The document discusses project cost management and financial analysis techniques. It covers:
1) Various cost estimating methods used at different project stages from approximate to detailed estimates.
2) The importance of developing a project budget and allocating costs to work items to establish a cost baseline.
3) Key financial analysis methods used in project appraisal including payback period, net present value (NPV), and internal rate of return (IRR). Positive NPV and highest IRR projects are typically selected.
1. 3rd Forum on Construction Project Management Theory VS Practice
(Project Cost)
13th January 2018 presented by
Ir. Noor Iziddin Abdullah Bin Haji Ghazali
Project Management Technical Division
(PMTD),
The Institution of Engineers (IEM)
2. Knowledge
Areas
Project Management Process Groups
Initiating Process
Group
Planning Process Group Executing Process
Group
Monitoring & Controlling
Process Group
Closing Process
Group
Project Integration
Management
Develop Project
Charter
Develop Project Management Plan Direct and Manage
Project Execution
•Monitor & Control Project
work
• Perform Integrated
Change Control
Close Project or
Phase
Project Scope
Management
•Plan scope management
•Collect requirements
•Define Scope
•Create WBS
•Verify scope
•Control scope
Project Time
Management
•Plan schedule management
•Define activities
•Sequence Activities
•Estimate Activity resources
•Estimate Activity durations
•Develop schedule
Control Schedule
Project Cost
Management
•Plan cost management
•Estimate cost
•Determine budget
Control Cost
Project Quality
Management
Plan Quality Perform Quality
Assurance
Perform Quality Control
Project Human
Resource Management
Develop Human Resource Plan •Acquire project team
•Develop project team
•Manage Project team
Project
Communication
Management
Identify
Stakeholders
Plan Communications •Manage
Communications
Control communications
Project Risk
Management
•Plan Risk Management
•Identify Risk
•Perform Qualitative Risk Analysis
•Perform Quantitative Risk Analysis
•Plan Risk Response
Control Risk
3. Knowledge
Areas
Project Management Process Groups
Initiating Process Group Planning Process Group Executing Process
Group
Monitoring &
Controlling Process
Group
Closing Process Group
Project
Procurement
Management
Plan Procurements Conduct
Procurements
Administer
Procurements
Close Procurements
Project
Stakeholder
Management
Identify Stakeholders •Plan Stakeholer Management Manage Stakeholder
Engagement
Control Stakeholder
Engagement
8. PROJECT MANAGEMENT IN PRACTISE
SCOPE
SCOPE INCREASE BUT TIME & COST COULD POSSIBLY
LESSER INCREASE
PRACTICAL TIPS:
1.INTER-PERSONAL RELATIONSHIP/EQ
2.NEW TECHNOLOGY SUCH AS
a. BUILDING INFORMATION MODELLING
(BIM)
b. INTEGRATED BUILDING SYSTEM (IBS)
c. SMART PROJECT MANAGEMENT
d. ARTIFICIAL INTELLIGENCE(AI) & BIG DATA
e. CYBERSECURITY
9. Project Life Cycle
Example Phases
Concept and
Proposal
Development
Implementation
Termination
Verification
Final PhaseIntermediate PhasesInitial Phase
12. COST ESTIMATING
• Involves developing an estimate of the cost of
the resources needed to complete project
activities
- How much will it cost
• Pricing is a business decision
- How much to charge the customer
13. • Everybody wants an estimate before you
start work
• You have to do work to make an estimate
• The more accurate the estimate required,
the more work is needed
The Estimating Dilemma
14. Estimating Methods in Building
Industry
Stage Design Estimate User Method
Brief Pre-proposal QS Functional
Sketch Proposal QS Approximate
Sketch/Detail Budget QS Elemental
Detail Sanction QS Empirical
Detail/Working Control QS BoQ
Working Tender Contractor Network
Working Work Contractor SOR
15. The cost is assumed to be proportional to a
measure such as net floor space of a building,
road length
Standard tables of costs are used
◦ National Statistics
◦ Company Internal Records
Cost tables may include costs for specific aspects
as well as overall costs
Each cost table will only be valid for a specific
location and period of time
Approximate Methods
17. • A coarser method of approximate estimating
• Sometimes used to estimate in terms of
functional requirements
– Cost per bed of a hospital
– Cost per pupil of a school
– Cost per seat in an office building
• Location and time specific
Functional Methods
18. • The project is broken down into major elements
and each is estimated by applying a cost factor
from a table
• The cost of each component is calculated
according to its specific size not the total size of
the project
Elemental Estimating
Approximate Method
Building 200,000 sq ft
Roofing = 200,000 x
$0.25
= $50,000
Elemental Method
Roof 25,000 sq ft
Roofing = 25,000 x $2.50
= $62,500
19. • Costs are extrapolated from the cost of
schemes of similar size, scope and type
• Overall parameters and indicators which
influence cost are established using either
regression analysis or curve fitting, from
established data or industry standard
formulae.
Empirical Estimating
20. • A bill of quantities (BQ) is “taken-off” from the
detail design documents
• Standard costs are applied to each item in the
bill of quantities
• Where there is insufficient data or the item
cannot be “measured” a “lump sum” is
estimated based on experience (guess) or a
sub-contractors quote (risk transference)
Bill of Quantities
21. • A detailed estimate based upon a detailed
work breakdown structure and associated
critical path network
Network Estimate
22. • Detailed breakdown of cost of
individual tasks
• Used for VOs etc.
• Commonly used on cost plus contracts
Schedule of Rates
23. • Contractors are not in business to win bids
• Contractors are in business to make money
• Estimating is the base of a company's success
• Good estimating
– minimises contractor's risk
– facilitates project management
Estimating for Contractors
24. Misread or misinterpreted specifications, drawing, or any
other contract document
Takeoff omissions or overlaps
Missing quotes
Estimating by unit prices
Prorating indiscriminately
Crumbling under pressure to procure work
Underestimating the complexity of a project
Expecting and excessive amount of favourable changes
Overemphasising volume purchasing
Undertaking a project with incomplete bid documents
Common Estimating Mistakes
25. • Company labour tables and current material
prices should be stored in your database.
• Manual estimating is not cost effective and it
is subject to more errors and omissions.
• Computerised estimating should automate
and expedite the manual estimating process.
• Establish an estimate review procedure.
Improving Estimating
26. Cost Budgeting
Cost budgeting involves allocating the overall
cost estimates to individual work items to
establish a cost baseline for performance
measurement
27. Budgeting
The Budget is the only basis against which to
measure achievement.
Budget must be capable of being baselined &
used as the basis for performance measurement
and control.
Budget must reflect the way resources are
applied to achieve planned objectives over time.
Budget must be structured in relation to the
build-up of estimates, and to the collection of
actuals.
28. Developing a Project Operating Budget
Operating budget is derived from the WBS
As we layer the plan progressively, the
operating budget for each key stage is
developed.
As the detailed budget for each key stage is
derived, we must compare the total project
budget and analyse the variance.
Any negative deviations must be scrutinised,
and action planning be taken to contain the
situation.
29. Operating Budgets
• Operating budgets include the following cost types:
• Capital costs
– Usually associated with purchased items that can be
depreciated. (e.g.Hardware, workstations)
• Revenue costs/General Overhead
– Running costs of the project. [Based on length of project
and the number of people involved]. General Overhead is
normally applied as a standard formula.
• People costs
– Based on an individual’s actual cost plus an overhead
charge to cover fixed costs of the organisation.
• Contract costs
– Valid quotations and tenders from external suppliers.
• Contingency or Reserve
– Reserve set aside to ensure additional monies can be
injected into the budget when needed.
31. Financial Analysis of Projects
• Financial considerations are often an
important consideration in selecting projects
• Three primary methods for determining the
projected financial value of projects:
– Payback analysis
– Net present value (NPV) analysis
– Return on investment (ROI)
31
32. Payback Analysis
• Another important financial consideration is payback
analysis
• The payback period is the amount of time it will take
to recoup, in the form of net cash inflows, the net
dollars invested in a project
• Payback occurs when the cumulative discounted
benefits and costs are greater than zero
• Many organizations want IT projects to have a fairly
short payback period
32
33. Financial Models
• The Payback Model
– Measures the time it will take to recover the
project investment
– Shorter paybacks are more desirable- often a
time horizon must be met to accept the project
– Emphasizes cash flows, a key factor in business
– Limitations of payback:
• Ignores the time value of money
• Assumes cash inflows only for the investment
period (and not beyond).
• No flexibility to deal with variable inflow streams or
additional investment.
• Does not consider profitability
34. 1/14/2018 34
Pay Back method
Project A B C
Initial Investment (RM10,000) (RM10,000) (RM10,000)
Net Cash inflow Year 1 5,000 5,000 5,000
2 3,000 5,000 4,000
3 2,000 1,000 4,000
4 2,000 1,000 4,000
5 1,000 - 1,000
Payback period 3 years 2 years 2. 25 years
Ranking (choice) 3 1 2
35. 1/14/2018 35
Discounted Cash Flow
• Consider the timing of fund flowing in
• Consider the interest factor
• Two principle methods
– Net present value (NPV)
– Internal rate of return (IRR)
36. 1/14/2018 36
Discounting Factor
To invest RM1,000 in the bank at 10% interest rate, cash will
be accumulated as follows
Now – Year 0 RM1,000
Year 1 RM1,000 + RM100 = RM1,100
Year 2 RM1,100 + RM110 = RM1,210
Year 3 RM1,210 + RM121 = RM1,331
Year 4 RM1,331 + ……………………..
Year 5 …………………………………..
If we were to receive RM1,000 sometime in the
future,what is its value now if the current rate of
interest is 10% ?
37. Net Present Value Analysis
• Net present value (NPV) analysis is a method
of calculating the expected net monetary gain
or loss from a project by discounting all
expected future cash inflows and outflows to
the present point in time
• Projects with a positive NPV should be
considered if financial value is a key criterion
• The higher the NPV, the better
37
38. Financial Models
• The Net Present Value (NPV) Model
– Uses management’s minimum desired rate-of-return
(discount rate) to compute the present value of all net
cash inflows
• Positive NPV: the project meets the minimum
desired rate of return and is eligible for further
consideration
• Negative NPV: project is rejected
39. Example: Calculating the Payback Period and Internal
Rate of Return
Project A
investment 700
annual savings 225
payback period 3.1
IRR 32%
Project B
investment 400
annual savings 110
payback period 3.6
IRR 28%
Both projects are estimated to have constant annual savings
over the next 5 years.
Payback criteria for this company- must be within 5 year horizon
40. Example: Calculating the Net Present Value
Reconsider the same 2 projects with a 15% discount rate, 5 year Time Horizon
yearly rate of return 15%
year 0 1 2 3 4 5 totals
Project A
outflows -700 -700
inflows 225 225 225 225 225 1125
undiscounted net return -700 225 225 225 225 225 425
discounted net returns -700 195.7 170.1 147.9 128.6 111.9 54.2
or use the NPV formula: 54.2
Project B
outflows -400 -400
inflows 110 110 110 110 110 550
undiscounted net return -400 110 110 110 110 110 150
discounted net returns -400 95.7 83.2 72.3 62.9 54.7 -31.3
or use the NPV formula: -31.3
41. 1/14/2018 41
Net Present Value method
Project A
Initial Investment (RM 2,000)
Net Cash inflow Year 1 RM 400
2 RM 600
3 RM 700
4 RM 600
5 RM 500
42. 1/14/2018 42
Net Present Value method
Project A Year Cash Flow Discount rate Present Value
Initial Investment 0 (RM 2,000) 1.000 (RM 2,000.00)
Net Cash inflow 1 RM 400 0.909 RM 363.60
2 RM 600 0.826 RM 495.60
3 RM 700 0.751 RM 525.70
4 RM 600 0.683 RM 409.80
5 RM 500 0.621 RM 310.50
TOTAL CASH INFLOW AT PRESENT VALUE ( NOW ) RM 2,105.20
LESS CASH OUTFLOW RM 2,000.00
NET CASH INFLOW AT PRESENT VALUE RM 105.20
Choice is made by selecting the one with the highest Net Present Value
44. 1/14/2018 44
Internal rate of return method
Project A at 10 % at 15 %
Net Present Value RM 105.20 (RM 135.10)
The Internal rate of return is where the NPV is = 0
In the above example for NPV to be at RM 0 = rate of discount is
between 10 % and 15 %
Therefore the IRR = 10 % + ( 105.20 x 5 )
( 105.20 + 135.10 )
= 10 % + 2.19
= 12.19 %
45. Return on Investment
• Return on investment (ROI) is income divided
by investment
ROI = (total discounted benefits - total discounted
costs) / discounted costs
• The higher the ROI, the better
• Many organizations have a required rate of
return or minimum acceptable rate of return
on investment for projects
45
46. NPV, ROI, and Payback Analysis
for Project 1
46
Excel file
47. NPV, ROI, and Payback Analysis
for Project 2
47
Excel file
48. Weighted Scoring Model
• A weighted scoring model is a tool that provides a systematic
process for selecting projects based on many criteria
– First identify criteria important to the project selection process
– Then assign weights (percentages) to each criterion so they add up to
100%
– Then assign scores to each criterion for each project
– Multiply the scores by the weights and get the total weighted scores
• The higher the weighted score, the better
48
51. Types of Costs
• Direct 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
52. Contract Bid Summary Costs
Direct costs $80,000
Direct overhead $20,000
Total direct costs $100,000
G&A overhead (20%) $20,000
Total costs $120,000
Profit (20%) $24,000
Total bid $144,000
54. Refining Estimates
• Reasons for 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.
57. Revenue to Operating Profit
Total Revenue
Gross Profit
Operating Profit or EBITDA
Cost of
Sales
Cost of
Sales
Operational
Expenditure
57
58. Operating Profit or EBITDA
Gross Profit less Operating Costs gives the
Operating Profit for the business
Operating Profit = Revenue less Direct and Indirect
costs
Operating Profit is calculated before Depreciation,
Amortisation, Interest and Taxation and so is
referred to as EBITDA
“Earning Before Interest, Tax,
Depreciation and Amortisation”
EBITDA Margin or Operating Margin is calculated
by dividing Operating Profit or EBITDA by Revenue
and expressing as a percentage
If Revenue is $100 and Operating Profit $40 then
EBITDA margin is $40 / $100 = 40%
EBITDA Margin = EBITDA / Revenue
Allows for easy comparison between different
operators
58
Operating Profit or EBITDA is a closely
watched indicator of commercial
performance in the industry
– Highlights the company’s ability to
generate cash
– Is not so sensitive to accounting policies
– Highlights operational efficiency and cost
savings
– Used as the basis for valuation techniques
59. Setting up a coffee shop requires cash – you need
“capital”
$ 700
$400 of your own money
Inject $400 as shareholder
funds in return for an equity
stake or share of the
ownership of the business
$300 from the bank
Borrow $300 from the bank
and inject as a Long Term
Liability or Bank Loan
Banks do not own the
business
$ 700 Capital Employed
$
Dividend
s
$100 pa
$ Interest and
repayment of
the loan
59
60. From Revenue to Free Cash Flow
Total Revenue
Gross Profit
Operating Profit or EBITDA
Free Cash
Flow
Cost of
Sales
Cost of
Sales
Operational
Expenditure
Cost of
Sales
Operational
Expenditure
Capex
Cash
Taxes
Free cash flow is not
the same as profit
Capital expenditure
does not hit the P&L
60
61. The value of a company is its ability to generate future free cash flow
Free Cash Flow
Banks and institutions
Holders of Debt
Interest and principal payments
Shareholders
Holders of Equity
Dividends
Now
EnterpriseValue
The Future
$
61
63. Key Considerations for System Design
using Total cost of ownership (TCO)
1) Initial CAPEX Cost of Components
2) Installation / Civil Works Costs associated with Components
3) Maintenance Cycles & Costs associated with Components
4) Manpower Costs for Operations & Maintenance associated with Components
5) Lifetime / Life Cycles of Components/Equipment
6) Ambient Temperature & Humidity have effect on Lifetime
7) Cost of Fuel (Diesel / Octane / Hydrogen / Methanol) & Grid
8) Operational Parameters of Components (Charging Rate / Fuel Consumption)
9) Economic Factors (Inflation Rate, Duties & Taxes)
A Total Cost of Ownership (TCO) approach provides the most comprehensive method
to evaluate different components while designing an energy system for a particular
site
64. Research has shown that businesses typically use three (3)
techniques in practice for assessing investment decisions
1. Payback Period - How long does the project take to
recoup the initial outlay
2. Net Present Value (NPV) - The application of Discounted
Cash Flow (DCF) and answers the question, if we were to
spend all the monies and receive all the benefits today,
what would it be worth
3. Internal Rate of Return (IRR) - A concept closely related
to the NPV which gives the discount rate which if applied
in DCF would give a NPV of zero
65. The Discount Rate
1. Selecting the appropriate discount rate involves
looking at the returns of projects of similar risk in the
market place to identify the appropriate discount rate
2. Discount rates vary depending on the risk attached to
the investment
3. The Weighted Average Cost of Capital (WACC) for your
company is the discount rate that should be used for
your projects - Your finance department will supply the
WACC
66. We can calculate a weighted average
cost of capital
Equity 70% Debt 30%
(70% x 11%) + (30% x 6%) = 9.5%
6%11%
Total Capital Employed
WACC 9.5%
Capital comes from banks
and shareholders, both of
whom want a return.
Shareholders take on more
risk and so demand a
higher return than banks.
If banks want 6% and
shareholders want 11%
then the average must be
somewhere in the middle.
The average will depend on
the weightings of equity
and debt and hence the
term “weighted average
cost of capital”, or WACC.
67. Financial requirements in
projects
1. Payback period between 2 to 3 years ? (length of
time for the initial investment to be repaid out of the
net cash inflows from the project)
2. Positive value of NPV in dollar & cents
3. Need to show Break Even Point from their graph, the
point at which a project is neither making a Profit or a
Loss
4. IRR > WACC (or discount rate) for Malaysia is
between 7 % to 9 %
5. TCO including spare part price list