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FMI Quarterly/March 2015/March 1, 2015

The Basic Ingredients of an Accurate Cost-to-Complete Estimate

Funding_money_equip_imageFailing to include any of the vital ingredients produces unfortunate results.

In most construction firms, there are few things as misunderstood or as poorly managed as developing an accurate projection of costs to complete (CTC). This is particularly true when it comes to understanding how to estimate the remaining labor costs on a labor-intensive project. Trade contractors live and die by their ability to estimate, manage and project labor costs. Consequently, producing accurate CTC estimates is a fundamental and basic project management function. However, the process is typically not well-understood by project managers, the people who manage the project managers, and, in many cases, the people who manage the people who manage the project managers.

On bid day, estimators are expected to accurately determine how much labor cost will be required to complete an entire project with less than adequate plans and specs, absolutely no history of completed work on the current project, and a limited amount of time. Why then can project managers not produce better quality estimates after being on a project for several months, having some actual work in place and having a feel for the variables on the project? The answer to this question is relatively simple: Most project managers do not understand the basic ingredients of a fundamentally sound cost-to-complete estimate.

Like any good recipe, failure to include one or more of the important ingredients will produce a less than desirable result. Since labor is the big wild card in the cost-to-complete estimate, the following ingredients will focus on the labor portion of this process.

INGREDIENT #1 — Basic understanding of the definition of a cost-to-complete estimate and how that CTC impacts the overall financial performance of the company

At a very basic level, it is important to understand that a CTC estimate or projection is simply an estimate of direct costs required to complete the remaining work on a project. Therefore, the two basic questions that need to be answered to produce a sound CTC are:

  • What specific tasks or work activities on the project still need to be completed?
  • How many labor hours and dollars will be required to complete this remaining work?

These sound like simple questions, but many project managers do not understand the basic idea that the CTC is simply an estimate to complete the remaining work.

Beyond the simple definition of a CTC is the fact that the CTC ultimately determines how much revenue and gross profit can be recognized on a project every month. If CTCs are inaccurate, the contractor’s monthly income statement, which summarizes all work in progress, will be impacted and incorrect. The CTC helps determine how much revenue has been earned. The revenue earned is independent of the revenue billed or collected. Inaccurate CTCs often create significant swings in the overall profitability of the company from month to month and signal to shareholders, bankers and surety agents that projects are not being well-managed. The title of project manager implies that the person in this role is actually managing the financial aspects of a project as well as the logistical and physical project issues. For those who are not competent with this core financial skill, “project witness” may be a more appropriate job title than project manager.

INGREDIENT #2 — A logical project budget that breaks a large project down into multiple small projects to allow for accurate tracking

To develop a good CTC, there is specific job cost and productivity information that must be tracked from the time a project starts through completion. Failing to set up a logical project budget is one of the biggest mistakes that contractors make. Ultimately, the quality of the initial budget impacts the reliability of every CTC completed during the life of a project. Failure to do this correctly before labor is charged to a project is a serious mistake and one that cannot be fixed later.

The key here is to determine the appropriate number of labor phases and codes needed to accurately track labor cost and productivity. This format for tracking labor should be determined by the PM and field manager (not the estimator), based on how the project will actually be constructed. The setup for labor tracking should meet the following requirements:

  • Unless a specific work activity is extremely similar throughout the entire project and it can be easily measured/quantified in an objective way, there should be no more than about 400-500 man-hours in any one labor code.
  • Phases and codes should be based on definable work activities, pieces or “chunks” of work, sometimes referred to as work packages.
  • A definable work activity, piece or chunk of work should typically be completed somewhere in the range of two weeks, give or take a week.
  • Labor phases/codes should closely mirror the activities on the project schedule and sequence of how the work will actually be performed.

Breaking a project down into smaller bite-sized pieces allows the PM to easily determine which activities are completed, which ones are partially completed, approximately how much work is remaining on these activities, and which activities have not yet started. This should provide a fairly objective means of identifying the remaining work on the project, which is the first piece of information that is needed to prepare a good CTC.

INGREDIENT #3 — A process for tracking and reporting actual quantities or units installed in addition to man-hours reported to a cost code

Once the PM identifies the specific work remaining to complete the project, the next step is to estimate the labor to perform this work. Good estimating is part science and part art. As for the science, the best and most logical way to estimate the remaining work is to start with real productivity data for the installed units to date. In simple terms, this means that beyond simply reporting time to a cost code, there must be a process to track and report the actual units or quantities associated with the reported hours. Since productivity is defined as units per man-hour, tracking installed quantities is a necessity. The idea is not to come up with perfect measurements for quantities installed, but something more scientific than a pure guess as to how much of an activity is completed and how much more needs to be done. Depending on the type of work being performed, quantities can be measured in a variety of ways. A few examples are:

  • Feet of pipe
  • Feet or pounds of duct
  • Linear feet of framing
  • Square feet of drywall
  • Number of fixtures, doorframes, etc.
  • Cubic yards of concrete

Tracking the actual production of work installed to date will provide the best starting point to estimate the man-hours on the remaining work. However, it is not reasonable to assume that the productivity on the remaining units or quantities will be the same as the actual production to date. This is where the art of estimating the amount of labor required to complete the remaining work comes into play. For example, early production of a work element and later production tend to be somewhat slower than the midrange of a work element. This is the classic S-curve of production: slower-faster-slower.

INGREDIENT #4 — Ability to use experience and logic to determine how project variables will likely impact productivity on the remaining work

In many cases, project managers use a straight-line formula to extrapolate the number of man-hours to complete an activity. This assumes that the remaining units or quantities will be installed at the same productivity rate as the work completed to date. This is a bad assumption. Applying the art of estimating requires experience and the ability to identify variables on the project that may impact productivity either good or bad. A few specific productivity killers to consider when applying the art include the following:

  • Poor project scheduling and coordination by the GC or CM
  • Failure to complete an area before jumping to another part of the building
  • Minimal use of prefabrication or modularization
  • Unusually cold, hot, humid or wet weather
  • Trade stacking by GC or CM
  • Late start or schedule compression by GC or CM
  • Equipment and/or material delays
  • Large number of change orders on the project, especially late in the project
  • Large amount of “go-back” work
  • Slow decision-making by owner, GC or CM
  • Logistical impact of moving up a multistory building
  • Site access and logistics

While you may be able to overcome one of these variables and maintain something close to the average estimated productivity rate for most of the project, when multiple issues from the list above occur on a project, productivity on the remaining units typically drops at a significant rate. For example, when several (two or three) of these variables are present, an activity that could typically be produced at 10 widgets per hour could quickly drop to eight widgets per hour. When four or more of these variables are present, productivity could easily drop to four widgets per hour. Couple this impact with an original cost estimate that was bad to begin with, and you have the perfect recipe for colossal margin fade.

Accurately projecting labor on a large project that is going bad is extremely difficult because it requires much more art to determine the impact of a project that is going bad at an increasing rate. Rarely can you determine just how bad the negative news will get until the last person is off the project. As a result, most contractors initially underestimate the CTC on a larger project that’s been plagued by problems. Underestimating the CTC, of course, overstates the current project profitability and overstates the anticipated profit at completion. Bad projects typically continue to get worse at an increasing rate, which is difficult to model or project using historical data and science alone. Self-performing contractors are especially vulnerable to the risks of worsening projects. On the positive side, a good project can go nominally better than estimated, but on the other end of the spectrum, a bad project can go infinitely worse than the estimate.

Conclusions

Being a self-performing contractor is risky business. Large, labor-intensive projects won in a competitive bid situation are even riskier business. Being a successful project manager in this environment requires a lot of skill, hard work and the ability to identify potential cost overruns early. By using the CTC best practices described in these four ingredients, you will not only become a better project manager, but you will also identify problem projects sooner, take action earlier and proactively impact project outcomes. Q

Scott Kimpland is a director with FMI Corporation. He can be reached at 813.636.1263 or via email at skimpland@fminet.com.

 

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