Copyright 2008 ComputerEase Software, Inc. All rights reserved. 12/4/2008
ComputerEase Software, Inc. 6460 Harrison Ave., Suite 200 Cincinnati, OH 45247
The text of this publication, or any part thereof, may not be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, storage in an information retrieval system, or otherwise, without the prior written permission of ComputerEase Software, Inc. Willful violation of this Copyright law of the United States can result in civil damages up to $50,000 (US) per infringement (17 USC 506; reasonable attorney fees may be awarded (17 USC 505); and copyright infringements can be a criminal offense. (17 USC506). All names, products and services mentioned are the trademarks or registered trademarks of the respective vendors or organizations.
Publisher ComputerEase Software
Bob Mattlin, CPA A Brief Background Founder and owner of ComputerEase, Bob Mattlin, came from a family background in construction and a personal background as a CPA for a national accounting firm. As computer technologies became increasingly available in the early eighties, Mr. Mattlin had a vision of using this technology to pull together his accounting and construction-industry knowledge to improve the way contractors managed their businesses. Twenty-five years later, he owns the industry-leading company in construction management software solutions and continues working to improve contractors' business practices. Construction is a competitive industry, and ComputerEase provides contractors with the edge they need to stay strong and productive.
Contents
5
Table of Contents Introduction
2
Terrible Mistake #1
4
Company profits are misstated and misleading-THEY ARE WRONG!!!...................................................................................................................................
4
Company................................................................................................................................... profits are misstated.
4
EXERCISE................................................................................................................................... #1:
5
Terrible Mistake #2
7
Project managers are under the false assumption that all is well and the job ................................................................................................................................... is progressing nicely and making money.
7
Project managers could be misled in thinking the job is going along fine................................................................................................................................... based on actual hours to date.
7
EXERCISE................................................................................................................................... #2
8
Terrible Mistake #3
10
Without projected costs, percent complete analysis is impossible. ...................................................................................................................................
10
Project managers need an early warning system to measure job status before it is too late. ...................................................................................................................................
11
EXERCISE #3 ...................................................................................................................................
11
Terrible Mistake #4
13
The estimator is out of touch with job performance and has no ................................................................................................................................... idea where his estimate stands until the job is over.
13
Estimator has to stay involved throughout the job. ...................................................................................................................................
14
EXERCISE #4: ...................................................................................................................................
14
Terrible Mistake #5
16
Job billings ................................................................................................................................... are out of sync with job costs.
16
Job Billings on the Balance Sheet are incorrect. ...................................................................................................................................
17
EXERCISE #5: ...................................................................................................................................
17
Terrible Mistake #6
19
The contractor’s CPA is required to make large and surprising adjustments ................................................................................................................................... to the year end financial statements.
19
CPAs should not have to make large and surprising adjustments ................................................................................................................................... at the end of the year.
20
EXERCISE #6: ...................................................................................................................................
20
5
6
9 Mistakes
23
Terrible Mistake #7 No one knows the job schedule has fallen behind until it’s too late to make ................................................................................................................................... up the lost time.
23
Job schedules are wrong using the cost-to-cost method. ...................................................................................................................................
24
EXERCISE #7: ...................................................................................................................................
24
26
Terrible Mistake #8 Can’t measure ................................................................................................................................... unit productivity without projected costs.
26
Cannot compare estimated unit productivity with actual unit ................................................................................................................................... productivity.
27
EXERCISE #8: ...................................................................................................................................
27
29
Terrible Mistake #9 Without projected costs, “fade and gain” comparisons are not possible....................................................................................................................................
29
Without projected costs, PM’s cannot get a handle on week to ................................................................................................................................... week performance.
30
EXERCISE #9: ...................................................................................................................................
30
How To Fix the Nine Mistakes Using Projected Costs
32
Cost-to-Cost ................................................................................................................................... Method: Don’t use it!!
32
Projected Cost methods used to solve problems brought on by ................................................................................................................................... cost-to-cost method
33
Percent Complete Method .......................................................................................................................................................... 33 34 Estimating the total.......................................................................................................................................................... cost remaining method to complete an item
Measuring ................................................................................................................................... the “fade” or “gain” in projected cost
34
Using labor hours to calculate percent complete ...................................................................................................................................
35
................................................................................................................................... “Stripping” the estimators magical market price
36
Calculating the “fade” or “gain” in the revised estimate using hours ...................................................................................................................................
37
Using Hours to calculate “fade” or “gain” in the revised estimate ...................................................................................................................................
37
Measuring unit productivity is the best way to project percent complete
39
The “fade”/“gain” analysis is a good weekly benchmark when using productivity ................................................................................................................................... per hour
39
Answers...................................................................................................................................
40
42
Reports Sample -................................................................................................................................... Percent Complete
42
Sample -................................................................................................................................... Percent Complete
43
Sample -................................................................................................................................... Work In Progress
44
ComputerEase Software, Inc.
Contents
7
Sample -................................................................................................................................... Profit Variance
45
Sample -................................................................................................................................... Labor Analysis
46
Sample -................................................................................................................................... Unit Cost Report
47
Sample -................................................................................................................................... Schedule
48
Sample -................................................................................................................................... Unit Productivity Report
49
7
Introduction
Introduction
2
Introduction Most contractors start out with the owner serving as the “project manager” on jobs. The owner visits the job sites every day and has a keen sense of what is going on. He is hands-on and can quickly see when things are going wrong. With the owner managing jobs, they usually come in on time and on budget. But in time, growth brings more and larger jobs and the owner can no longer keep up with them. The owner finds he needs new tools to measure job progress. We will discuss the measuring tools available to owners, estimators and project managers to assist them in determining accurate job costs before the job is over. The methods discussed will greatly improve how job costs are reported. Using these methods will forewarn the construction team of any problems before they get out of hand. The worst thing that can happen to a contractor is to find out that a job lost money after it was completed. The most important purpose of using a projected cost system is to prevent this from happening. The first section of this report starts off with “NINE Terrible Mistakes.” This section discusses the serious problems caused by not knowing where the job stands at all times. After learning the problems that come about by not projecting job costs, we discuss ways to prevent them from happening.
Let’s start with those NINE Terrible Mistakes….
9 Terrible Mistakes
Terrible Mistake #1
Terrible Mistake #1
4
Terrible Mistake #1 Company profits are misstated and misleading-THEY ARE WRONG!!! A construction company has no idea where it stands without an accurate projection of job costs. The example shown on the next page clearly illustrates that the financial statement cannot be correct if a revised estimate is not calculated based on remaining costs and actual costs. Work in progress on the balance sheet is misstated because a true picture is impossible without projected costs. The illustration shows how using a cost-to-cost method of computing percent complete can distort the financial statements. Several problems are highlighted on the next exhibit: o
Profits are misstated
o
Estimated tax payments are incorrect
o
Cash flow analysis is difficult with the wrong profit
o
Bonding companies are given wrong financial statements
Company profits are misstated. Here is an example of how the cost-to-cost method distorts the financial statements: ABC Financial Statement Cost to Cost
Projected Cost
Contract
$125,000
$125,000
Estimated Cost
$100,000
$100,000
Billed Revenue-50%
$ 62,500
$ 62,500
Costs to date
$ 50,000
$ 50,000
Projected costs to complete
$ 50,000
$150,000
Revised Estimate
$100,000
$________
Percent Complete
50%
25%
Profit (Loss)
$ 12,500
$________
Federal Income Tax Estimate
$
$________
4,000
(40%*$125,000-50,000)
Over(Under) Billed 9 Terrible Mistakes
None
$________
5
9 Mistakes
EXERCISE #1: Calculate the following for the Projected Cost column: 1. Revised Estimate ______________ 2. Profit or Loss _______________ 3. Tax ________________ 4. Over(Under) Billed _________________
ComputerEase Software, Inc.
Terrible Mistake #2
7
9 Mistakes
Terrible Mistake #2 Project managers are under the false assumption that all is well and the job is progressing nicely and making money. The project manager has no idea where he stands on a job without making regular estimates of projected costs. The estimator has the responsibility to give the PM a break down of the hours and units he used in his estimate. For example, without an estimate, the PM can’t know that he used 500 hours to complete 500 square feet when he should have completed 1,000 square feet with that amount of hours. The PM needs to know how many hours he has used and how many hours he has left to finish the bid item. Without estimated hours he cannot know where the job stands. Project managers want to be informed on how well they are doing on their jobs. There are many studies that prove project managers are very frustrated by not having benchmarks to measure the performance on their jobs. The PM wants to know desperately where he stands on a job. Like everyone, he wants recognition for a job well done. Using projected cost calculations is the only way for him to know the status of his jobs.
Project managers could be misled in thinking the job is going along fine based on actual hours to date. If the estimator provides both units and hours to the PM, a labor analysis report similar to the one below can be used by the PM to measure job progress.
Unit Production Method
Actual Hour Method Estimated
Actual
%
Remaining
Estimated
Estimated
Actual
Actual
%
Remaining
Hours
Hours
Complete
Hours
Hours
Units
Hours
Units
Complete
Hours
1,000
250
______
______
1,000
2,000
250
200
_______
_______
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Terrible Mistake #2
EXERCISE #2 Calculate the following: 1. Actual Hour Method % Complete ______________________ 2. Actual Hour Method Remaining Hours ______________________ 3. Unit Production Method % Complete _______________________ 4. Unit Production Method Remaining Hours ______________________
9 Terrible Mistakes
8
Terrible Mistake #3
Terrible Mistake #3
10
Terrible Mistake #3 Without projected costs, percent complete analysis is impossible. Without using percent complete calculations, the PM finds out too late that a bid item is in trouble. If the PM knew he used 50% of the hours but only completed 25% of the work, he can focus on turning things around early and prevent having to wait until the end of the job to find out that he lost money. The cost-to-cost method will not show the PM that a bid item is falling behind. The longer the work continues off budget, the worse the job losses become. It is very difficult to make up for the losses on a bid item once they have fallen behind. A percent complete analysis provides the information needed to produce the work in progress report. Without a percent complete analysis, the WIP report cannot be produced. Bonding companies and banks rely more on a construction company’s work in progress report than any other analysis. The WIP report is used by management as the starting point of job analysis. The percent complete report alerts the PM of problems at the bid item level. The WIP report is used for total job status and is calculated using the individual bid item analysis from the percent complete report. In accounting terms, the percent complete report is the sub ledger, or detail work up of the WIP report. Learning which jobs are in trouble from an over all perspective is one thing, determining which bid items are causing the problems is another. If the PM doesn’t calculate what expected remaining costs are, the WIP report and the percent complete report are useless.
9 Terrible Mistakes
11
9 Mistakes
Project managers need an early warning system to measure job status before it is too late. Using cost-to-cost, here is a sample job which highlights the distortion: Work Item
%
Contract
Complete
Estimated
Cost to
Cost
Revised
Estimated
Projected Profit (Loss)
Cost
Date
Remaining
Estimate
Profit (Loss)
Excavate
100
12,000
10,000
10,000
0
10,000
2,000
2,000
Form
50
12,000
10,000
5,000
5,000
10,000
2,000
2,000
Pour
25
12,000
10,000
2,500
7,500
10,000
2,000
2,000
WIP
58
36,000
30,000
17,500
12,500
30,000
6,000
6,000
Report
If the Percent Complete method is used, the same job looks like this: Work Item
%
Contract
Complete
Estimated
Cost to
Cost
Revised
Estimated
Cost
Date
Remaining
Estimate
Profit (Loss)
Projected Profit (Loss)
Excavate
100
12,000
10,000
10,000
0
10,000
2,000
2,000
Form
33
12,000
10,000
5,000
_______
_______
2,000
_______
Pour
25
12,000
10,000
2,500
7,500
10,000
2,000
2,000
WIP
______
36,000
30,000
17,500
6,000
Report
EXERCISE #3 Calculate the following if the bid item “Form” is only 33% complete: 1. “Form” Cost Remaining ________________________ 2. “Form” Revised Estimate ____________________________ 3. “Form” Projected Profit (Loss) ________________________________ 4. WIP Report % Complete _________________________ ComputerEase Software, Inc.
Terrible Mistake #4
13
9 Mistakes
Terrible Mistake #4 The estimator is out of touch with job performance and has no idea where his estimate stands until the job is over. The estimator is usually as surprised as anyone when the job he bid runs into trouble. The estimator’s job requires more than just calculating a bid. He has to keep an eye on the job at all times to make sure his estimate is being produced with the same methods he used in developing the bid. The PM and estimator should be in touch constantly. The PM and estimator must know how actual costs compare to estimated costs throughout the job’s completion. The estimator can provide valuable information to the PM as a bid item begins to show a loss. Regular project meetings should bring the estimator and PM together to discuss problems early in the job, before it is too late. The estimator should always be involved in calculating projected costs. Since he bid the work, he is a valuable resource to the PM. The estimator and PM use two methods to make sure that production in the field is ahead of the estimate. The first method is comparing the actual unit cost with the estimated unit cost. By providing the PM with the unit cost used in the estimate, the PM can monitor performance at any stage of the job by comparing his unit cost of production with the estimated unit cost of production. This gives the PM an early warning signal very early in the job’s progress. The second method compares units of production from the field with the units of production used by the estimator. The PM has valuable information if he knows the estimator used a productivity rate of say 10 units per hour and compares it to his 12 units per hour. He quickly knows he is probably doing pretty good. If there are 1000 units in the bid item, the PM knows where he stands after only 10 are put in place. The PM has to know what his projected unit performance is at all times.
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Terrible Mistake #4
14
Estimator has to stay involved throughout the job. Estimator is given this progress report based on cost-to-cost.
Work Item
Estimated
Actual
Remaining
Cost
Cost
Cost
% Complete
Revised
Estimate
Actual
Estimated
Actual
Projected
Estimate
d Unit
Units
Unit Cost
Unit
Unit Cost
Cost Excavate
10,000
8,750
0
100
8,750
1,000
1,000
10.00
8.75
8.75
Form
10,000
5,000
5,000
50
10,000
2,000
1,000
5.00
5.00
5.00
Estimator is given this progress report based on an updated estimate.
Work Item
Estimated
Actual
Remaining
%
Revised
Estimated
Actual
Estimated
Actual
Projected
Cost
Cost
Cost
Complete
Estimate
Unit
Units
Unit Cost
Unit Cost
Unit Cost
Excavate
10,000
8,750
0
100
8,750
1,000
1,000
10.00
8.75
8.75
Form
10,000
5,000
5,000
50
_______
2,000
1,000
5.00
5.00
_______
EXERCISE #4: If the PM reports that it will require an additional 75% of the original estimated cost to complete the bid item “Form�, calculate the following: 1. Projected Unit Cost _________________ 2. Revised Estimate ________________________
9 Terrible Mistakes
Terrible Mistake #5
Terrible Mistake #5
16
Terrible Mistake #5 Job billings are out of sync with job costs. Trouble is ahead if a job becomes overbilled or under billed due to losses. There are few things worse than finding out late in the job that the money isn’t there to pay for the remaining work. Billings should progress as much as possible at the same pace as the work. Front end loading is a good option if the job is running on budget. But if the job is in trouble, front end loading can only create problems later on in the job. Bonding companies and banks look at billings and job cost status more than anything else. They want to make sure that future billings will cover remaining costs. That’s why they demand accurate work in progress reports. Preparing accurate WIP reports cannot be done without projecting future costs to complete. The contractor suffers many problems if billings get out of whack with job costs. The problem can be easily highlighted by an example; if the contract value on a job is $10,000, estimated cost is $8,000 and actual cost to date is $4,000, billings at 50% complete should be $5,000. But if the work is only 40% complete and the projected costs are now recalculated to be $10,000 at completion, then billing $5,000 would create an overbilling situation. In this example if the work is only 40% complete then billings should only be at 40% or $4,000. There can also be cash flow problems if a job is under billed. If the job is 50% complete and 50% of the estimated costs have been incurred, the contractor should be sure that 50% of the contract value is billed. If the company bills too far ahead of job costs, the excess billings become a liability on the balance sheet. If the job is under billed, the contractor is not taking advantage of optimum cash flow. This is key information for banks and bonding agents. A contractor doesn’t want to be wrong with this calculation. As far as bonding companies and banks are concerned, it is the single most important number on a contractor’s financial statement.
9 Terrible Mistakes
17
9 Mistakes
Job Billings on the Balance Sheet are incorrect. The below report was prepared using the cost-to-cost method.
Work Item
Contract
Total
Cost
Billed
%
Remaining
Over
Under
Complete
Cost
Billed
Billed
Excavate
12,000
12,000
8,750
100
0
0
0
Form
12,000
6,000
5,000
50
5,000
0
0
Pour
12,000
3,000
2,500
25
7,500
0
0
Total Job
36,000
21,000
16,250
12,500
0
0
EXERCISE #5: Assume the PM reports that, based on his projections, the bid item “Form” is only 40% complete, calculate: 1. “Form” Remaining cost _____________________ 2. “Form” Over(Under) Billed amount _____________________
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Terrible Mistake #6
19
9 Mistakes
Terrible Mistake #6 The contractor’s CPA is required to make large and surprising adjustments to the year end financial statements. The percent complete calculation is what drives the values shown on the WIP report. The percent complete numbers cannot be accurate if projected costs are not used. If the WIP report is wrong, the CPA has to untangle the errors that were made. The adjustments the CPA makes directly effects the profit and loss of the company. CPA adjustments would not be necessary if the PM used projected costs to evaluate their jobs throughout the year. Every contractor should be able to accurately calculate a WIP report without the use of a CPA. Job analysis throughout the year is impossible without an accurate WIP report. The owner is usually disappointed with profits after the CPA is finished adjusting the WIP report. He cruised along during the year thinking he made more money than he actually did. Worse yet, the company could have paid too much in estimated federal and state income taxes based on erroneous profits. Paying taxes when it wasn’t necessary, of course, hurts cash flow. A well managed contractor should know their projected job costs at all times. Incorrect financial information is prevented with accurate and timely projected costs. The bonding company and the bank do not want to be surprised with a CPA’s year end adjustments. The controller or accounting personnel in the company must demand an accurate WIP report from the PM and estimator before he prepares any financial statement. He has to understand job costs and projected costs and must work hand in hand with the PM in developing future job costs. Without a job analysis, his financial statements are of little value.
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Terrible Mistake #6
20
CPAs should not have to make large and surprising adjustments at the end of the year. Below is an abbreviated WIP report highlighting the problems caused by improper estimates of percent complete:
Work Item
Contract
Total
Cost
Billed
%
Remaining
Revised
Projected Over
Under
Complete
Cost
Estimate
Profit
Billed
Billed
Excavate
12,000
12,000
8,750
100
0
8,750
3,250
0
0
Form
12,000
6,000
5,000
50
5,000
10,000
2,000
0
0
Pour
12,000
3,000
2,500
25
7,500
10,000
0
0
Total Job
36,000
21,000 16,250
12,500
28,750
0
0
Work
Contract
Item Excavat
Total
Cost
Billed
2,000 7,250
%
Remaining
Revised
Projected
Over
Under
Complete
Cost
Estimate
Profit
Billed
Billed
12,000
12,000 8,750
100
0
8,750
3,250
0
0
Form
12,000
6,000
5,000
60
3,333
8,333
______
_____
_____
Pour
12,000
3,000
2,500
25
7,500
10,000
2,000
0
0
Total
36,000
21,000 16,25
10,833
27,083
______
_____
______
e
Job
0
EXERCISE #6: The above WIP report is handed to your CPA at the end of the year. After a careful review with the PM, the CPA determines the bid item “Form” is actually 60% complete based on projected cost analysis. Calculate the following adjustments: 1. “Form” Over(Under) Billed _______________________________ 2. Job Over(Under) Billed ________________________
9 Terrible Mistakes
21
9 Mistakes
3. Sales Adjustment _____________________ 4. Is Under billed shown as an asset or liability on the Balance Sheet?
ComputerEase Software, Inc.
Terrible Mistake #7
23
9 Mistakes
Terrible Mistake #7 No one knows the job schedule has fallen behind until it’s too late to make up the lost time. The cost-to-cost method of measuring job progress will eventually cause an incorrect job schedule. If a bid item is on the critical path and assumed to be 50% complete when it is actually only 25% complete, the schedule will have to be adjusted at some time. It is better to know of adjustments to the schedule as soon as possible. Customers, bonding agents, bankers and subcontractors do not want to be surprised by a job falling behind. Job progress reporting based on a percent complete method will assist in finding early scheduling problems. Any bid item on the critical path has to be monitored closely and kept current as to percent complete. During initial job planning, the PM will usually schedule less hours than the estimated hours. This is his built-in cushion for performance. For example, if the estimator “gave� him 1000 hours to complete a task, he might initially try and schedule only 800 hours. The PM knows if he can bring the job in within 800 hours he will make a profit beyond the estimated profit. The 800 hours, not the 1,000 hours becomes his benchmark. The PM realizes that to hit the 800 hours the job has to run efficiently. There can be no work stoppages, all subs must show up when needed and finish on time, materials must be delivered to match manpower on the job and crews must be on the job when needed. Without projecting job costs, the PM can be surprised by events causing a change in schedule. He needs to know well ahead of time of any job schedule changes. If he assumes he is 50% complete because he has used 50% of the hours, his schedule can become unwieldy if in fact he is only 30% complete.
ComputerEase Software, Inc.
Terrible Mistake #7
24
Job schedules are wrong using the cost-to-cost method. The following example demonstrates how cost-to-cost can distort a schedule. Work Item
Estimated Actual Hours
%
Hours
Hours Complete Remaining
Revised Hours to Schedule
Excavate
1,000
920
100
0
0
Form
1,000
500
50
500
______
Pour
1,000
250
25
750
______
EXERCISE #7: If “Form” is 70% complete and “Pour” is 10% complete, calculate the Revised Hours to Schedule: 1. Form _________________________ 2. Pour __________________________
9 Terrible Mistakes
Terrible Mistake #8
Terrible Mistake #8
26
Terrible Mistake #8 Can’t measure unit productivity without projected costs. One of the more important measurements to track job progress is comparing actual unit production with estimated unit production. Without projected costs, it is impossible to compare actual unit productivity against estimated unit productivity. The calculation of unit productivity is easy to make if four things are known: Estimated hours and estimated units to be complete per hour Actual hours and actual units put in place. If the estimate was to complete 500 units in 500 hours and the project manager met this rate of production, it can be assumed the job is on target. The real advantage of this method is the PM and the estimator can tell where bid item stands when only 50 units are complete. If he used 20% of the hours (100) to put 10% (50) of the units in place, he is producing only ½ unit per hour and not the estimated 1 unit per hour. The estimated units per hour of production must be provided by the estimator. Not only must he provide the PM with estimated unit costs, but he must show how he came up with those costs. He has to provide what productivity rate per hour he used to come up with his overall unit cost. The PM is left in the dark if all he has to measure is unit costs. He knows he must match the rate of productivity per hour with the estimate. And he needs to know early in the jobs progress. By projecting the 100 hours used above to complete the first 50 units, the problem is clearly highlighted. The PM sees that it will take 900 hours to complete the remaining 90% (450) of units. Perhaps something can be done in time to recapture some of the losses incurred. Using the projection is much better than waiting until the end of the job and finding out it took 1000 hours to install 500 units. If the hourly cost rate for the company is $100, that is a $50,000 loss!
9 Terrible Mistakes
27
9 Mistakes
Cannot compare estimated unit productivity with actual unit productivity. This report was prepared using the cost-to-cost method.
Units Work Item
Units
Work %
Proj
Actual
Actual Units Per Hour
Projected
Est
Compl
%
Hours
Excavate LS
1000
1000
100
100
200
5.00
Units Per Hour 5.00
Form SFT
1000
500
50
50
500
1.00
_____
Pour Cu Yds
1000
250
25
25
200
1.25
_____
EXERCISE #8: Assume that the PM reports that bid item “Form” will require 750 more hours to complete and “Pour” will require 300 more hours: What is the Projected Units per Hour? 1. FORM_____________________ 2. POUR_____________________
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Terrible Mistake #9
29
9 Mistakes
Terrible Mistake #9 Without projected costs, “fade and gain” comparisons are not possible. Fade and gain analysis measures the differences in projected costs from one week to the next. By comparing the week to week change in projected costs the PM is provided an important trend analysis as to where his job stands. If estimated projected costs decreased during a week it will show up as a “gain.” If the PM has to increase his estimate of projected costs, it means he suffered a “fade.” If for example the PM last week projected job costs to be $115,567, and this week projected $105,567, he gained $10,000. The gain represents more production with less cost for that week. Since the job starts off with projected costs equaling the estimated cost, the PM is looking for week to week gains with hopefully no fade. This is a simple and fast method to compare job performance from week to week. The above example calculated the fade/gain for the complete job. The PM needs to take another step and review the fade/gain on each bid item. The $10,000 gain above will be the net number after all bid items are taken into consideration. Some bid items will have week to week gains and some will fade week to week. As an example, the bid item “Form” could have gained (projected cost decrease) by $20,000, while the bid item “Pour” faded by $10,000 (projected costs increased). The PM will work diligently to try and get some of the fade back for next weeks reporting. In analyzing fade and gain changes, PM’s are working more and more with unit productivity measurements. Comparing actual unit performance against budgeted unit performance is the most accurate method of projecting job costs. If the PM produced 50% of the items with 60% of the labor hours for the week, he will have a revised estimated cost of 120% representing a fade in projected cost for that week of 20%. His goal will be to place the remaining 50% of the units with only 40% of the original labor budget-thus gaining back the 20% fade and completing the task at 100% of the original budget. It is easy to see with the fade/gain projected cost analysis, the PM has a better handle on week to week job performance.
ComputerEase Software, Inc.
Terrible Mistake #9
Without projected costs, PM’s cannot get a handle on week to week performance. Cost to cost fade/gain calculation Week 1
Week 2
Contract amount
12,000
12,000
Estimated cost
10,000
10,000
Actual cost
2,000
5,000
Remaining estimate
8,000
5,000
Projected total cost
10,000
10,000
Job income
2,000
2,000
(Fade)/Gain
-0-
-0-
Percent Complete fade/gain calculation Week 1
Week 2
Contract amount
12,000
14,000
Estimated cost
10,000
11,000
Actual cost
2,000
6,000
Remaining estimate
8,000
?
10,000
?
Job income
2,000
?
(Fade)/Gain
-0-
?
Projected total cost
EXERCISE #9: For Week 2, if the task is 40% complete calculate the following: Remaining estimate ______________ Projected Cost __________________ Job Income ____________________ Job income fade/gain_____________
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How To Fix the Nine Mistakes Using Projected Costs
How To Fix the Nine Mistakes Using Projected Costs
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How To Fix the Nine Mistakes Using Projected Costs Forecasting job costs creates the opportunity to correct job losses before they get out of hand. Measuring the difference between estimated costs and actual costs cannot be fully accomplished without estimating projected costs. Estimating future costs on a job gives the entire construction team an early chance to turn around a work item that is losing money before the job is complete. Developing methods to forecast job costs are the most important calculations a contractor can make. Most contractors will use one of five methods to calculate percent complete and we will discuss these methods in detail: Cost-to-Cost Percent Complete Estimate total cost to complete Labor hours to complete Unit Productivity
Cost-to-Cost Method: Don’t use it!! The cost-to-cost method compares actual costs with estimated costs to develop the percent complete. For example, if the work item’s estimated cost is $10,000 and $5,000 of cost has been incurred, it is assumed the job is 50% complete. Actual completion of a work item is not taken into account with the cost-to-cost method. It is an assumption that costs to date represent the percent complete when compared to the estimate. There is no consideration for what projected costs may be. All kinds of things go wrong when this method is used: ·
Financial statements are misstated since the WIP report is not correct.
·
Cash flow is irregular because billings don’t match costs.
·
Losses continue to pile up.
·
Bonding agents don’t trust the financial statements. They want to know what cash will be available to finish the job.
·
Owners don’t know where they stand.
·
Scheduling becomes difficult if PM is not aware of “future” trouble.
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The cost-to-cost method produces a WIP report shown below:
Est.
Actual
Cost
Cost
Cost
Remaining
10,000
5,000
5,000
%
Work %
**Compl Compl 50%
Revised
Over/Under
Est.
Budget
10,000
0
**Calculated by dividing actual cost by estimated cost without reference to projected costs to complete. Just because we incurred 50% of the estimated cost does not mean we are 50% complete. Table 1
Projected Cost methods used to solve problems brought on by cost-to-cost method Percent Complete Method The percent complete method corrects the problem caused by the cost-to-cost method. An additional step is taken by estimating the projected costs needed to complete a work item. The picture changes drastically if projected costs are calculated based on an estimate that the work item is only 25% complete. Instead of $5,000 to complete the work item as shown above, the projected cost method calculates that it will take $15,000 to finish the item. In other words, it took 50% of the estimated cost to produce 25% of the work. We know if work continues at the same pace as the first 25%, the item will end up costing $20,000-a projected over budget of $10,000. By projecting job costs the WIP report shows a different picture.
Est.
Actual
Cost
Cost
Cost
Remaining
10,000
5,000
15,000
% Compl
Work %
Revised
Over/Under
Compl
Est.
Budget
25%
20,000
10,000
Compared to the cost-to-cost report which showed a $0 over/under budget, the percent complete method shows a projected over budget of $10,000. Table 2 ComputerEase Software, Inc.
How To Fix the Nine Mistakes Using Projected Costs
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Another advantage of using the percent complete method is that it detects problems early. Because the PM caught the problem at the 25% stage, resources can be re-directed to the problem and perhaps recover some of the projected over budget amount. The revised projected cost estimate of $20,000 is quite different than the $10,000 calculated with the cost-to-cost method.
Estimating the total cost remaining method to complete an item Most contractors would refer to this method as re-estimating the job. This method is commonly used by contractors that are not able to use estimated labor hours or estimated units to calculate percent complete. Unlike other methods, the PM has nothing to “hang his hat” on. He is unable to use labor hours or units to help measure percent complete. He has to come up with his best estimate of what it will take to complete the bid item. In our example if the PM estimates that it will take 10,000 to complete the work item the WIP report would look like this. Est.
Actual
Cost
Cost
Cost
Remaining
10,000
5,000
10,000
Work % **Compl 33%
Revised
Over/Under
Est.
Budget
15,000
5,000
**Calculated based on the PM’s estimate of costs remaining. Table 3
Measuring the “fade” or “gain” in projected cost One way to measure how effectively the PM is projecting job costs is to analyze the “fade” or “gain” in projected cost every week. This keeps track of the difference in the revised estimate from week to week. It is normally measured using the WIP report. For example, we will assume in week one that the original estimate was $10,000 and the PM estimates $5,000 of remaining costs. He projects he is 50% complete. The revised estimate stays at $10,000 because he is making the budget. Since the first week is on target with the estimate, there is no fade or gain. In week two, the PM estimates he has $3,000 remaining in costs to complete the bid item. His project is projected to be 75% complete. His revised estimate is now $12,000. During week 2 his revised estimate faded by $2,000 as shown below. 9 Terrible Mistakes
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Original
Actual
Remain
Bid
Costs
Costs
Revised % Compl
$10,000
Estimate
Fade
$10,000
Week One
10,000
5,000
5,000
50%
10,000
-0-
Week Two
10,000
9,000
3,000
75%
12,000 (2000)
Table 4 Calculating fade.
Using labor hours to calculate percent complete Comparing estimated labor hours against actual labor hours gives the PM a more precise way to predict future costs. Most labor oriented subcontractors use this method. While it is better than estimating total costs to complete a work item, it also has it weaknesses. The PM normally is “tuned in” to labor hours. If the estimator “gives him” 1000 hours to complete a bid item, he may schedule only 800 hours. He knows if he gets the work done in 800 hours he has made money-he beat the budget with a margin. It is a simple way for him to keep track of how well he is doing on the job . Example of PM scheduling less than estimated. Revised Est hours 1,000
Schedule hours 800
Actual hours 400
%
Hours
50%
800
Table 5 Using the PM’s cushion to calculate revised hours.
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“Stripping” the estimators magical market price The estimator should always give the PM the number of hours he estimated before the job starts. The estimate is the beginning of job forecasting. Accurate percentage complete calculations cannot be made without an estimate. Most estimators use a “market price” in their bid which can be tough to break out the hours. Let’s take an example of concrete flat work being estimated at $4.00 per sq ft. The $4.00 per sq ft is the rate the “market” has established for bidding purposes. The estimator is pretty much locked into this number. He obviously won’t get much work if he uses $6.00 a sq ft when his competition is bidding it at $4.00 sq ft. Of course, the estimator has to take into account the type of slab it is and any unusual factors. A slab on the 6th floor will be quoted differently than a basement slab for example. The market price of $4.00 per sq ft needs to be broken down for the PM. The all inclusive estimated unit cost of $4.00 does him little good. His key to making money is managing labor. He needs to know the hours remaining to complete the bid item. He asks the estimator to “strip” the estimate of all costs except for labor. It turns out the estimator already made the labor calculation. In putting his bid together, he wanted to check his market price before submitting the bid. He estimated it would take 40 hours to complete 1,000 sq ft of slab. Here is his calculation. Remember, he used the market rate for the estimate and didn’t know what the labor factor was in the $4.00.
Estimated cost
$4,000 ($4 sq ft X 1,000 sq ft)
Less material cost
-1,500
Less sub cost Total Labor
-500 $2,000 / $50 (labor rate with O.H.) = 40 hours
Table 6 Stripping the estimate to determine labor.
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Calculating the “fade” or “gain” in the revised estimate using hours Let’s assume the PM used 4 hours to complete 100 sq ft of the concrete pour in the first week and he projects it will take 36 hours to finish the remaining 900 sq ft. Since he did 10% of the work and used 10% of the hours, his revised estimate is the same as the original estimate, 40 hours. He is on track. In week two, the PM runs into some problems and needed 8 hours to pour another 100 sq ft. He calculates his remaining time to be 30 hours. His revised estimate has changed to 42 hours (adding the 30 hours to the 12 hours he has used). His revised estimate went from 40 hours to 42 hours. The 42 hours becomes the new basis for the calculation of the fade
Using Hours to calculate “fade” or “gain” in the revised estimate Units in
Hours
Remain
Revised
Place
Used
Hrs
Estimate
Original Bid
1,000 sq ft
40
40
40 hrs
0
Week one
100 sq ft
4
36
40 hrs
0
Week two
100 sq ft
8
30
42 hrs
Fade
-2 hrs
In week three, the PM hopes to reduce his revised estimate below the original estimate. Table 7 Calculating the “fade” or “gain” in the revised estimate using hours.
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Measuring unit productivity is the best way to project percent complete
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Measuring unit productivity is the best way to project percent complete Measuring job performance is best derived by calculating how many units per hour were installed compared to the estimated rate of production. In the above example, the estimator calculated a production rate of 25 sq ft per hour (1,000 sq ft / 40 hours estimated). This becomes the project manager’s measure of performance. Using the unit productivity method to calculate percent complete results in early detection of the production per hour rate. Measuring unit productivity per hour gives the PM something to shoot for everyday. Because he knows how many hours were used in that day’s pour, for example, and how many square feet he poured, he knows the unit productivity at the end of the day. He learns in the very first pour, the first 100 sq ft, how well he is doing. Best of all, he is only 10 percent complete. Had this production rate been off, he would have time to address the problem.
The “fade”/“gain” analysis is a good weekly benchmark when using productivity per hour The “fade”/”gain”calculation in the above example gave the PM a measurement that he could compare week to week. His first week pour was on target, he poured 100sq ft in 4 hours. His productivity was 25 sq ft per hour, matching the estimated production per hour. During the second week, however, he didn’t perform as well. It took him 8 hours to pour the same 100 sq ft. His production rate for that week fell to only 12.5 sq ft per hour. It is clearly illustrated that he had a problem and was able to find it very early in the job.
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Measuring unit productivity is the best way to project percent complete
Answers Exercise #1:
Exercise #7:
1. $200,000
1.
214
2. ($18,750)
2. 2,250
3. $0 4. $31,250 Overbilled.
Exercise #8: 1. .8
Exercise #2:
2. 2
1. 25%
Exercise #9:
2. $750
1. $9,000
3. 10%
2. $15,000
4. $2,250
3. ($1,000) 4. $3,000 Fade
Exercise #3: 1. $10,000 2. $15,000 3. ($3,000) 4. 50% Exercise #4: 1. $6.25 2. $12,500 Exercise #5: 1. $7,500 2. $1,200 Overbilled Exercise #6: 1. $1,200 Under billed 2. $1,200 Under billed 3. $1,200 4. Asset 9 Terrible Mistakes
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Reports
Reports
Reports Sample - Percent Complete
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43
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Sample - Percent Complete
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Reports
Sample - Work In Progress
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45
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Sample - Profit Variance
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Reports
Sample - Labor Analysis
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47
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Sample - Unit Cost Report
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Reports
Sample - Schedule
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Sample - Unit Productivity Report
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