1. 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

2. Where We Are Now
Dr. Tomas U. Ganiron Jr

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. Apportion Method of Allocating Project Costs Using the Work Breakdown Structure
FIGURE 5.1
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12. Simplified Basic Function Point Count Process for a Prospective Project or Deliverable
TABLE 5.2
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13. Example: Function Point Count Method
TABLE 5.3
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14. 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
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15. Support Cost Estimate Worksheet
FIGURE 5.2
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16. Phase Estimating over Product Life Cycle
FIGURE 5.3
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17. Top-Down and Bottom-Up Estimates
FIGURE 5.4
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18. 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

19. 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

20. 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
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21. Three Views of Cost
FIGURE 5.6
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22. 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

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

24. 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

25. WBS Figure
TABLE 5.4
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26. Learning Curves Unit Values
TABLE A5.1
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27. Learning Curves Cumulative Values
TABLE A5.2
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28. Project Cash Flow Analysis

29. 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.

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

31. 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

32. 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

33. 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%

34. 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?

35. 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.

36. 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%

37. (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

38. Step 3 – Create an Income Statement1 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

39. Step 4 – Develop a Cash Flow Statement1 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

40. An Excel Worksheet

41. Investment & Salvage Value
Example 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

42. 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

43. Question (b): Yes, Accept the Project !
Is this investment justifiable at a MARR of 15%?
PW(15%) = -$148, $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

44. 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%

45. 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

46. 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.

47. 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

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

49. 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

50. 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

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

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

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

54. 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.

56. Example 9.4 Applying Specific Inflation Rates

57. 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 % %

58. 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.

60. 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

61. 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

62. 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

63. 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

64. 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

65. 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

66. 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

67. 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

68. 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

69. 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

70. 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

71. 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

72. 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

73. 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

74. 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

75. 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

76. 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

77. 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

78. 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

79. 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

80. 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

81. 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

82. 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

83. 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

84. 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

85. 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

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

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

88. 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!

89. 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

90. 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

91. COST MANAGEMENT

92. 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

93. 1- Resource Planning
Involves determining what physical resources (people, equipment, materials etc) and what quantities of each should be used to perform project activities.

94. 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.

95. 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.

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

97. 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.

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

99. 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

100. 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

101. 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.

102. 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.

103. 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.

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

105. Inputs to Cost Budgeting
Cost Estimates
Work Breakdown Structure
Project Schedule

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

107. 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.

109. 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

110. 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.

111. 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.

112. 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.

113. 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.

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

115. 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

116. 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.

117. 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

118. THANK YOU

119. 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