CHAPTER FOUR 4-MANAGERIAL PROCESS 4.1 Estimating project time and costs 4-2 Project cash flows 4.3 Performance and payment bonds 4-5 Cost Control. Management tools, accounts, general cost control systems. CHAPTER FOUR 1 Dr. Tomas U. Ganiron Jr 1

Where We Are Now Dr. Tomas U. Ganiron Jr

Estimating Projects Estimating Types of Estimates The process of forecasting or approximating the time and cost of completing project deliverables. The task of balancing expectations of stakeholders and need for control while the project is implemented. Types of Estimates Top-down (macro) estimates: analogy, group consensus, or mathematical relationships Bottom-up (micro) estimates: estimates of elements of the work breakdown structure Dr. Tomas U. Ganiron Jr

Why Estimating Time and Cost Are Important To support good decisions. To schedule work. To determine how long the project should take and its cost. To determine whether the project is worth doing. To develop cash flow needs. To determine how well the project is progressing. To develop time-phased budgets and establish the project baseline. EXHIBIT 5.1 Dr. Tomas U. Ganiron Jr

Factors Influencing the Quality of Estimates Planning Horizon Other (Nonproject) Factors Project Duration Quality of Estimates Organization Culture People Padding Estimates Project Structure and Organization Dr. Tomas U. Ganiron Jr

Estimating Guidelines for Times, Costs, and Resources Have people familiar with the tasks make the estimate. Use several people to make estimates. Base estimates on normal conditions, efficient methods, and a normal level of resources. Use consistent time units in estimating task times. Treat each task as independent, don’t aggregate. Don’t make allowances for contingencies. Adding a risk assessment helps avoid surprises to stakeholders. Dr. Tomas U. Ganiron Jr

Top-Down versus Bottom-Up Estimating Top-Down Estimates Are usually are derived from someone who uses experience and/or information to determine the project duration and total cost. Are made by top managers who have little knowledge of the processes used to complete the project. Bottom-Up Approach Can serve as a check on cost elements in the WBS by rolling up the work packages and associated cost accounts to major deliverables at the work package level. Dr. Tomas U. Ganiron Jr

Top-Down versus Bottom-Up Estimating Conditions for Preferring Top-Down or Bottom-up Time and Cost Estimates Condition Macro Estimates Micro Estimates Strategic decision making X Cost and time important X High uncertainty X Internal, small project X Fixed-price contract X Customer wants details X Unstable scope X TABLE 5.1 Dr. Tomas U. Ganiron Jr

Estimating Projects: Preferred Approach Make rough top-down estimates. Develop the WBS/OBS. Make bottom-up estimates. Develop schedules and budgets. Reconcile differences between top-down and bottom-up estimates Dr. Tomas U. Ganiron Jr

Top-Down Approaches for Estimating Project Times and Costs Consensus methods Ratio methods Apportion method Function point methods for software and system projects Learning curves Project Estimate Times Costs Dr. Tomas U. Ganiron Jr

Apportion Method of Allocating Project Costs Using the Work Breakdown Structure FIGURE 5.1 Dr. Tomas U. Ganiron Jr

Simplified Basic Function Point Count Process for a Prospective Project or Deliverable TABLE 5.2 Dr. Tomas U. Ganiron Jr

Example: Function Point Count Method TABLE 5.3 Dr. Tomas U. Ganiron Jr

Bottom-Up Approaches for Estimating Project Times and Costs Template methods Parametric procedures applied to specific tasks Range estimates for the WBS work packages Phase estimating: A hybrid Dr. Tomas U. Ganiron Jr

Support Cost Estimate Worksheet FIGURE 5.2 Dr. Tomas U. Ganiron Jr

Phase Estimating over Product Life Cycle FIGURE 5.3 Dr. Tomas U. Ganiron Jr

Top-Down and Bottom-Up Estimates FIGURE 5.4 Dr. Tomas U. Ganiron Jr

Level of Detail Level of detail is different for different levels of management. Level of detail in the WBS varies with the complexity of the project. Excessive detail is costly. Fosters a focus on departmental outcomes Creates unproductive paperwork Insufficient detail is costly. Lack of focus on goals Wasted effort on nonessential activities Dr. Tomas U. Ganiron Jr

Types of Costs Direct Costs Direct (Project) Overhead Costs Costs that are clearly chargeable to a specific work package. Labor, materials, equipment, and other Direct (Project) Overhead Costs Costs incurred that are directly tied to an identifiable project deliverable or work package. Salary, rents, supplies, specialized machinery General and Administrative Overhead Costs Organization costs indirectly linked to a specific package that are apportioned to the project Dr. Tomas U. Ganiron Jr

Contract Bid Summary Costs Direct costs $80,000 Direct overhead $20,000 Total direct costs $100,000 G&A overhead (20%) Total costs $120,000 Profit (20%) $24,000 Total bid $144,000 FIGURE 5.5 Dr. Tomas U. Ganiron Jr

Three Views of Cost FIGURE 5.6 Dr. Tomas U. Ganiron Jr

Refining Estimates Reasons for Adjusting Estimates Adjusting Estimates Interaction costs are hidden in estimates. Normal conditions do not apply. Things go wrong on projects. Changes in project scope and plans. Adjusting Estimates Time and cost estimates of specific activities are adjusted as the risks, resources, and situation particulars become more clearly defined. Dr. Tomas U. Ganiron Jr

Creating a Database for Estimating FIGURE 5.7 Dr. Tomas U. Ganiron Jr

Key Terms Apportionment methods Overhead costs Bottom-up estimates Contingency funds Delphi method Direct costs Function points Learning curves Overhead costs Padding estimates Phase estimating Range estimating Ratio methods Template method Time and cost databases Dr. Tomas U. Ganiron Jr

WBS Figure TABLE 5.4 Dr. Tomas U. Ganiron Jr

Learning Curves Unit Values TABLE A5.1 Dr. Tomas U. Ganiron Jr

Learning Curves Cumulative Values TABLE A5.2 Dr. Tomas U. Ganiron Jr

Project Cash Flow Analysis

Elements of Investment Decision Identification of Investment Opportunities Generation of Cash Flows Measures of Investment Worth Project Selection Project Implementation Project-Control/Post-Audit Our focus in this chapter is to develop the format of after-tax cash flow statements.

Types of Cash Flow Elements in Project Analysis Differential or incremental cash flow: cash flow due asset

Cash Flows from Operating Activities Approach 1 Income Statement Approach Approach 2 Direct Cash Flow Approach Operating revenues Cost of goods sold Depreciation Operating expenses Interest expenses Taxable income Income taxes Net income + Depreciation - Cost of goods sold - Operating expenses - Interest expenses - Income taxes Cash flow from operation

A Typical Format used for Presenting Cash Flow Statement + Net income +Depreciation Capital investment + Proceeds from sales of depreciable assets Gains tax Investments in working capital + Working capital recovery + Borrowed funds Repayment of principal Net cash flow Operating activities Income statement Revenues Expenses Cost of goods sold Depreciation Debt interest Operating expenses Taxable income Income taxes Net income + Investing activities + Financing activities

Example 9.1 When Projects Require only Operating and Investing Activities Project Nature: Installation of a new computer control system Financial Data: Investment: $125,000 Project life: 5 years Working capital investment: $23,331 Salvage value: $50,000 Annual labor savings: $100,000 Annual additional expenses: Labor: $20,000 Material: $12,000 Overhead: $8,000 Depreciation Method: 7-year MACRS Income tax rate: 40% MARR: 15%

Questions (a) Develop the project’s cash flows over its project life. (b) Is this project justifiable at a MARR of 15%? (c) What is the internal rate of return of this project?

When Projects Require Working Capital Investments Working capital means the amount carried in cash, accounts receivable, and inventory that is available to meet day-to-day operating needs. How to treat working capital investments: just like a capital expenditure except that no depreciation is allowed.

Allowed Depreciation Amount (a) Step 1: Depreciation Calculation Cost Base = $125,000 Recovery Period = 7-year MACRS N MACRS Rate Depreciation Amount Allowed Depreciation Amount 1 14.29% $17,863 2 24.49% $30,613 3 17.49% $21,863 4 12.49% $15,613 5 8.93% $11,150 $5,575 6 8.92% 7 8 4.46%

(a) Step 2: Gains (Losses) associated with Asset Disposal Salvage value = $50,000 Book Value (year 5) = Cost Base – Total Depreciation = $125,000 - $ 91,525 = $ 33,475 Taxable gains = Salvage Value – Book Value = $50,000 - $ 33,475 = $16,525 Gains taxes = (Taxable Gains)(Tax Rate) = $16,525 (0.40) = $6,610

Step 3 – Create an Income Statement 1 2 3 4 5 Revenues $100,000 Expenses: Labor 20,000 Material 12,000 Overhead 8,000 Depreciation 17,863 30,613 21,863 15,613 5,581 Taxable Income $42,137 $29,387 $38,137 $44,387 $54,419 Income Taxes (40%) 16,855 11,755 15,255 17,755 21,768 Net Income $25,282 $17,632 $22,882 $26,632 $32,651

Step 4 – Develop a Cash Flow Statement 1 2 3 4 5 Operating Activities: Net Income $25,282 $17,632 $22,882 $26,632 $32,651 Depreciation 17,863 30,613 21,863 15,613 5,581 Investment Activities: Investment (125,000) Working capital (23,331) 23,331 Salvage 50,000 Gains Tax (6,613) Net Cash Flow ($148,331) $43,145 $48,245 $44,745 $42,245 $104,950

An Excel Worksheet

Investment & Salvage Value Example 9.1 - Net Cash Flow Table Generated by Traditional Method Using Approach 2 A B C D E F G H I J Year End Investment & Salvage Value Revenue Labor Expenses Materials Overhead Depreciation Taxable Income Income Taxes Net Cash Flow -$125,000 -23,331 1 $100,000 20,000 12,000 8,000 $17,863 42,137 16,855 $43,145 2 100,000 30,613 29,387 11,755 $48,245 3 21,863 38,137 15,255 $44,745 4 15,613 44,387 17,755 $42,245 5 5,581 54,419 21,678 $38,232 50,000* 23,331 16,525 6,613 $43,387 *Salvage value Note that H = C-D-E-F-G I = 0.4 * H J= B+C-D-E-F-I Information required to calculate the income taxes

Working capital recovery cycles Cash Flow Diagram including Working Capital $23,331 Working capital recovery $44,745 $81,619 $48,245 $43,145 $42,245 1 2 3 4 5 $125,000 Investment in physical assets $23,331 $23,331 $23,331 Investment in working capital 1 2 3 4 5 Years $23,331 $23,331 Working capital recovery cycles

Question (b): Yes, Accept the Project ! Is this investment justifiable at a MARR of 15%? PW(15%) = -$148,331 + +$43,145(P/F, 15%, 1) + . . . . + $104,950 (P/F, 15%, 5) = $31,420 > 0 Yes, Accept the Project ! $104,950 $48,245 $44,745 $42,245 $43,145 1 2 3 4 5 Years $148,331

Question (C): IRR IRR = 22.55% A B 1 Period Cash Flow 2 ($148,331) 3 ($148,331) 3 43,145 4 48,245 5 44,745 6 42,245 7 104,950 =IRR(B2:B7,0.10) IRR = 22.55%

Rate of Return Analysis (IRR = 22.55%) Beginning Balance -$148,331 -$138,635 -$121,652 -$104,339 -$85,622 Return on Investment (interest) -$33,449 -$31,262 -$27,432 -$23,528 -$19,328 Payment $43,145 $48,245 $44,745 $42,245 $104,950 Project

When Projects are Financed with Borrowed Funds Key issue: Interest payment is a tax-deductible expense. What Needs to Be Done: Once a loan repayment schedule is known, separate the interest payments from the annual installments. What about Principal Payments? As the amount of borrowing is NOT viewed as income to the borrower, the repayments of principal are NOT viewed as expenses either– NO tax effect.

Loan Repayment Schedule (Example 9.2) Amount financed: $62,500, or 50% of total capital expenditure Financing rate: 10% per year Annual installment: $16,487 or, A = $62,500(A/P, 10%, 5) End of Year Beginning Balance Interest Payment Principal Payment Ending 1 $62,500 $6,250 $10,237 $52,263 2 52,263 5,226 11,261 41,002 3 4,100 12,387 28,615 4 2,861 13,626 14,989 5 1,499 14,988 $16,487

Additional entries related to debt financing Table 9.4 Additional entries related to debt financing

When Projects Results in Negative Taxable Income Negative taxable income (project loss) means you can reduce your taxable income from regular business operation by the amount of loss, which results in a tax savings. Handling Project Loss Regular Business Project Combined Operation Taxable income Income taxes (35%) $100M $35M (10M) ? $90M $31.5M Tax savings Tax Savings = $35M - $31.5M = $3.5M Or (10M)(0.35) = -$3.5M

Effects of Inflation on Project Cash Flows Item Effects of Inflation Depreciation expense Depreciation expense is charged to taxable income in dollars of declining values; taxable income is overstated, resulting in higher taxes Note: Depreciation expenses are based on historical costs and always expressed in actual dollars

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

Item Effects of Inflation Loan repayments Borrowers repay historical loan amounts with dollars of decreased purchasing power, reducing the debt-financing cost.

Item Effects of Inflation Working capital requirement Known as working capital drain, the cost of working capital increases in an inflationary environment.

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

Example 9.4 Applying Specific Inflation Rates

Rate of Return Analysis under Inflation Principle:True (real) rate of return should be based on constant dollars. If the rate of return is computed based on actual dollars, the real rate of return can be calculated as: n Net cash flows in actual dollars Net cash flows in constant dollars 1 2 3 4 -$30,000 13,570 15,860 13,358 13,626 12,336 13,108 10,036 9,307 IRR 31.34% 19.40%

Decision Criterion If you use 31.34% as your IRR, you should use a market interest rate (or inflation-adjusted MARR) to make an accept and reject decision. If you use 19.40% as your IRR, you should use an inflation-free interest rate (inflation-free MARR) to make an accept and reject decision.

The Sensible Choice For Managing Risk Surety Bonds The Sensible Choice For Managing Risk Surety Bonds – the sensible choice for managing risk. Dr. Tomas U. Ganiron Jr

Can Surety Bonds Help You? How do you evaluate & manage risk? How do you ensure projects are completed on time, on budget, and to contract specifications? How do you ensure contractors successfully meet obligations? As a project owner, how do you evaluate and manage risk on construction projects? How do you ensure projects are completed on time, on budget, and to contract specifications? How do you ensure that contractors successfully meet obligations? Dr. Tomas U. Ganiron Jr

Can Surety Bonds Help You? Bid Bond Performance Bond Payment Bond One way is with bid, performance, and payment bonds. Specifying a surety bond ensures capable and qualified contractors and protects you from financial loss in the event of contractor failure. Dr. Tomas U. Ganiron Jr

Surety Bonds vs. Traditional Insurance 3-party 2-party Risk transfer Duty to obligee Duty to insured Regulated by State Insurance Departments Premium fee for prequalification services Premium actuarially determined Project specific Usually term specific Penal sum Policy limits Surety bonds and traditional insurance are provided by insurance companies and both are licensed and regulated by state insurance departments. However, surety bonds are more like bank credit in that the surety company’s financial resources back the contractor’s commitment to enter into a contract with an owner. In order to obtain a surety bond, the contractor must qualify – that is meet the surety’s comprehensive underwriting standards. Bonds are a three party agreement among the owner (referred to as the obligee), the contractor (referred to as the principal), and the surety company. Traditional insurance is a two-party agreement between the insurance company and the insured. With surety bonds, the premium is a fee for the surety’s prequalification services. With insurance, the premium is based on expected loss. There is no deductible on a surety bond, although the surety may require the contractor to reimburse the surety in the event of claims payment. Dr. Tomas U. Ganiron Jr

Contract Surety Bonds Bid Bond Performance Bond Payment Bond There are three basic types of contract surety bonds. The bid bond assures that the bid has been submitted in good faith, that the contractor intends to enter into the contract at the price bid, and the contractor will provide the required performance and payment bonds. Dr. Tomas U. Ganiron Jr

Contract Surety Bonds Bid Bond Performance Bond Payment Bond The performance bond assures the owner that the contractor is capable and qualified to perform the contract and protects the owner from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions. Dr. Tomas U. Ganiron Jr

Contract Surety Bonds Bid Bond Performance Bond Payment Bond The payment bond assures that certain subcontractors, laborers, and materials suppliers will be paid in the event of contractor default and prevents subcontractors from filing mechanics’ liens on a project. Dr. Tomas U. Ganiron Jr

Fundamentals of Surety Contractor default is preventable Surety companies & producers prequalify contractors Surety companies back the bond with their own assets The fundamental concept of contract surety is that contractor default is preventable. Surety companies and surety bond producers spend a great deal of time and expense in the underwriting process to qualify a contractor before issuing a surety bond. Since surety companies back the bond with their own assets, they conduct a careful, professional, and rigorous prequalification review of the contractor. Dr. Tomas U. Ganiron Jr

The 3 Cs Of Prequalification Capital Capacity Character Prequalification is an in-depth look at the contractor’s entire business operation to determine the contractor’s ability to meet current and future contractual and financial obligations. Basically, underwriting is a look at the three Cs of prequalification: Capital, which looks at the contractor’s financial strength, Capacity, which analyzes the contractor’s ability to perform the contract, and Character, which is a look at the contractor’s reputation. Dr. Tomas U. Ganiron Jr

Analyzing Financial Strength Capital Financial statements Working capital Work-in-progress Indemnity The surety underwriter and surety bond producer have access to detailed financial information that most contractors will not share with a project owner. The surety team analyzes: Annual and interim financial statements Investment strategies Cost control mechanisms Work in progress, including bonded & non-bonded projects Cash flow Net worth Working capital and Bank & other credit relationships Dr. Tomas U. Ganiron Jr

Evaluating Ability To Perform Capital Financial statements Working capital Work-in-progress Indemnity Capacity Resumes Contingency plan Business plan Equipment The surety also investigates the contractor’s business operations and ability to perform. It will look at Prior experience and whether the contractor has completed similar projects. Whether the contractor has or can obtain the necessary equipment to perform the work. It will review organizational charts of key employees and request resumes of the principal and key employees. The surety also reviews reports on past, current, & future work load, including bonded & non-bonded projects. It will analyze the contractor’s business plan and Ask how the business will continue in the event of the principal’s or key employee’s death or disablement. Dr. Tomas U. Ganiron Jr

Business plan – short & long term Assessing Reputation Capital Financial statements Working capital Work-in-progress Indemnity Capacity Resumes Contingency plan Business plan – short & long term Equipment Character Reputation Relationships References The surety will also investigate business relationships with Subcontractors Suppliers Project owners and Lenders to determine the contractor’s reputation in the industry. Dr. Tomas U. Ganiron Jr

Reviewing Business Ventures Surety Document business commitments that can affect the contractor’s business Owning property Side ventures The surety is also interested in business commitments that can affect the contractor’s business, such as owning property and side ventures. One contractor with 13 contracts underway used $850,000 in contract funds for outside investments and could not raise the capital to continue. The surety company provided financing so the projects could be completed. Dr. Tomas U. Ganiron Jr

Source: Dun & Bradstreet Contractor Failure While the premise of surety bonding is to prevent contractor failure, construction is filled with risk. Contractor default is an unfortunate, and sometimes unavoidable, circumstance. According to Dun & Bradstreet, in the 1990s, an average of 10,000 contractors failed each year leaving liabilities of $3 billion per year. They also found that the number of years a failed contractor was in business had no effect on the likelihood of default. Based on the Engineering News-Record (ENR) annual “Top 400 Contractors” list, of the top 50 contractors for the year 1990, 26% were not represented at all in the “Top 400” list of 2000. Source: Dun & Bradstreet Dr. Tomas U. Ganiron Jr

Why Do Contractors Fail? Inadequate Management New Owner Failure Over Expansion Change in Scope Failure Usually it takes a combination of events to force a contractor into default. Factors that can contribute to contractor failure are Management problems, including: Inadequate accounting, financial, and project management systems Changes in ownership or personnel Changes in scope of business Rapid over-expansion, either in volume or expansion into new geographic territory. Labor and material problems that can lead to default include: Subcontractor failure Labor and materials shortages and Cost escalations. Sub Failure Materials Shortages Cost Escalations Dr. Tomas U. Ganiron Jr

Why Do Contractors Fail? Economic Downturn Inclement Weather Failure Failure Onerous Terms Work Environment Other factors may occur that are simply beyond the contractor’s control, such as inclement weather, unexpected economic downturn, onerous contract terms or work environment, unforeseen changes in job site conditions, or death or illness of a key employee. Death or Illness of Key Employee Dr. Tomas U. Ganiron Jr

Claims Principal Obligee Surety In the unfortunate event the contractor does fail, the surety has legal obligations to the project owner and the contractor. Surety Dr. Tomas U. Ganiron Jr

Expediting The Claims Process Clearly define default in contract Submit status reports to surety Promptly notify surety of performance or payment problems Owner must file formal declaration of default To expedite the claims process, make certain that what constitutes default is defined in the contract and keep the surety informed with status reports of job progress and notification of performance and payment problems as they occur. In the event of contractor default, the project owner must file a formal declaration of default. Dr. Tomas U. Ganiron Jr

Responsibility Of The Surety Acknowledge claim Investigate claim Determine & fulfill obligations Once notified, the surety will: acknowledge the claim and then conduct an impartial investigation. If the surety finds the contractor to be in default, it has certain obligations as defined in the bond form. Dr. Tomas U. Ganiron Jr

Performance Bond Protection Surety Re-let the job Provide replacement contractor Retain original contractor Reimburse owner penal sum The surety generally does one of four things: Re-lets the job for completion Provides a replacement contractor Retains the original contractor, providing trained personnel or financial assistance, or Reimburses the owner the penal sum of the bond. Dr. Tomas U. Ganiron Jr

Payment Bond Protection Assures payment No mechanics’ liens Keeps subcontractors on the job Surety When a payment bond is in place, certain subcontractors, suppliers, and laborers are assured payment in the event of contractor default. This protects the owner from mechanics’ liens and keeps key subcontractors on the job because they know they will be paid. Dr. Tomas U. Ganiron Jr

Surety Bonds vs. Letters of Credit Surety Credit Bank Credit Premium Interest Expect reimbursement if loss Repay loan Principal benefit of surety credit Borrower has benefit of bank $ There are alternatives to surety bonds, the most common being a letter of credit. So how do letters of credit measure up to surety bonds? The surety company analyzes the contractor’s ability to perform. With a letter of credit, the banker examines the quality and liquidity of the collateral in case there is a demand on the LOC. If the bank is satisfied of the contractor’s ability to pay, there is no further prequalification. The performance and payment bond each cover 100% of the contract price. A letter of credit is limited to the stated amount, usually only 5-10% of the contract price. The surety bond remains in effect for the duration of the contract and may include a one-year maintenance period as well. The letter of credit is usually date specific, generally for one year. It may contain an “evergreen” clause for automatic renewal, with related fees. In the event of contractor default, the surety conducts an impartial investigation of the claim. If the contractor is in default, the surety company completes the contract. With a letter of credit, the bank pays on demand of the holder. The owner must then administer completion of the contract with the funds remaining. Under the payment bond, the surety pays rightful claims on certain subcontractors, laborers, and suppliers. With a letter of credit, the owner must determine the validity of these claims. If there is not enough money from the letter of credit, the owner must decide which claims to pay. If subcontractors are not paid, they may file liens on the project. Dr. Tomas U. Ganiron Jr

The Value Of Surety Bonds Bid Bonds Performance Bonds Payment Bonds One way to reduce the risk of construction is with bid, performance, and payment bonds. A bid bond means that the contractor is capable and responsible. It also limits unrealistic bids from contractors who would not be capable of performing the contract. If the contractor is awarded the contract but fails to enter into the agreement, the surety may be required to pay the difference between the awarded bid and the next lowest bid or pay the bond penalty, usually 10% of the contract amount. Dr. Tomas U. Ganiron Jr

The Value Of Surety Bonds Bid Bonds Performance Bonds Payment Bonds The performance bond protects the owner from financial loss should the contractor fail to meet the terms and conditions of the contract. A qualified, bonded contractor is more likely to complete the project according to the contract provisions. Default is not in the best interest of the surety, contractor, or owner. When problems occur, the surety may offer financial, technical, or managerial assistance to the contractor in order to prevent default. Dr. Tomas U. Ganiron Jr

The Value Of Surety Bonds Bid Bonds Performance Bonds Payment Bonds Payment bonds assure that certain subcontractors, suppliers, and laborers will be paid. Subcontractors and suppliers cannot file mechanics’ liens on the project and the owner is protected from unwarranted double-payments to subs and suppliers. The absence of liens can smooth the transition from a construction loan to permanent financing. As an added bonus, subcontractors and suppliers may lower prices when they know they are assured payment protection. There is no cost for the payment bond when it is issued with the performance bond. Dr. Tomas U. Ganiron Jr

Cost of Surety Bonds Project Amount Approx. Bond Premium $1 Million $7,700 – $13,500 $5 Million $33,200 – $47,250 $10 Million $56,950 – $81,000 $20 Million $101,950 – $146,000 * Premiums may vary depending on size, type & contractors bonding capacity. The cost of a performance bond is a one-time premium, which typically ranges from ½ to 2% of the contract amount, depending on the size and type of the project and the contractor’s bonding capacity. There is usually no charge for the bid bond or payment bond. *For a small and emerging contractor, premiums can start around 2.5-3%. Dr. Tomas U. Ganiron Jr

Premium Calculation Examples Established Contractor $500,000 Contract Reviewed/Audited Financial Statements Frequent Bond User <1.0-1.5% Bond Rate (average – 1.35%) <$5,000-7,500 Likely no other costs involved (collateral, escrow, SBA)

Premium Calculation Examples Emerging Contractor $500,000 Contract Limited Financial Info. (Tax Returns/Quickbooks) Limited Bonding History 1.8-3.0% Flat Rate (average – 2.5%) $9,000-12,500 May not include cost of getting bond (i.e., funds control, collateral, SBA fees)

How Is Premium Paid? Premium is billed BY the contractor TO the owner Usually paid on first billing, along with: Mobilization General Conditions Bond Cost of bond is included in final contract price Contractor pays the bond premium to the surety Prompt Pay Is Key To A Contractor’s Success!

The Underlying Agreement Look at obligations Determine risks Match capable principal to fulfill agreement Surety Just as the endorsement of a loan stands as a guarantee of the fulfillment of the terms and conditions of a loan agreement, a performance bond on a construction contract guarantees the fulfillment of a contract. The underlying agreement is the primary instrument to establish the risk associated with the guarantee. A surety underwriter is trained to look at obligations, determine the risk, and match up the principal that he/she feels is capable of fulfilling the agreement. A bond is much like a “consultant’s report.” However, should this consultant make a mistake, he/she will back the decision with his/her money. Dr. Tomas U. Ganiron Jr

Bond Specifications Owner specifies surety bonds in contract documents Contractor contacts surety bond producer Producer guides contractor through prequalification Contractor obtains bonds & delivers to owner Specifying a bond for a project is easy. Simply state the requirement in the contract specifications. It is the contractor’s responsibility to contact a surety bond producer and obtain the necessary bonds. The surety bond producer guides the contractor through the prequalification process and helps him or her develop a business relationship with a surety company. Dr. Tomas U. Ganiron Jr

COST MANAGEMENT

COST MANAGEMENT Includes processes required to ensure that the project is completed within the approved budget. Processes involved are: 1- Resource Planning 2- Cost Estimating 3- Cost Budgeting 4- Cost Control

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

Inputs to Resource Planning 1. Work Breakdown Structure: A deliverable-oriented grouping of project elements that organizes and defines the total scope of the project. It Identifies the project elements that will need resources. 2. Historical Information 3. Scope Statement: Contains the project justification and the project objectives.

Inputs to Resource Planning 4. Resource Pool Description: Knowledge of what resources are potentially available. 5. Organizational Policies: The policies of the performing organization regarding staffing and the rental or purchase of supplies and equipment.

Tools and Techniques to Resource Planning Expert Judgment Alternative identifications: To adopt different approaches for the same problem.

Outputs from Resource Planning Resource Requirements: Description of what types of resources are required and in what quantities for each element of the work break down structure.

Cost Estimating Developing an approximation (estimates) of the costs of the resources needed to complete project activities. Includes identifying and considering various costing alternatives.

Cost Estimating and Pricing Cost Estimating involves developing an assessment of the likely quantitative result-how much will it cost the performing organization to provide the product or service involved. Pricing is a business decision-how much will the performing organization charge for the product or service

Inputs to Cost Estimating Work Breakdown Structure Resource Requirement Resource Rates: scheduled or non-scheduled Activity Duration Estimates Historical Information Chart of Accounts: Describes the coding structure used by the performing organization to report financial information in its general ledger

Tools and Techniques for Cost Estimating Analogous Estimating / Top-down Estimating: Using the actual cost of a previous, similar project as the basis for estimating the cost of the current project. It is less costly but less accurate. (Rough-cost Estimate) Parametric Modeling: Using project characteristics (parameters) in a mathematical model to predict project costs.

Tools and Techniques for Cost Estimating Bottom-up Estimating: Estimating the cost of individual work items, then summarizing or rolling up the individual estimates to get a project title. (Detailed Estimate) Computerized Tools: Use of computerized tools such as project management software and spreadsheets to assist with cost estimating.

Outputs from Cost Estimating Cost Estimates Supporting Details like Scope of work, Calculation sheet, Assumptions made, Possible range of results, etc. Cost Management Plan describing how cost variances will be managed.

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

Inputs to Cost Budgeting Cost Estimates Work Breakdown Structure Project Schedule

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

Outputs from Cost Budgeting Cost Baseline A time-phased budget that will be used to measure and monitor cost performance on the project. It is developed by summing estimated costs by period and is usually displayed in the form of an S-curve.

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

Cost Control Cost Control includes: Monitoring cost performances to detect variances from plan. Ensuring that all appropriate changes are recorded accurately in the cost baseline Preventing incorrect, inappropriate, or unauthorized changes from being included in the cost baseline. Informing appropriate stakeholders of authorized changes.

Inputs to Cost Control Cost Baseline Performance Reports Provide information about cost performance such as which budgets have been met and which have not. It also alerts the project team to issues which may cause problems in the future.

Inputs to Cost Control Change Requests These may occur in many forms-oral or written, direct or indirect, externally or internally initiated, and legally mandated or optional. These may require increasing the budget or may allow decreasing it.

Tools and Techniques for Cost Control Cost Change Control System It defines the procedures by which the cost baseline may be changed. It includes the paperwork, tracking systems, and approval levels necessary for authorizing changes. Performance Measurement It helps to assess the magnitude of any variations which do occur.

Tools and Techniques for Cost Control Additional Planning Perspective changes may require new or revised cost estimates or analysis of alternate approaches. Computerized Tools

Outputs from Cost Control Revised Cost Estimates Budget Updates Corrective Action Estimate at Completion It is a forecast of total project costs based on project performance. Lessons Learned

OBJECTS OF COST CONTROL 1 – To have a knowledge of the profit and loss of the project throughout the duration of the project. PROJECT PROFITS Client payments. Sale of surplus or scrap material and plant Payments for plants or labor by others, where, this plant or labor is , from time to time not required for the project. PROJECT LOSSES Labor and site office costs Plant costs Site overheads i.e. site facilities, access roads and office etc Cost of tendering including bonds, insurance, etc. Material costs. Head office overheads proportioned over all current projects.

OBJECTS OF COST CONTROL 2 – To have a comparison between the actual project performance and that conceived in the original project plan. Comparison is basically done according to the following bases: According to units of production According to line items; e.g., labour, material, equipment, overheads, --- 3 – Provides feedback data on actual project performance to future project planning

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The Owner’s Responsibilities Provide working set of plans and specifications Establish terms of the agreement Ensure full & timely payment Maintain adequate insurance Pay property taxes Communicate Owner However, there are things an owner can do to get the most from the surety bond: Provide a working set of plans and specifications Establish terms of the agreement Make payments to the contractor in full and on time Maintain adequate insurance Pay property taxes and Communicate with the contractor and surety Dr. Tomas U. Ganiron Jr