Estimating Purchasing and Cost Control - Essay Example

? Estimating Purchasing and Cost Control By of Words Introduction Cost management is an integral part of financial control and management in any for profit and non-profit organisation, notwithstanding the industry or sector. The same applies particularly to the engineering and construction sector in which the huge amounts of financial and other resources pumped must be accounted for to stakeholders such as the government, project funders and the public/customers (Ashworth, 2004). Unfortunately, for various reasons, many countries’ construction sectors lag behind in the use of cost control techniques such as the Cost Value Reconciliation (CVR) and Earned Value (EV), two rather common methods of cost control. Many a stakeholder cites the technical skills and the huge resources required as the reasons many constructions firms and financial managers do not apply CVR in their cost control practices. Most affected by the cost and skill requirements of CVR and other cost control techniques such as CVR and Earned Value (EV) are the small and medium-sized construction and engineering firms that lack the wherewithal to design and implement these techniques of cost control. The other reason for the little use of cost control techniques such as CVR and EV is the apparent lack of literary coverage and information on these methods, implying that stakeholders are not quite conversant with the methods (Cooke & Williams, 2009). Nonetheless, these methods are generally used in the construction and engineering industry to measure and monitor project progress, profitability and performance for their strengths. One advantage of EV is that it is capable of combining the assessment of work cost, schedule and scope in a single integrated process or system. What is more, Earned Value gives accurate information and forecasts on project problems, which are important contributory factors in project management. EV has been shown to affect project planning and control aspects more even as it improves project scope and the analysis of project performance. EV is thus a positive predictor of project success. The popularity of EV is evident in the many government contracts that are assessed using this method, more so in its application to assist substantiate contract disputes. This paper explores the use of cost control methods such as the Coat Value Reconciliation (CVR) and the Earned Value (EV) with regards to their effectiveness in providing information on costs, in the monitoring work progress, their benefits, ease of use, advantages and disadvantages. Practicing CVR and EV The importance of using these cost control methods in the construction and engineering sector is the uniqueness and the uncertainties that characterise each project. In fact, every project in the industry has its own set of challenges and hardships that affect not only their successful completion but also their effective use of the available resources. The uncertainties inherent in construction projects result in losses and ultimate project collapse even for big, long-established, sophisticated and financially endowed constructors (Potts, 2008). With more sophisticated structures being ordered by clients every other day with the budgets getting tighter by the day, construction firms must embrace cost control and sound finance management to achieve their objectives. Just like any other cost control measures, CVR has several core elements or principles by which it is successfully applied to give the required data. Important in CVR are the totals for cost and value, which are crucial in establishing a firm’s profitability (Sidwell, 2005). In this regard, CVR’s major objective is to achieve accuracy while displaying a firm’s accounts. CVR’s display of financial accounts and position is thus among the most accurate compared to other methods. It is thus quite apparent that CVR seeks to portray a firm’s statutory accounts as a legal obligation (Sidwell, 2005). Additionally vital is CVR’s capacity to provide information for use by firms’ and construction management teams for day-to-day operations. However, CVR becomes more meaningful when presented or used together with the financial analysis of the contract/project in question. The main important element of CVR is thus the availed data without which complete analysis of cost and certainty of arriving at the right profit and financial position is diminished. Additionally, CVR forms have expected profits, forecast value and profit figures at the completion of a project, tender figures, contractor’s payment application, current certified value, cash received to date, cost to date and the certified sums unpaid, making it quite efficient in providing owners with information (Sidwell, 2005). The importance of this information is evident during the comprehensive evaluation of CVR, which is quite essential for the determination of a project’s current financial standing. There are several examples of CVR models that construction and engineering firms may adopt while applying CVR to enhance its informative benefits. An example of these models is one in which the cost accounting system for an entire project is established after which external interim valuation is received from “cut-off’ cost accounts to help in the establishment of the cost-to-date for work already performed. This model also entails the amendment of external valuation to incorporate overvaluations, undervaluation, variations and claims (Sidwell, 2005). Contractors then adjust the cost-to-date figures to take care of cost accruals, labour, subcontractors, plant and materials then add provisions for any additional work covered that might not have been indicated in or covered under the contract (Sidwell, 2005). The adjusted totals are then reconciled so that a clear picture of the performance and profitability of the immediate project is established. Practicing Earned Value Just like CVR, EV has several principles or elements that make it an important cost and performance control in construction and engineering projects. Thus, any implementation of EV management practices should embrace and apply project plans, which identify the work to be completed. Second, EV also entails the valuation of planned work, otherwise referred to as Planned Value (PV) or Budgeted Cost of Work Schedule (BCWS). Third, EV entails a pre-determined and pre-defined earning rules by the accomplished work would be quantified. In essence, the latter feature is what is referred to as the Earned Value (EV). The other features of EV are schedule performance, project quantification, performance indicators and forecasts such as under budget and over budget (Defense Systems Management College, 1997). Effectiveness of CVR and EV The informational and evaluation benefits of CVR and EV are evident in the sense that they deal with the constraints of time, cost and quality, which are the factors on which the success or failure of a construction project hinge. Importantly, CVR and EV exploit the interrelation among these vital factors in providing data for project implementation and management. In addition, CVR and EV address the element of financial risks, financial losses and uncertainty that is synonymous with construction and engineering projects. CVR and EV thus give information that help analysts and accountants to unravel the perplexing nature of the construction industry occasioned by the efforts, sheer manpower, uncertainty and risk aversion (Tammo, 1999). CVR and EV have consequently been rather useful and efficient cost control and financial management tools for the construction and engineering sectors with regards to availing information. Specifically, the effectiveness of CVR is shown in its use in determining and reporting project profitability on a regular basis, more so with regards to the comparison of cost with value/revenue on one hand and with time on the other. It thus shows the cumulative loss or profit incurred on a construction project. CVR has several advantages and disadvantages associated with its use in cost control. Advantages and Disadvantages of CVR The first advantage that makes CVR quite effective in cost control is that it offers accurate financial information on the current loss or profit of a given project or for a specified financial period. In this regard, CVR gives project and company management teams the vital information for problem identification and solution, highlighting the importance of reserves and giving the possible causes/reasons for loss or profit (www.scribd.com, 2012). Thus, it is a useful tool in the prevention of future losses during project implementation. The other advantage of CVR is that it gives greater control of cost and performance outside the confines of a project as cost control measures are applied at the organisational level rather than at the project level. Thus, project and company objectives are achieved via an enhanced organisational management and cost control (www.scribd.com, 2012). Its promotion of reconciliation at frequent intervals has also been a source of strength for CVR as profitability or lack thereof is established and financial difficulties and problems easily and timely pointed out. CVR also monitors cost in relation to time, in the process aiding progress performance. In addition, it also ensures the time frame for cost and value reconciliations is reduced at the project level as most of the assessments and calculations are done externally by client. One easily identified disadvantage of CVR is that it focuses on skill requirements of those producing the CVR form. These skills are required only for the information obtained to be subjected to judgment. Second, CVR gives the hired client the sole responsibility of determining the value earned, implying the possibility of adverse effects on internal stakeholders such as contractors (www.scribd.com, 2012). For instance, contractors’ accounts may be adversely affected if the actions and calculations of the hired client are not properly monitored. Traditional CVR processes are also not ideal for short-term contractors and small value operations and contractor not financially endowed. That is, the value of such projects may not correspond with the cost incurred for this level of financial control. The other disadvantage of CVR is that it indicates losses but does not categorise what triggers these losses. CVR also becomes tedious at the organisational level as it requires information with different cut off dates to be transferred from different projects to company accounts (www.scribd.com, 2012). Advantages and Disadvantages of EV EV, which compares the planned work, actual work and cost of work, has its advantages and disadvantages as well. The main beneficiaries of the EV method are project owners who receive much better project performance metric from EV compared to what is received from traditional cost and time reporting methods. The two main reasons for these better metric performances are that EV combines both cost and time performance parameters, for instance, by comparing and allocating costs to activities on a Gantt chart (Marshall, 2007). That is, time and cost resources such as staff, equipment, labour and management overheads are integrated and interlinked. Also included in the cost-time comparisons and resource allocations in EV are risks such as fluctuating and escalating costs and long completion period for major construction projects such as civil infrastructure projects (Abba, 2000). The second advantage of EV for project owners is that it avails the most accurate information on the latest level of project performance as it compares the budgeted and the actual costs, allowing for the creation of simple curves and giving insights into the specific problem areas that require rectification (www.aipm2010.com.au, 2010). Conclusion Cost Value Reconciliation and Earned Value are two of the methods used in the construction industry to regularly determine and report the profitability of construction projects. In essence, these techniques compare the costs of a project and its revenues at a specified time o establish the cumulative profit or loss suffered by a project. In CVR, the cost and revenue are made to correspond by checking a project’s bank statement to ensure all costs are accounted for, thus improving cost management and financial control. However, the use of CVR is hampered by its resource requirements, technical skill needs and its cost, making it rather inappropriate for small and medium size companies and projects. The benefits or uses of CVR and EV to project owners include showing information on a project’s profit or loss on a regular basis, for current accounting period and the current cash position of a contractor. Finally, these techniques give the details of overhead recovery on given contracts. Consequent to these functions, CVR and EV enable construction companies to identify actions that may result in the reduction of cost-related liabilities and to plan for expenditures. Importantly, CVR and EV enable companies to monitor, estimate and adjust their rates on the basis of the reported loss or profit. References Abba, W. (2000) "How Earned Value Got to Prime Time: A Short Look Back and a Glance Ahead". PMI College of Performance Management. Retrieved on October 18, 2012 from http://www.pmi-cpm.org/members/library/EVLook%20Back-Glance%20Ahead.abba.pdf. Ashworth, A. (2004) “Cost Studies of Buildings” Retrieved on October 18, 2012 from http://www.dawsonera.com/depp/reader/protected/external/EBookView/S9781405891059/S465 Cooke, B., and Williams, P. (2009) Construction planning, programming and control, third edition. Chichester: Blackwell. Defense Systems Management College. (1997) Earned value management textbook. Fort Belvoir, VA: Defense Systems Management College.  Marshall, R. (2007) The Contribution of Earned Value Management to Project Success of Contracted Efforts. Journal of Contract Management, 1(1): 331. Potts, K. (2008) Construction cost management – learning from case studies. Abington: Taylor & Francis. Sidwell, A. C. (2005) Cost value reconciliation in the UK construction industry. Queensland University of Technology. Tammo, T. W. (1999) “Earned Value, Clear and Simple.” Los Angeles County Metropolitan Authority. Retrieved on October 18, 2012 from http://www.academia-research.com/filecache/instr/e/a/734595_earned-value.pdf www.aipm2010.com.au (2010) “Earned Value in Construction Projects- in Search of the Holy Grail.” Retrieved on October 18, 2012 from http://www.academia-research.com/filecache/instr/a/i/734595_aipm2010_0021.pdf www.scribd.com (2012) “Cost Value Reconciliation and Earned Value.” Retrieved on October 18, 2012 from http://www.scribd.com/doc/45115572/Cost-Value-Reconciliation-and-Earned-Value   Read More