Financial institutions who are involved in providing finance for engineering and construction projects are now required more than ever to predict and report on the likelihood of loan default before it actually occurs. Project management standards have identified the best practices that must adopted to ensure robust cost variance at completion reporting. Those best practices are crucial to enforce transparency, accountability and real-time monitoring and evaluation of projects’ financial key performance indicators and metrics.
Project Management Information System (PMIS) similar to PMWeb provides those financial institutions as well as the contractors with an integrated ready-to-use platform to implement those best practices and achieve the desired outcome. All those forms allow having all supportive documents attached to the record to provide the complete details of each transaction. Those supportive documents will be uploaded and stored in the right folder or subfolder of PMWeb document management repository. In addition, a workflow can be created to formalize the steps for submitting, reviewing and approving each transaction. The trust-worthy data captured in those transactions will provide the organization with information needed to have the insight to make better and faster informed decisions.
Defining the Project Performance Budget
Regardless of your project size, type or location, every project represents an investment that was based on estimating the cost for delivering the project’s scope of work. The Work Breakdown Structure (WBS) is the technique used to define the project scope of work and determine what is included and what is excluded from each work package. This will enable the organization to estimate the labor and non-labor resources needed, materials to be procured and scope of work to be subcontracted to deliver the project. Accordingly, it makes sense that reporting the project’s financial performance should be aligned with the WBS levels for which they will become the project’s cost breakdown structure.
Assumptions for the unknown scope of works and events to be identified and assessed. The project risk register will be used to capture likelihood and impact of those assumptions and identify the most appropriate response actions to treat them. This could result in increasing the cost estimate to accommodate for additional management effort, replacing vendors and suppliers, subcontracting more project scope and allowing funds for contingency and management reserve.
The cost estimate will become the basis for establishing the project budget where additional cost might be added to cover the cost of project finance, home office overhead and profit. The project performance budget will become the total investment amount that the organization wants to earn revenue as well as spend on the project to achieve the desired profit or return on investment.
The budget planned spending will detail the spending that organization anticipates to have during the project life cycle. This requires aligning the budget with the project’s integrated schedule by associating each budget line item with the relevant project schedule activity. The spending plan for each financial period covered by the activity could be front loaded, back loaded, linear, bell shaped or any other curve format that is aligned on how actually the budget will be sent.
Managing the Revenue Contract
When the contractor submits his bid proposal, the contractor strategy for presenting his price might vary from how the budget was detailed, although the total of both would remain the same. Some contractors might front load the proposal to secure additional funds to finance the project. Other contractors might lower the price of project items that could be deleted or reduced while increasing the price of items that could be increased. With the absence of “unbalanced bid” clause, many contractors might opt to do this. Of course, the alerting part of having unbalanced bids that reporting project’s actual profit and loss will not be true. Unbalanced bids could result in having part of the project scope delivered at high profit while other scope of work at loss.
During the project’s execution, changes to the project scope will usually occur. The contractor needs to capture all pending, approved and disputed changes along with all supportive documentation. For those disputed changes, the contractor will usually submit a claim requesting for the financial, time extension and prolongation costs associated with those changes.
On monthly basis, the contractor will submit the monthly project invoice for completed works and material on site. Today, most engineering and construction projects use the activity percent complete of cost-loaded project schedule to determine the amount to be invoiced at the end of each progress period. Retention of completed works and material on site will adjust the amount that the contractor will be entitled to have.
There is a growing trend to have pre-agreed values to calculate the percent complete for the progressed project schedule activities. This will expedite the process on agreeing on what percent complete each activity should have based on tangible achievements or deliverables.
The actual payment of the approved progress invoice, or account receivable, needs to be captured and how it was paid. Some project’s agreements require that the approved progress invoice be of a minimum value to be paid otherwise it will be delayed for the following month.
Managing the Project Cost
The same approved project budget will be used to place the actual commitments against the project. Those could be subcontract agreements, material supplies as well as internal company commitments such as plant, project management, overhead contribution. This will provide the financial institution as well as the contractor a better understanding of the actual costs sources that the project will encounter. The selection and award of subcontracts and material supplies need to be competitive and compliant with the project scope of work and specifications. This will require technical and commercial evaluation of received bids before selecting the successful bidder.
The different commitment agreements will be detailed to the same cost breakdown structure levels used in the project performance budget and revenue contract. The commitment agreements could be in different currency than the currency in the project budget and revenue contract. This is very true when it comes to imported equipment and material supplies.
Similar to the performance budget and revenue contract, the anticipated invoicing for the scope of work needs to be captured to identify the payment obligations, or cash out, on the contractor. Payments can be made in full the approved progress invoice or partial.
Changes to the project could happen for many reasons and the contractor needs to implement a proactive policy to capture all potential changes as soon as a change event get identified by a subcontractor, supplier or even the contractor’s own team. This helps the contractor to be fully aware of all events and incidents that could increase the project cost.
If after reviewing the submitted potential change request it’s found that the change is valid and could have an impact on the project approved budget and/or delivery schedule, a change management will be generated from the submitted potential change request. The change management will capture the cost and time impact of the change on both, the approved project budget and cost commitment.
This will also get the contractor to submit his request for a change order based on the additional scope of work and the impact it has on the project. This will result in starting the change process for which a change order will be issued to the contractor as detailed earlier. Usually, only when the contractor’s change order is approved by the project owner, the contractor will issue a change order for relevant subcontractor or supplier.
This would also affect the approved project budget where budget requests will be used to increase or decrease the project budget depending on the nature of the change order as well as shift funds from one cost center to another. The most common budget shift is when funds get shifted from the contingency cost center to another cost center to cove for the cost of accepted project risks that were already considered in the risk mitigation plan.
On monthly basis, the subcontractors, supplier and contractor’s project management team and other business units involved in the project delivery will submit the monthly project invoice for completed works and material on site. It is highly recommended to use the same percent complete used in the revenue contract unless there are pre-agreed percentages to evaluate the actual cost of work in place. Retention of completed works and material on site will adjust the amount that the subcontractors and suppliers will be entitled to have.
Should the actual cost for delivering the project is not fully captured in the commitments, PMWeb allows capturing actual cost from timesheets and miscellaneous invoice. The timesheet module allows capturing the labor and non-labor resource hours against each cost breakdown structure as well as project schedule activity. The captured hours can be based on normal working hours, overtime, weekend and other type of hours. The rate for each hour type will vary depending on the organization’s approach in calculating premium hours.
The miscellaneous invoices can be used to capture cost of services, material and other items that are not part of a commitment contract. The progress invoices can have multi-currency depending on what is being purchased.
The actual payment of the approved progress invoice, or account payable, needs to be captured with details on when and how it was paid.
Reporting the Project’s Profit and Loss
The cost worksheet provides a tabular presentation of the project’s profit and lost against the different cost breakdown structure levels or cost centers. The cost worksheet will detail the current project performance budget which includes all approved budget requests and adjustments as well as the projected budget (BAC) which adds all pending change requests to the current budget. The earned value (EV) for each cost center will be calculated by multiplying revised budget with the approved percent complete for the cost center as calculated by the updated project schedule. The cost worksheet will also show the commitment cost against each cost center and approved changes to detail the revised commitment and all pending and disputed changes to details the projected cost at completion for each cost center (EAC). The actual cost (AC) incurred against each cost center will be also displayed. Should the contractor desire to view the actual revenue earned, this can be done too.
The project’s profit and loss as of the report date or cost variance (CV), will be the difference the between the earned value and actual cost. The cost performance index (CPI) will detail the project’s efficiency in maintaining the project budget. The estimated cost to complete (ETC) the balance of the project’s scope of work will be the Estimate At Completion (EAC) minus the Actual Cost (AC) to date. To determine whether the project will be at profit or loss when it is completed, the variance at completion (VAC) will be the difference between the projected budget at completion (BAC) and the Estimate at Completion (EAC). Those metrics are critical for assessing if the project will be completed within the approved budget thus achieving the desired profit.
Reporting the Project’s Earning Performance
The cost loaded integrated project schedule will be used to defined the planned revenue earning which was established when the baseline schedule was approved by the project owner and the actual revenue earned will indicate how good the contractor is in achieving the scheduled scope of work (SV). Along with the total float (TF), the schedule variance (SV) and schedule performance index (SPI) provide three important metrics to report on the project’s ability to achieve timely completion.
Financial institutions who are involved in providing finance for engineering and construction projects are now required more than ever to predict and report on the likelihood of loan default before it actually occurs. Using proven project management best practices along with the technology that supports implementing those practices provide financial institutions with a robust cost variance at completion monitoring and evaluation solution. This will ensure transparency, accountability and real-time reporting of the project’s financial performance status and health to provide the insight for better and faster informed decisions on how to reduce the risks of loan default.