Changes in projects often affect the costs and expenditure. Some of the changes might be unforeseen, but generally the responsibility lie with the project company.
Cost control aims for avoiding any unnecessary costs.
The amount of money need to be spent and received within budget and timing of each transaction is appropriate. For that reason many organisations employ cost engineers.
One of the most important factors within the cost control function is accurate and timely reporting. Measuring, analysing and reporting costs is imperative.
To begin...
To begin we have to understand all the different categories of cost.
Main cost elements of a typical project are presented in figure below.
Let's define some of those in more detail.
Variable costs - costs incurred at a rate proportional to rate working on the project. Often called direct costs, which are measured and allocated to specific task, product or service.
Variable costs are further divided into direct expenses of bought materials, equipments, parts and direct labour costs (own personnel, temporary staff and their wages and salaries).
Generally variable costs would account for half of the costs of a project.
Control can be achieved through sensible purchasing procedures. Once a purchase order is raised the commitment is high. Therefore, it is imperative to manage the release of purchase orders as closely as possible. We should keep amendments as low as possible as they are often associated with additional expenses.
Hire of machinery or equipment is particularly important as the time for hire will determine the costs of the hire.
In terms of direct labour costs control is important to avoid budget overruns, late working and overtime. Jobs that run longer than estimate always overrun the budgets. Often more time with less resources will save direct labour costs. Control can be achieved through good motivation, training and continuous control of progress.
Fixed costs - these constitute to company's overheads. Often called indirect costs. These are generally incurred through running a business and these are not directly associated with the task, product or project. These can include management, administrative costs, indirect purchases, labour, expenses. Often some of those might be allocated as variable (direct costs).
Management always strives to keep the fixed costs as low as possible.
High overheads can reduce the competitive advantage. However, most project managers have no direct control over the business fixed costs. Costs of accommodation, sales, marketing, heat and light, salaries are often out of their direct control.
It is important to know, however, that businesses incur fixed costs every day, despite whether a project is run or not. Often if a project runs late it will most likely use indirect costs than expected or budgeted.
The only control that the project manager might have over the fixed cost is to use it to ensure the project will finish on time.
The boundaries...
The boundaries between fixed and variable costs are not always so straight forward. Fixed costs might contain variable elements. For example, communications, printing etc. will increase depending on business activity.
This is the variable elements of overhead costs where project managers might be able to make some savings.
Some projects might allow to reimburse the costs of those calls, paper, communications, however as direct costs. Even when a business runs numbers of project at the same time an effort should be made to differentiate those costs separately. Sometimes these might be significant and worth recovering.
Every expense that can be charged directly to a project should be charged. Otherwise these will generate overheads costs.
Many companies struggle to collect these information. It might be useful however to implement some practices to help with cost determination. For example, using a simple requisition system for bulk photocopying with mandatory use for cost codes for particular client. We might also use mandatory use of cost codes for any expenses towards a project.
To recover...
We know already that most projects are costed including direct costs (with labour burden) as time recorded multiplied as standard hourly rate applicable to the cost. The amount is than added to the direct cost as a percent rate. This is to recover the company's overhead costs. This is often called "absorption costing". The percentage will generally be determined by business accountants. It will highly depend on accurate labour forecasts and effective budgeting and control.
Business with large research and development departments will generally have higher overhead costs (even up to 200%). I labour intensive industries they will generally be up to 50%.
The lower overhead costs, the higher competitive advantage.
Customers might ask for breakdown of the overhead costs by asking for breakdown at any time.
In a situation of cancelled orders for example, or inaccurate estimation of the workload the planned overheads will fall below the plan and affect the revenue. Remedy can be made through:
- increase of sale through marketing efforts
- ensure new customer to pay for some previously regarded indirect costs,
- make economies to reduce overhead costs (through redundancies for example),
- increase the overhead rate through increased prices but this might reduce the number of orders.
Businesses need to be rather precise in calculating and estimating overhead costs accurately to avoid these. We should also try and avoid over-budgeting as it might affect the product price. However sort term benefits might be incurred through higher profits, on along term it might affect the competitive advantage.
Staying on budget...
The main goal, however, is to try and stay within the budgeted costs of a project. In many cases, this is the only cost objective put on the project manager. For internal projects (for example when developing internal IT system) there is no external customer or profit to be looked after.
But, where there is a profit involved, these can be rather fragile.
The contractor generally will have the responsibility for ensuring that customer's costs also stay on budget. This is normally reflected in the price contract.
There are also cost-plus projects where the contractor is able to mark-up costs and transfer to client with no fixed-price limit. A long-running cost-plus service contract are happening but, generally, contractor must claim only legitimate costs and carry work as efficiently as the contractor would be spending their own money.
At times, to the overall cost responsibilities, a project manager might be responsible for predicting costs and reporting them to the client.
Total Cost Approach
The Total Cost Approach requires managers of department to assess an impact of changes in their respected area on other functions of the business (department). It might involve increasing expenditure in one department to generate greater cost savings in another.
Here, the emphasis is put on the project planning stage to ensure all relevant affected stakeholders (departments) are involved. With a goal of cost considerations and savings often ideas might be generated during such meetings. This involves accepting some parts of a 'cheaper costs" activities by other departments.
The total cost approach should be extended to include costs incurred by customer after the product is handed to them. These could be the costs of maintenance or operation. At times, higher provisional costs might bring longer term benefits and cost savings.
Customers might be involved into the discussions of quality, design and cost for this purpose. Continuous cooperation between the contractor and customer during the design stage might bring significant cost savings.
Cost checklist...
There are many risks that can lead to overrunning the budget. Below are some helpful considerations that can reduce those risks:
Total Cost Approach and awareness of costs for those who design product or service to engineers, managers and customers.
WBS development with work packages of manageable sizes.
Code of accounts systems aligned with WBS.
Cost budget for each package.
Accounting system allowing collect and analyse costs.
Practicable work schedule.
Motivated staff to ensure work meets its schedule.
Method for comparing planned costs with actual costs.
Effective quality control of each task to ensure they can be completed right first time.
Proper drafting specifications and contracts.
Customer evaluation of credibility to ensure payments can be made.
Less discreet evaluation of suppliers to meet deadlines with correct cost and quality.
Effective tendering to allow for lowest costs with the best quality.
Control of modifications and contract variations, including justified claims of price increase.
Strict controls of payments to suppliers and subcontractors to ensure these are not overpaid or paid too soon.
Recovery from customer of costs due to contractual changes requested by customer.
Effective invoicing to customer, ensuring that claims for progress payments or cost reimbursements are paid on time.
Effective credit control.
Internal security audits to prevent thief or fraud.
Effective and regular cost progress reports to senior management, highlighting any schedule or budget overruns for corrective actions to be taken
Resetting budgets
At any time it should be possible for the budget to be stated as an initial amount and approved by the client. Any additions should also be approved. These need to be current and valid.
A typical project budget graph should resemble an S curve.
Reserve budgets should also be made, for example for currency fluctuations. the currency units are rather important. The common approach is to convert it to the "home currency". Sometimes, however a costing might be granted by a contract in customer's currency.
When collecting costs...
Each company should have established procedures for collecting, analysing and approving costs. These tasks are generally the role of accountants.
Purchased materials - costs can be collected via:
- the dates when an order was placed,
- dates when invoices are due to be paid
- stores processes and time from when goods are received to allocated in stores for use.
Each of the methods has its advantages and disadvantages. The project manager should choose the best method for monitoring and recording the costs within a project.
Generally, the data collection would be done as soon when the orders are placed. This will give the earliest possible indication of cost trends against the budget. Communication between the purchasing department and the project manager should be established. If any items are used from company general stock, those can be easily withdrawn and added to the project costs. Some might want to preallocate some items earlier on separate location to ensure reserves are in place.
Payments made to suppliers, however, makes the most accurate data of the costs of materials. Many times, however, the information from supplier invoices is received far too late. Therefore, those should ideally be collected at the point of commitment.
The costs, should be checked later on to the invoice to ensure there is no variations. There might be incidental expenses not counted for i.e. freight charges, insurance, packaging, custom duties etc.
Items used for a project should also be controlled. A change in scope might reduce the number if items used, thus this would affect the actual costs. Materials might be sent back to suppliers for credit or used elsewhere in a project.
Labour costs
The most common way of collecting labour costs is to complete time-sheets regularly. These are generally collected weekly and record the time to the nearest half an hour.
Figure below presents an example of a weekly timesheet.
Many companies now have a software to enter the details into a computer. It is important, however, that the manager responsible for the entires should check and verified the information. This is generally done by adding the approval signature.
The time records should be as accurate as possible. Time spent on each project should also be recorded. People should be entering those every day. If these are done once a week, it is certainly hard to remember accurate information.
At times, time audits should be performed.
Agency workers will generally be provided by their own agency time-sheets. The contracting company would be expected to sign them and approve. This times will generally appear on the agency invoice.
For projects, the agency workers should be encouraged to complete contractor's own time-sheets. Normally, the agency will charge on a weekly basis.
Some of the new project management software systems allow home-working staff to add their hours into a computer system. We must ensure that these are checked, audited and approved. Employees should also be aware of relevant cost codes to ensure correct time to relevant project is recorded accurately.
Subcontractors time data might be obtained through daywork sheets. Sometimes invoices from subcontractors arrive after a long period of time. Therefore, there might be a delay in gathering the accurate and on-time information for the project decisions. Keeping daywork sheets allows continuous monitoring and later, allows for gathering correct information when authorising the invoices.
Audits
The managers and supervisors should be auditing, checking and approving the time sheets regularly. It helps to protect the projects from being overcharged and avoid errors. Fraud reduced. Companies should also set limits for each managers to approve any costs.
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