Practical Project Cost Control for Large Complex Projects

Project Value Delivery

PRACTICALCOST CONTROL

FORLARGE, COMPLEX PROJECTS

Jeremie AverousDecember 2014

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2© Project Value Delivery, 2014w w w . P r o j e c t V a l u e D e l i v e r y . c o m

More details about the topics of this presentation in our

Cost Control Handbook

An Advanced Project Management book published in Singapore!

W e E m p o w e r O r g a n i z a t i o n sT o b e R e l i a b l y S u c c e s s f u l i n

E x e c u t i n g L a r g e , C o m p l e x P r o j e c t sDiscover more on

w w w . P r o j e c t V a l u e D e l i v e r y . c o m

Project Soft PowerUnleashing Value

from YourLarge, Complex

Projects

Project Health Check

Project Coaching

Organizational maturity

Team effectivenessIntercultural leadership

Advanced project trainingProject Startup support

Project Recovery

Advanced risk management

Project Control and Reporting

Support systems integration

Convergence planning

Remote sites integration

Leadership development

4Page 3-Dec-14 4© Project Value Delivery, 2014w w w . P r o j e c t V a l u e D e l i v e r y . c o m

Introduction

Introduction1: Cost Control in Projects

Why Cost Control is different from AccountingInterfaces with Project ControlProfile & career of Cost Controllers

2: PVD Cost Control Golden Rules3: Forecasting Principles

Quantity-based ForecastingProductivity-based Forecasting

4: Reflecting forecasts in Project ReportingSensitivities (Achievable vs Prudent)Contingency Management

5: Time-phasing of cost and Financial reporting

6: Cost Control ForensicsConclusion

• What is Cost Control all about?

What is Project Cost Control?

• Something (secret) that is done by Finance• Registration of invoices from vendors and booking

timesheets• Trying to figure out how to squeeze everything in the

budget (anybody knows what the budget is?)• Approval of invoices to pay vendors• A back-office function that is on another floor• Etc.

To run like clockwork, there is a lot more to Project Cost Control than what you might think!

Introduction

Project cost control’s purpose is to maintain an accurate forecast at a specific phase of the project, based on all the information available at the time the forecast is made.

The objective is to allow proper decision-making by the Project Manager.

The remit of Cost Control is thus essentially different from the usual remit of Accounting.

COST CONTROL BASIC DEFINITIONS AND CONCEPTS

BudgetCommit-

InvoicedAmount

Forecast

ActualCost

Cost To Complete

ETCEstimate

To Complete

Accruals

ForecastVariance

Cost Management basic definitions

The Project Cost Model

Project Cost Model

-Breakdown Structure-time-phased-Source currencies

Monthly Project Performance Report(EAC, fixed FOREX)

Financial P&L Reports (POC, variable FOREX)

Commitments

Progress

Reforecasts

Management of Change

Cash flow model(by currency & entity)

Part 1:Cost Control in

Projects

Starting a Project is like leaving on an

Intercontinental journey

The sea make look calm but it will still get rough

The Three Fundamental Questions

WHERE ARE WE?(ARE WE ON COURSE?)

WHERE ARE WE GOING?

WHAT DO WE NEED TO DO TO BE BACK ON COURSE?

In Manufacturing,the future is

an extrapolationof the past

In Projects,the future

needs to bere-forecast

Cost Control is not Accounting

TWO DIFFERENT DISCIPLINES THAT NEED TO WORK TOGETHER

COST CONTROL ACCOUNTING / FINANCE

- Focus on the future- Understands the business- Follows commitments

- Focus on project end point

- Focus on the past- Same for any business- Follows invoicing and

payment- Variable exchange rates- Cash flow management- Focus on reporting period

end point (PoC accounting)

Usual failure mode observed in the field of Cost Control

• The Urgent takes over the Important!

Invoice processingPaymentsAngry vendorsCash managementFinancingFinancial reporting

ForecastingTrend analysisIdentification of trends on

actual commitments

Common “maturity’ observations when no strong Cost Management

• Costs for internal resources as actual costs instead of standard rates– Extreme complication of cost tracking

• Commitments are not tracked – only invoicing– Invoicing without commitments– Poor control on project bottom line because of

invoicing delays• Poor consistency with project execution strategy

and forecast schedule• No support to PM in scenario planning

The Cost Controller profile

• A good Cost Controller is not necessarily someone with an accounting profile

• Graduate engineers are often very successful

• An excellent path towards Project Controls and Project Management roles.

The Cost Controller profile

• Business skills:– understanding of contractual arrangements,– understanding of the project activity

• Process skills: able to design, implement and improve information gathering processes, and the adequate Breakdown Structure

• Technical skills:– knowledge of database basics, how to write requests

and reports;– knowledge of the dedicated Cost Control tool

• Leadership skills: ability to influence project parties to provide the required information at the right moment and to devise accurate cost forecasts

We Can Deal with Bad News, We Can’t Deal With Surprises

Get out of your seat toget the information

Where are the COMMITMENTS?

20M$ oversight over 3 months

INVOICES TAKE FOREVER TO ARRIVE.DON’t COUNT ON THEM TO KEEP CONTROL

Make sure you know where you’re going!

Don’t end your journey like this… and pennyless!...

Part 2:PVD Cost Control

Golden Rules

PVD Project Cost Control 14 Golden Rules

• The main objective of Cost Management is toenable the Project Manager to take decisions based on an accurate description of the project financial situation, derived from the organization’s current knowledge and understanding of reality.

14 Golden Rules

Cost Control Golden Rules 1/5

• Accountability: Budget Owners are accountable for their budget (including forecast and time-phasing). PM retains ultimate accountability. Cost Control supports and challenges

• Forecasting focus: The primary focus of Cost Management is accurate and realistic Forecasting along with prompt Reporting

• Maintenance of the reference ‘Project Cost Model’: the basis for all financial assessments, modelling and reporting of the Company’s Forecasts and results on the Project

• Project Scope & Schedule consistency: Main Contract (plus any Change Orders), and latest project schedule. Includes comprehensive understanding of the Main Contract term.

• No surprises: Variances should be exclusively caused by triggering events and not by internal oversights

• Candidness principles: cost acknowledgment and reporting must be candid and reflect actual understanding of reality

• Immediacy principle: reflect significant new costs as soon as they are anticipated even if a detailed assessment is not yet available

• Timeliness of reporting: produce the relevant reports on time

• Commitment tracking focus: Project Cost Management is responsible for ensuring that systems, processes and procedures are in place to identify and track Commitments for all Cost Allocations and categories.

• Prudence principle for Estimated at Completion Forecast: includes recognizing Costs as soon as they are probable and not recognizing Revenues until they are certain

• Realism principle for ‘Achievable’ Forecast: Project Cost Management reports what is realistically achievable, both with respect to final Costs and final Revenues

• Accuracy over precision: cost updates should be accurate but not necessarily precise

• Data integrity principle: Project Cost Management ensures the integrity and consistency of the cost and Accounting data in the Project’s Forecast and Cost

• Cost reconciliation principle: project cost model and accounting are compared on a monthly basis

Cost Control Golden Rules

• Golden Rules will be explained throughout the presentation

Part 3:Forecasting Principles

The Three Fundamental QuestionsWHERE ARE WE?

(ARE WE ON COURSE?)

WHERE ARE WE GOING?

FORECASTING FUNDAMENTALS

Accurate,not Precise

Precise,not Accurate

Should the forecast be precise or accurate?

• “Dead Reckoning”

Useful definitionsExternal Resources (Supply-Chain)

Procurement

Subcontracting

Purchase Order

Subcontract

Bulk, Standard Equipment

Services

Complicated Equipment(Purchase Order)

2 main types of Forecasting

BULK & STANDARD MATERIAL

SERVICES, SUBCONTRACTS

Quantity-based

Remains to CommitVsCommitted

Productivity based

Estimate to CompleteVsEstimate at Completion

• What are the conditions for good forecast??

Conditions for Forecast Quality

• Committed Budget Owners– Each Work Package to have ONE Budget Owner– Avoid Padding of budgets by Budget Owners

• Adequate communication between project parties– A good cost engineer/controller seeks

information and does not remain at his/her desk

• Appropriate Breakdown Structure– Relevant granularity and fit with project

execution structure– No need of high level of detail

• Don’t follow cost at Engineering CTR level

Forecast for Revenue

• Recognition of Revenue in Forecast for Variation Orders follows very strict rules– No recognition when VO is not signed– Some organizations allows exceptions but:

• require the highest levels of approval• Requires scope of work approval by Client• Needs to be accepted by auditors

BULK/ QUANTITIES FORECASTING FUNDAMENTALS

Forecasting Bulk Quantities

Net MTO(Bill of Material)

FORECAST

Allowancefor Accuracies[Engineering]

Allowancefor MTO exclusions

[Engineering](maturity of MTO)

Supply factor& cuts, nesting[Procurement]

GeneralRisk & Opportunity

Contingency

Bulk allowance management

ERECTED

Forecast for Bulk Procurement

• Everything is based on the right level of allowances– Be clear on allowances + contingency– Allowance for supply/nesting is supplier

and fabricator dependent!– Make sure receipt is done properly– Be clear on treatment of extra material

(take-back clause, scrap etc)

EARNED VALUE FORECASTING FUNDAMENTALS

12h flight

= COST

We’ve been flying for 6 hours.We spent 50% of the fuel.Are we OK?

We’ve done half the way.We spent 40% of the fuel.Are we OK?

Project Controls is a discipline by itself

• My cost is lower than expected: what does it mean?

• My physical progress is lower than expected: what does it mean?

• One risk was realized: what does it mean?

Earned Value Analysis

$Budget

Cost Variance (<0)

Schedule Variance (>0)

Forecast consideringFuture as in initial budget

Forecast consideringCost Performance Index

Earned Value Analysis:Forecasting using EVM

What can we take from Earned Value Analysis?

2 Legs to aSound Forecast

Quality of Commitments Tracking

Quality of Schedule Progress

Actual Physical Progress??

Forecast Trick

• Investigate quality of forecast when progress on a work package is about 20-30%– Earlier: not enough trend– Later: too late!

Advanced Earned Value

• Take into account that productivity changes with progress!– Typically productivity diminishes when progress

reaches > 80%• For good quality forecast:

– pinpoint deliverables that have been completed already

– measure productivity on completed deliverables to extrapolate to the rest of the project!

Typical example of productivity decrease in engineering

• Example of causes:– Physical progress measurement standard optimistic– Rework on documents “AFC” (further revisions)– Review process more onerous than expected

Time in project

Engineering productivity

Cost Management basic concepts

Different configurations

(right or wrong?)

Budget

Commitment

Invoiced

ActualCost

WRONG!

BudgetCommitment

Invoiced

ActualCost

WRONG!

Budget

Commitment

Invoiced

ActualCost

WRONG!

BudgetCommitment

Invoiced

ActualCost

CAREFUL

Budget

Commitment

Invoiced

ActualCost

WRONG!

BREAKDOWN STRUCTURE ISSUES

70© Project Value Delivery, 2014w w w . P r o j e c t V a l u e D e l i v e r y . c o mDesign the appropriate breakdown !

What are the issues to take into account?

• Reporting• Client requirements,• Legal entities• In-/Out-country• specific costs that are early indicators e.g. airfreight

costs• Subcontracting strategy• Allowances to be split out • One WP should generally refer to one type of cost and

cost follow-up method.

Breakdown Structure detail

Too little detailwill not allow

to graspthe project drivers

Too much detaildrowns the team

and removes agility

Effectiveness

OptimalBreakdown

DetailRange

Project Control traps

Too much detail!Not enough time for analysis

KEEPING TRACK OF ALL VARIANCES

Data Integrity:Variances traceability

• All Forecast Variances must be traceable– Cost control to maintain detailed (WP by WP)

register of all EAC variances to allow• Auditability trail,• Keeping the history makes it easier to hand over cost

control of the project to a new person if needed,• Allows to track discrepancies or budgets that would

need more attention by looking in the past at all variances introduced in the cost model.

• Repeated variances on a WP is an indicator of an issue to be investigated

WATCH FOR CONSEQUENTIAL COSTS

Watch for consequential costs!

• While we have covered the different phases of a project, it is essential to always analyze if a Variance observed might not lead to other Variances:– Late engineering leading to claims and delays from

suppliers– Late procurement leading to extra transportation

costs (airfreight) and offshore standby– Late fabrication leading to offshore standby– Etc

• Always seek the root cause and examine if no Consequential Variances!

Part 4: Reflecting Forecasts in Project

Reporting

EAC and ‘Achievable’

• EAC - Forecast: PRUDENT P80• ‘Achievable’ from Sensitivity Analysis

FORECAST and ‘ACHIEVABLE’are both equally important

Reforecasting for Revenue

Unsigned Change Order

CostEAC

CostRevenue

Sensitivities

Forecast and Achievable

Forecast

Achievable

Single Project Accounting

Business Results

Expectations

Reforecasting for COST

When you know something is going to happen to your cost forecast, don’t wait until you have got all your cost elements to reforecast!

Reforecast immediately (as soon as practicable) even if you have only an order of magnitude!

Sensitivities: the right order

‘Achievable’

EAC - FORECAST

FORECASTING FOR CONTINGENCY

CONTINGENCY IS OWNED BY SENIOR MANAGEMENT

Contingency

Time in the project

Natural evolution of calculated (‘Monte Carlo’) for

contingency[based on ETC]

Contingency level as released by Senior Management

The area between the two curves is in effect Management contingency

Contingency evolution during project execution

Contingency: Caution

• Releasing contingency to compensate for higher costs compared to the budget is not acceptable.

• The engagement of the contingency ‘reserve’ is one of the ultimate responsibilities of the Project Manager

• At any time it is not permissible to release contingency below the calculated contingency.

A BAD EXAMPLE ON A 36 MO PROJECT

Forecast RevenueForecast Total Cost (EAC)Forecast total Cost w/o contingency

Contingency is used (too early) to cover cost overruns

18 months

PROJECT DYNAMICS

Time in the project

Project Forecast revenue

Late recognition of Change Orders create a second sudden margin improvement

Project Forecast cost

Project Contingency

Late release of contingency create a sudden margin

improvement

End of Integration/ Commissioning

Forecast Profit evolution during project execution

Time in the project

Achievable revenue

Achievable cost

Achievable profit evolution during project execution

Part 5: Time-phasing of Cost and Financial

Reporing

Forecasting and Time-Spread

• Forecasting must not just address the issue of Estimate-at-Completion forecast,

But also the forecast needs to be times-spread for each Work Package!

M1 M2 M3 M4 M5 M6 M7 M8 M9 M10 M11 M12 M13 M14

WP1 0 0 0 456 56 435 657 7658 878 9769 969 969 63 242

WP2 0 0 0 0 0 5456 646 6574 7547 765 989 1324 536 5477

WP3 4235 535 536 636 47 474 5687 58 6969 979 70 721 21545 3452

WP4 44 44 44 44 44 44 55 55 77 0 0 0 0 0

WP5 75 0 0 5536 74 7657 0 0 43 6326 0 0 0

TODAY FORECASTACTUALS

Why is Time-Spread important?

For long projects, proper time-spread of cost & revenue is critical to the organization’s financial performance, and in particular to market anticipation (quarterly & yearly)

>> SHARE PRICE OF COMPANY!

What is Percentage of Completion (POC) Accounting?

• PoC is the method chosen to report long projects lasting over several reporting periods

• PoC=

• Recognized Profit = PoC x Total Forecast Profit

Actual cost spentTotal forecast cost

Cost POC and physical progress POC

• Cost POC and Physical progress POC are different– Cost POC is generally lower than Physical

progress POC

• If there is too much of a difference between cost POC and physical progress POC, INVESTIGATE!!

What is PoC accounting?

RevenueCost

Profit

What is PoC accounting?

RecognizedProfit

Profit

Why should PM’s be concerned?

PMs and PoC accounting

PM’s are supposed to focus on the ultimate performance of the project at completion

However, PM you need to be aware of the effect of :The variability of the reported project result

OnThe Company’s financial result

during the execution of the Project

The main PoC accounting effects

The amplification effect

PoC accountingamplifies

the impact of changesin project profit forecast

RecognizedProfit

Profit

RecognizedProfit

Profit

The delay effect

• Delay (slow progress) will impact significantly revenue recognition for a given period– significant impact on company’s forecast short term

financials

The delay amplification effect

RecognizedProfit

Profit

Part 6: Cost Control Forensics

The Three Fundamental Questions

WHERE ARE WE?(ARE WE ON COURSE?)

WHERE ARE WE GOING?

What information?How do we make sense of it?

What is Project Controls?

Project Controls is about buildinginformation sensors, and makingsense of the information.

Cost Control Forensics:3 levels of maturity

• Level 1: quality of Commitments and Actuals– Actuals not Invoiced cost, comprehensive

commitments, cost breakdown structure• Level 2: quality of Forecast

– Consistency with project execution incl. time-phasing, allowances & contingency management, sensitivities, trends checking

• Level 3: support to decision-making– Ability to run scenario analysis

Conclusion

HOWAre youtaking

decisions?!?

Is that the way you are flying?

Conclusion

Cost Control for Large, Complex, long duration projects requires– Structure– Consistency– Discipline

…shared by all the project team.

Cost Control is in charge of advising the project manager and making sure that the processes run reliably

Communicate with the team!

Invest yourself as much as possible at the start of the project – this will decide 90% of the outcome