historical information or industry indices; and Contingency sums are allowances with the total project cost estimate to allow for scope changes due to poor scope definition and client requests. © Curtin University Page 32 of 104 Module 6 Project Selection Table of Contents Introduction......................................................................................................... Error! Bookmark not defined. Learning Outcomes................................................................................................. Error! Bookmark not defined. Module Topics....................................................................................................... Error! Bookmark not defined. Purpose and Project Selection Process..................................................................................................... 33 Project Selection Criteria..................................................................................................................... 34 Non-Financial Selection Methodologies..................................................................................................... 36 Financial Selection Methodologies........................................................................................................... 40 Required Reading...................................................................................................................................... 47 Summary................................................................................................................................................ 47 References........................................................................................................... Error! Bookmark not defined. Purpose and Project Selection Process Purpose of selection Project selection is “the process of evaluating individual projects or groups of projects” (Meredith & Mantel 1995, 39). It is often a challenging assignment - "each project will have different costs, benefits and risks... the selection of one project out of a set is a difficult task"(Meredith & Mantel 1995, 39). Project selection "can involve choosing between alternative projects for achieving the same objectives, or choosing between a range of project directed at a variety of objectives which cannot all proceed due to resource constraints" (WA Treasury 1994). Project selection and prioritisation is necessary as organisations will rarely have sufficient resources to undertake them all. These resources must be used properly - “to survive, firms must develop strategies for assessing and reassessing the use of their resources. Every allocation of resources is an investment in the future... (and) many of these investments are in projects” (Meredith & Mantel 1995, 41). © Curtin University Page 33 of 104 The need for a formal process Many private smaller organisations have no formal project selection process as they often only have 1 project at a time which often arises from operational necessity (current premises too small) or market/competitive necessity (bring new or more product to the market) Large private and public organisations need a formal process to select projects to ensure the projects selected represent good value for money, are aligned to strategic directions and are in response to relevant and well researched internal/external factors. There may be several selection processes as the project moves along the Project Life Cycle, a project that does not get selected for the next stage i.e. from concept to feasibility to detailed planning and design may be archived until internal and external factors change making the project feasible. Most large organisations have an early “screening process” that will eliminate unfeasible projects before significant organisational resources are consumed. The organisation should have documented guidelines and procedures for project evaluation and selection for the following reasons: To prevent projects being selected on a haphazard, ill-considered basis. As Davidson Frame (2002, 205) suggests “project selection should not occur by accident. An approach to choosing projects should be developed and rigorously adhered to”; To minimise the risk of selecting projects that might ultimately fail (for financial or political reasons etc); To ensure that the claimed benefits of a proposed project are properly considered and detailed by the project proposer, and rigorously challenged by the Project Selection Committee; To ensure that the project proposer knows what information is required in a project proposal. Guidelines can be used to help the proposer “understand how an idea will be evaluated before deciding on how best to present the idea”; and To provide an audit trail of the decision process (Miller 1997). The project selection process should be reviewed periodically, so there should be a “mechanism for revising and updating the (selection) process, including such issues as selecting new review board members and maintaining synchronisation between the strategies and the prioritisation criteria” (Mosteller 1995). Project Selection Criteria In order to objectively choose one project over another (or a single project) relevant selection criteria should be chosen that guide the selection panel. In the private sector, this would largely be focused on profits, market share and the organization’s strategic goals and objectives. In the Public sector where financial profit is often unachievable and unmeasurable the focus would be on service delivery and benefit to the community (often also influenced by politics) and the organization’s strategic goals and objectives. While the realization of maximum profits and benefits to the community are likely to be the project managers main focus the project sponsor and senior executive will want to be convinced that the project will further the organizations mission and strategic goals. Projects should be derived from the organisation's mission and strategic goals. As Cleland (1990, 60) observes, “the critical element of the evaluation approach is its use of criteria that ensure that projects will be integrated with the mission, objectives, strategy and goals of the organisation”. Organisational strategic planning must therefore be a prerequisite and foundation for the project selection process. The strategic planning process will identify several possible projects capable of fulfilling long-term and short term strategic objectives (Mosteller 1995). Project selector(s) must evaluate a range of alternative project proposals and select a project or set of projects for implementation that will meet these organisational objectives. One approach to arriving at a set of project selection criteria based on the organisational objectives is to use the Strength, Weaknesses, Opportunities and Threats (SWOT) analysis from the strategic planning process. The influence of organisation types The project selection process is significantly influenced by the type of organisation and its distinctive strategic objectives. Roman (1986) identifies three types of organisations that have differing goals: © Curtin University Page 34 of 104 Government Sector As a generalisation, its objectives tend to involve political, social, cultural, military and economic considerations. Characteristics of project selection by government include (Roman 1986): Project selection is based on need and mission goals; Need, time and scope are primary considerations; and Cost and value are secondary but important factors. Private Sector Profit is commonly the primary goal of private sector organisations. However, not all private sector projects are selected solely on their profit potential. In fact selection criteria “should go beyond the typical clichés about ‘survival’ and ‘maximising profits’ which are certainly real goals but are just as certainly not the only goals of the firm” (Meredith & Mantel 1995, 43). A project may be chosen which offers limited profit potential but which: Provides organisational stability e.g. maintain staff employment, organisational survival; Offers technological advancement e.g. new skills; Decreases effects of business cycles; Creates new markets e.g. diversification; Maintains or expands share of a specific market; Enhances the organisation's public image e.g. contribution to society; Reduces costs or overheads; Responds to new regulatory requirements; and Provides employee satisfaction. Non-Profit Sector The non-profit sector refers to such organisations as charities, religious bodies, social groups and professional associations. Project selection will vary depending on the operational environment of each organisation and can either be similar to government or private sector processes, with probably more commonality with the former. Some factors in selecting projects in non-profit organisations include (Roman 1986): The project should comply with the organisation's mission; The need of its constituency is a primary factor; Profit is not a primary motivator although the project frequently will need to be revenue producing; Selection based on cost/benefit analysis is critical; and Selection is driven by a desire to obtain public goodwill. Small private organisations often do not have a mission and strategic goals and project selection is often done by the owner based on a financial feasibility, experience and a “gut feel”. However, if the business owner requires funding for the project from a bank or lending institution they will be required to present a more formal business case supporting the funding application. In this way, the lending institution “selects” which projects to fund. © Curtin University Page 35 of 104 Non-Financial Selection Methodologies Non-numeric methodologies Non-numeric project selection methodologies do not use numbers and therefore "it is easy to dismiss such models as unscientific (but) they should not be discounted casually. These models are clearly goal-orientated and directly reflect the primary concerns of the organisation" (Meredith & Mantel 1995). Non-numeric methods “are generally used when there is only a limited amount of information available on each project or when the selection process must be completed quickly” (Chung & Huda 1998). Examples of nonnumeric methodologies are: The Sacred Cow - Projects arise out of a seed of an idea from top and influential management (i.e. the Boss’s favourite sporting team needs a new marketing campaign). "They will be maintained until successfully concluded, or until the boss, personally, recognises the idea as a failure and terminates it." (Meredith & Mantel 1995, 47). Although often dismissed as inappropriate and ill-considered, it generates projects that are supported by top management. The Operating Necessity - Projects are embarked upon with little management discretion in the selection process, i.e. rebuilding a factory destroyed by fire. The Competitive Necessity - Projects are selected in order to maintain the organisation's position and/or survival within a market, i.e. after the Apple iPhone original launch. The Product Line Extension - Projects "judged on the degree in which they fit the firm's existing product line, fill a gap, strengthen a weak link, or extend the line in a new, desirable direction" (Meredith & Mantel 1995, 48). Comparative Benefit Models - Assess the comparative benefit of projects that are not easy to compare. Examples of this method are: i) Forced Comparison Departments in an organisation prepare ranked lists of projects. These projects are successively compared as follows (Mosteller 1995): Departmental Rankings Department A Department B Department C Project A1 Project B1 Project C1 Project A2 Project B2 Project C2 Project A3 Project B3 Project A4 Project B4 Initial projects compared: Project A1 Project B1 Project C1 First project selected – Project B1 Then the following projects are compared: Project A1 Project B2 Project C1 iii) Peer Review This involves unbiased external assessment of the merits of a proposed project. Peer review is common in scientific areas particularly for government funded R&D project proposals and has the advantages of appearing to be fair. iv) Profile Model Senior executive assesses projects "on the basis of a subjective evaluation of their attributes... The ratings are qualitative in nature. No numerical assessments are made" (Souder 1988). Table 1: Criteria comparison (adapted from Souder 1988) Criteria Extent to which project meets criteria Project X Project Y © Curtin University Page 36 of 104 Reliability High Low Maintainability Medium High Safety Medium Low Cost-effectiveness High Medium Durability High Low v) Murder Board Projects are strongly criticised by a panel (murder board) of people from different parts of the organisation. The project proposer must present and defend the project before the panel and “they should tear it apart and try to show how it is not workable” (Davidson Frame 2002, 203) Scoring methodologies There are other more formal and objective methods of non-financial selection where scoring methodologies can be used to evaluate the merits of proposed projects against a selected set of diverse and significant criteria. Either all projects meeting a certain total score may be chosen; or only a set of the highest scoring projects are selected until a total budget is reached. It is important to stress that “care should be taken to not place too much emphasis on the numbers. They are relative indications of which projects are best at addressing the issues. They are not extremely precise. Small differences in the calculated importance are probably not significant. However, large differences indicate that one project is clearly better than another. Obviously, the team needs to examine the resulting priorities to determine that they really do make sense” (Hales 1997). The following are some of the techniques for scoring. Unweighted Scoring – often performed by getting all senior executives and the project team around a table to give their score based on experience and opinions rather than hard facts which probably won’t be available at this early stage of the Project Life Cycle. o Without a range Projects receive a point for each criteria met (see Table 2). "The major disadvantages are that it assumes all criteria are of equal importance and it allows for no
