Practical Project Cost Control for Large Complex Projects

Project Value Delivery
PRACTICAL
COST CONTROL
© Project Value Delivery, 2014
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
FOR
LARGE, COMPLEX PROJECTS
Jeremie Averous
December 2014
Version 0

More details about the topics
of this presentation in our
Cost Control Handbook
An Advanced Project
Management book published
in Singapore!
2 © Project Value Delivery, 2014

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Introduction
3-w Dec-w 14 w . P r Page o 4 j e c t V a l u e D e l i v e r y . c o m
4 Introduction
1: Cost Control in Projects
Why Cost Control is different from Accounting
Interfaces with Project Control
Profile & career of Cost Controllers
2: PVD Cost Control Golden Rules
3: Forecasting Principles
Quantity-based Forecasting
Productivity-based Forecasting
4: Reflecting forecasts in Project Reporting
Sensitivities (Achievable vs Prudent)
Contingency Management
5: Time-phasing of cost and Financial
reporting
6: Cost Control Forensics
Conclusion

• 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

Cost Management basic definitions
Forecast
Variance
Budget
Cost To
Complete ETC
Commit-ment
Accruals
Invoiced
Amount
Forecast
Estimate
To
Complete
Actual
Cost

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
3-w Dec-w 14 w . P r Page o 1 2 j e c t V a l u e D e l i v e r y . c o m
12 Introduction
reporting
Conclusion

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 extrapolation
of the past

In Projects,
the future
needs to be
re-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 processing
Payments
Angry vendors
Cash management
Financing
Financial reporting
Forecasting
Trend analysis
Identification 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 to
get 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
29 Introduction
reporting
Conclusion

PVD Project Cost Control
14 Golden Rules
• The main objective of Cost Management is to
enable 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
37 Introduction
reporting
Conclusion

WHERE ARE WE?
(ARE WE ON COURSE?)
WHERE ARE WE GOING?
WHAT DO WE NEED TO DO TO BE BACK ON
COURSE?

FORECASTING FUNDAMENTALS

Should the forecast be precise or
accurate?
Accurate,
not Precise
Precise,
not Accurate

• “Dead Reckoning”

Useful definitions
External Resources (Supply-Chain)
Procurement
Subcontracting
Purchase Order
(Purchase Order) Equipment
Subcontract
Bulk, Standard
Equipment
Complicated
Services

2 main types of Forecasting
BULK & STANDARD MATERIAL
SERVICES, SUBCONTRACTS
Quantity-based
Remains to
Commit
Vs
Committed
Productivity
based
Estimate to
Complete
Vs
Estimate 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

Bulk allowance management
Forecasting Bulk Quantities
FORECAST
Net MTO
ERECTED
(Bill of Material)
Allowance
for Accuracies
[Engineering]
Allowance
for MTO exclusions
[Engineering]
(maturity of MTO)
Supply factor
& cuts, nesting
[Procurement]
General
Risk & Opportunity
Contingency

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

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 = 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)
Time
$
Earned Value Analysis:
Forecasting using EVM
Forecast considering
Cost Performance Index
AC
today
Forecast considering
Future as in initial budget
EV
BC
CPI=
SPI=
EV
AC
EV
BC

What can we take from Earned
Value Analysis?
2 Legs to a
Sound Forecast
Quality of
Commitments
Tracking
Quality of
Schedule Progress
data
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
Engineering productivity
~100%
0%
• Example of causes:
Time in project
– Physical progress measurement standard optimistic
– Rework on documents “AFC” (further revisions)
– Review process more onerous than expected

Cost Management basic concepts
Different
configurations
(right or wrong?)

Budget
Commitment
Invoiced
EAC
WRONG!
Actual
Cost

Budget
Commitment
OK
BUT
CAREFUL
Invoiced
EAC
Actual
Cost

Budget
WRONG!
Commitment
Invoiced
EAC
Actual
Cost

BREAKDOWN STRUCTURE ISSUES

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 Design 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.

Too much detail
drowns the team
and removes agility
Optimal
Breakdown
Detail
Range
Breakdown Structure detail
Effectiveness
Too little detail
will not allow
to grasp
the project drivers

Project Control traps

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
79 Introduction
reporting
Conclusion

EAC and ‘Achievable’
• EAC - Forecast: PRUDENT P80
• ‘Achievable’ from Sensitivity Analysis
FORECAST and ‘ACHIEVABLE’
are both equally important

Reforecasting for Revenue
Unsigned
Change
Order
Cost
EAC
Cost
Revenue
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
BEST
‘Achievable’
EAC - FORECAST
WORST

FORECASTING FOR
CONTINGENCY

Contingency evolution during
project execution
CONTINGENCY IS
OWNED BY SENIOR
MANAGEMENT
Contingency
Contingency level as
released by Senior
Management
Time in the project
The area between the two
curves is in effect
Management contingency
Natural evolution of
calculated (‘Monte Carlo’) for
contingency
[based on ETC]

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
Contingency is used (too early)
to cover cost overruns
Forecast Revenue
Forecast Total Cost (EAC)
Forecast total Cost w/o contingency
18 months

PROJECT DYNAMICS

$
Forecast Profit evolution during
project execution
Late recognition of Change
Orders create a second
sudden margin improvement
Late release of contingency
create a sudden margin
improvement
Project Forecast cost
End of
Integration/
Commissioning
Time in the project
Project Forecast revenue
Project Contingency

$
Achievable profit evolution during
project execution
Achievable revenue
Time in the project
Achievable cost

Part 5: Time-phasing
of Cost and Financial
Reporing
92 Introduction
reporting
Conclusion

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!
ACTUALS TODAY FORECAST
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

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=
Actual cost spent
Total forecast cost
• Recognized Profit = PoC x Total Forecast
Profit

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?
Revenue
Cost
Profit
Time

What is PoC accounting?
Recognized
Profit
Time
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
On
The Company’s financial result
during the execution of the Project

The main
PoC accounting effects

The amplification effect
PoC accounting
amplifies
the impact of changes
in project profit forecast

Recognized
Profit
Time
Profit
EVENT

Recognized
Profit
Time
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
Recognized
Profit
Time
Profit
DELAY

Part 6: Cost Control
Forensics
3-w Dec-w 14 w . P r Page o 1 j 07 e c t V a l u e D e l i v e r y . c o m
107 Introduction
reporting
Conclusion

WHERE ARE WE?
(ARE WE ON COURSE?)
WHERE ARE WE GOING?
WHAT DO WE NEED TO DO TO BE
BACK ON COURSE?

What information?
How do we make sense of it?

What is Project Controls?
Project Controls is about building
information sensors, and making
sense 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
3-w Dec-w 14 w . P r Page o 1 j 12 e c t V a l u e D e l i v e r y . c o m
112 Introduction
reporting
Conclusion

HOW
Are you
taking
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

PVD Project Cost Control
14 Golden Rules
• The main objective of Cost Management is to
enable 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

• 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 have been explained throughout the
presentation

Get out of your seat to
get the information

THANK YOU!
We Empower Organizations
T o b e R e l i a b l y S u c c e s s f u l i n
Executing Large, Complex Projects
Discover more on

More details about the topics
of this presentation in our
Cost Control
Handbook
An other Advanced Project
Management book by Project
Value Delivery

Project Value Delivery books
Available on all e-bookshops

Practical Project Cost Control for Large Complex Projects

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