CONSTRUCTION INDUSTRY DEVELOPMENT BOARD MALAYSIA

Facilities Management Training Module – Level 5

FACILITIES
MANAGEMENT - L5
LP04 - Finance and
Business Planning
Table of Contents

1.0 MAIN CONTENT ............................................................................................................................. 1

1.1 Purpose ................................................................................................................................. 1
1.2 Introduction ........................................................................................................................ 1
1.3 Occupational Definition .................................................................................................. 2
1.4 Roles & Responsibility ..................................................................................................... 2
1.5 Learning Outcome ............................................................................................................. 2
1.6 Assessment .......................................................................................................................... 2
2.0 PLAN OVERALL FM ACTIVITY BUDGET ................................................................................ 3
2.1 Purpose and Objectives of Budgeting ........................................................................ 3
2.2 Fundamental Principles of Budgeting ....................................................................... 4
2.3 O&M, Administrative and Management Cost ........................................................... 5
2.4 Operating Budgets vs. Capital Budgets for FMs ...................................................... 6
2.4.1 Operating Budgets .......................................................................................................... 6
2.4.2 Capital Budgets ................................................................................................................ 8
2.5 Overall FM Budget Based on FM Department Operational Activities .......... 11
2.5.1 Project Budget Preparation ....................................................................................... 11
2.5.2 Sources of Data for Budget Preparation ............................................................... 12
2.5.3 The Budgeting Process ................................................................................................ 12
2.5.4 Budget Planning Periods ............................................................................................ 14
2.6 Overall FM Budget for Management Team Approval ........................................ 15
2.6.1 Format of the Budget ................................................................................................... 15
3.0 PREPARE FINANCIAL MANAGEMENT PLANNING (FMP) ............................................. 21
3.1 Fundamental Principles of Financial Management ............................................ 21
3.2 What is Financial Planning? ....................................................................................... 22
3.3 Estimated FM Cost from FM Overall Budget Plan ............................................... 25
3.3.1 The Goals of Finance and Accounting Principles .............................................. 25
3.3.2 Lowest First Cost Analysis ......................................................................................... 26
3.3.3 Life Cycle Cost Analysis ............................................................................................... 27
3.3.4 Cost-Benefit Analysis ................................................................................................... 28
 3.3.5 Hard Costs and Soft Costs .......................................................................................... 29
3.4 Internal and External Financing Sources ............................................................... 30
3.4.1 Sources Of Funding ....................................................................................................... 30
3.4.2 Loan Application Process ........................................................................................... 35
3.5 Cost of Financing According to FM Scope of Services ........................................ 36
3.6 FM Revenue Trend Planned According to FM O&M Activity ........................... 36
3.6.1 On-going Facility Finances ......................................................................................... 36
3.6.2 Updating Asset Inventories ....................................................................................... 37
3.6.3 Contract Pricing Issues................................................................................................ 37
3.7 Financial Management Planning (FMP) ................................................................. 40
4.0 MANAGE PROJECT PROFIT AND LOSS (P&L) ................................................................... 42
4.1 Introduction to Basic Accounting ............................................................................. 42
4.1.1 Balance Sheet .................................................................................................................. 43
4.1.2 Profit and Loss ................................................................................................................ 44
4.1.3 Cash Flow ......................................................................................................................... 45
4.1.4 Debtors and Creditors ................................................................................................. 45
4.1.5 Variance Analysis .......................................................................................................... 45
4.1.6 Horizontal Analysis ...................................................................................................... 45
4.1.7 Understanding Common Ratios ............................................................................... 46
4.1.8 Ratios Simplified ............................................................................................................ 47
4.2 Project Profit and Loss Projected Based on Project Activity .......................... 47
4.3 Revenues ........................................................................................................................... 48
4.3.1 Progress Claim Method ............................................................................................... 48
4.3.2 Completion of Contract Method .............................................................................. 48
4.4 Direct Costs (COS) .......................................................................................................... 48
4.5 Indirect Costs ................................................................................................................... 49
4.6 Overhead ........................................................................................................................... 50
4.7 Revenue and Expenditure Management ................................................................ 51
4.8 Creating a Budget ........................................................................................................... 52
4.9 Corrective Action Planned According to Activity Report ................................. 54
4.9.1 Horizontal Analysis Overview .................................................................................. 55
4.9.2 Horizontal Analysis of the Income Statement .................................................... 55
5.0 MANAGE PROCUREMENT METHOD/APPROACH ........................................................... 57
5.1 What is Strategic Sourcing? ........................................................................................ 57
 5.1.1 Common Sourcing Goals ............................................................................................. 59
5.2 Scope of Goods and Services for Procurement Activity .................................... 61
5.3 Responsibilities .............................................................................................................. 61
5.4 Impact and Urgency to Core Business According to O&M Schedule ............. 63
5.5 What is Facilities Management? ................................................................................ 63
5.6 Strategy Overview .......................................................................................................... 64
5.7 Selecting a Strategy........................................................................................................ 65
5.8 Cost Factors ...................................................................................................................... 66
5.8.1 Indirect Cost .................................................................................................................... 66
5.8.2 Direct Cost ........................................................................................................................ 66
5.8.3 Control ............................................................................................................................... 66
5.8.4 Implications of Outsourcing ...................................................................................... 67
5.8.5 Conclusions ...................................................................................................................... 68
5.9 Procurement Cost Based on Scope of Goods and Services ............................... 68
5.9.1 Conflicting Views ........................................................................................................... 68
5.9.2 Focus on TCO .................................................................................................................. 70
5.9.3 Outsourcing Strategy in Relation to Procurement Process .......................... 71
5.9.4 Benefits of Out-Sourcing ............................................................................................. 73
5.9.5 Risks of Out-sourcing ................................................................................................... 75
5.9.6 Conclusion ........................................................................................................................ 76
5.10 Suitable Procurement Method................................................................................... 77
5.10.1 Obtaining Quality Goods and Services .................................................................. 77
5.10.2 Open Tendering ............................................................................................................. 77
5.10.3 Restricted Tendering ................................................................................................... 78
5.10.4 Request for Proposals (RFP) ..................................................................................... 78
5.10.5 Two Stage Tendering ................................................................................................... 79
5.10.6 Request for Quotations ............................................................................................... 79
5.10.7 Single-Source .................................................................................................................. 79
5.11 Procurement Activity Implemented ........................................................................ 81
5.11.1 Procurement and Supply Cycle ................................................................................ 81
5.11.2 Purchasing Process Flowchart ................................................................................. 82
 Learning
FINANCE AND
BUSINESS Package

04
PLANNING

1.0 MAIN CONTENT

1.1 Purpose

The purpose of this module is to address the need for a competent Facilities Manager where
he/she will provide a total managed solution for all the facilities that may exists in a single
or campus wide buildings.

In this regards, this module will benefit specifically to the Facilities Management company
to equip themselves with the relevant and core competencies knowledge required to run
their business and eventually they can become one of the main players in the Facilities
Management industry.

1.2 Introduction

Finance and business planning is the planning of the finances of an FM organization in

order to achieve organisation financial objectives.

This module will help trainees to learn and obtain knowledge on:-

1. Plan overall FM activity budget

- Budgeting basic principle & technique such as activity based costing, Standard
cost accounting, O&M cost elements (scope) and management & administration
cost elements (license, bills, rental, insurance)

2. Prepare financial management planning (FMP)

- Financial accounting basic principles and Financial planning technique

3. Manage project profit and loss (P&L)

- Basic project accounting, Profit and loss statement and format, Balance sheet and
cash flow

4. Manage procurement method/approach

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 - Outsourcing strategy in related to procurement process, type of procurement
method such as conventional method and direct purchase, procurement process
and procedures identify procurement cost and implement procurement activity.

1.3 Occupational Definition

Level 5 - Facilities Management Manager

Competent in applying a significant range of fundamental principles and complex

techniques across a wide and often unpredictable variety of contexts. Very substantial
personal autonomy and often significant responsibility for the work of others and for the
allocation of substantial resources features strongly, as do personal accountabilities for
analysis, diagnosis, planning, execution and evaluation.

1.4 Roles & Responsibility

The competent person shall be able to plan overall FM activity budget, prepare financial
management planning (FMP), manage project profit and loss (P&L) and manage
procurement method/approach.

1.5 Learning Outcome

The outcome of this coordination competency is to ensure that all the FM activities are
effective in ensuring short, medium and long term sustainability of the company.

Upon completion of this competency unit, trainees shall be able to:-

1. Plan overall FM activity budget

2. Prepare financial management plan (FMP)

3. Manage profit and loss (P&L)

4. Manage procurement method/approach.

1.6 Assessment

As per attached.

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2.0 PLAN OVERALL FM ACTIVITY BUDGET
Budgeting is the process of designing, implementing and operating budgets. It is the
managerial process of budget planning and preparation, budgetary control and the related
procedures. Budgeting is the highest level of accounting in terms of future which indicates a
definite course of action and not merely reporting.

It is an integral part of such managerial policies as long-term planning, cash flow, capital
expenditure and project management.

A budget is a financial plan. It is an estimate of income and expenditure over a set period of
time. Usually 12 months but can be 3 years and more than 5 years for long term planning. A
budget is used as a tool to aid decision making and to measure project/organization
performance.

In forecasting an estimate of what is likely to happen is made whereas budgeting is the

process of stating policy and programmed to be followed in future. Further, forecasting
does not connote any sense of control while budgeting is a tool of control since it represents
actions which can be shaped according to the situation so that it can be suited to the
conditions which may or may not happen.

In sum, budget is an operating and financial plan spelling out a target which the
management seems to attain on the basis of the forecasts made. A forecast denotes some
degree of flexibility while a budget denotes a definite target.

2.1 Purpose and Objectives of Budgeting

The overall purpose of budgeting is to plan different phases of business operations,

coordinate activities of different departments of the firm and to ensure effective control
over it.

To accomplish this purpose, a budget aims at attaining the following objectives:

a) To prognosticate the company’s future sales, production cost and other

expenses in order to earn desired amount of income and minimize the
possibility of business losses.

b) To anticipate the firm’s future financial condition and future need for funds to be
employed in the business with a view to keeping the firm solvent.

c) To decide the composition of capitalization in order to ensure availability of

funds at reasonable cost.

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 d) To coordinate the efforts of different departments of the firm toward the
common objectives.

e) To accelerate efficiency of operations of different departments, divisions and

cost centers of the firm.

f) To fix responsibilities of different departmental heads.

g) To ensure effective control over the firm’s cash, inventory and sales, and

h) To facilitate centralized control over the firm through the budgetary system.

2.2 Fundamental Principles of Budgeting

So as to ensure that budget serves as an effective technique of managerial decision making,

certain cardinal principles must be kept in view.

These principles are:

a) Management Support:

Top management’s support and cooperation is essential for successful

implementation of the budget. It should take interest not only in setting the targets
and finalizing the budgets but also constantly monitoring the actual performance to
find out the deviations if any and take curative steps, motivate the personnel and
reward the good performers.

b) Employees Involvement:

The budget should be established on the highest possible level of motivation. All
levels of management should participate in setting targets and preparing budget.
This will result in defining realistic targets.

Participation of employees in budgeting process will not only make them carefully
think about the likely development in the forthcoming period and prepare budget
accordingly but will also motivate them to strive hard to achieve budget levels of
efficiency and activity.

c) Statement of Organizational Goal:

The organizational goal should be quantified and clearly stated. These goals should
be set within the framework of corporate objectives and strategies. A well-defined
corporate policy and strategy is a pre-requisite for budgeting.

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 d) Responsibility Accounting:

Individual employees should be informed about expectations of the management.

Only those costs over which an individual has predominant control should be used
in evaluating performance of that individual. Responsibility reports often contain
budget to actual comparisons.

e) Organizational Structure:

There should be well-planned organizational structure with clearly defined

authority and responsibility of different levels of management. Role and
responsibilities of Budget Committee must be made known to the people in the
organization.

f) Flexibility:

If the basic assumptions underlying the budget change during the year, the budget
should be restated. This will enable the management to compare the actual level of
operations with the expected performance at that level.

g) Communication of Results:

Proper communications systems should be established for management reporting

and information service so that information pertaining to actual performance is
presented to the concerned manager timely and accurately so that remedial action
is taken wherever necessary.

h) Sound Accounting System:

Organization should have good accounting system so as to generate precise,

accurate, reliable and prompt information which is essential for successful
implementation of budget system.

2.3 O&M, Administrative and Management Cost

In developing a budget for new projects, capital renewal, and facility operations, it is
important to understand the needs and service levels of the overall organization. An on-
going facility budget is like a roadmap for the future of the FM department. Other
departments’ budgets affect the facility budget.

The highest costs in FM are the operational and maintenance costs over the lifespan of the
physical assets. Many companies refer to these budgets as their operations and
maintenance (O&M) budgets.

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It is common for the O&M costs of a facility to be more than ten times higher than the
original construction costs over the total lifespan of the physical assets. Therefore, it is
essential (from the start) that the proper preventive maintenance and repairs are
performed to assure effective operational and financial performance of physical assets.

2.4 Operating Budgets vs. Capital Budgets for FMs

From an accounting standpoint, there are two types of budgets: operating and capital. From
a facilities management viewpoint, budgets are likely to be categorized by program: for
example, maintenance, operations, space build-out, environmental, and security. One of the
continuing budget challenges for most facilities management and property management
organizations is taking the time to define and set rules for annual (or semi-
annual)operating versus capital expenditures. The facilities manager should have the
capability to manage and track each program in both operating and capital budgets.

2.4.1 Operating Budgets

An operating budget consists of all revenues and expenses over a period of time (typically a
quarter or a year) which a company, government, or organization uses to plan its
operations. An operating is prepared in advance of a reporting period as a goal or plan the
business expects to achieve.

Facilities managers are more likely to have control of the operating budget rather than the
capital budget. The operating budget is also far more likely to be the subject of intense
scrutiny and cost-cutting efforts. You can expect a closer examination of line items,
disproportionate to dollar value, than you would experience with capital budgets.

Portions of the yearly operating budget for an entire company are allocated to each
corporate department for its day-to-day operating requirements. The total allocation for
the facilities management department is subdivided into portions allocated to:-

i) personnel costs – e.g staff salaries and benefits

ii) non-personnel costs (administration and management ) – e.g rent, electric bills,
license, insurance and so on.

2.4.1.1 Components of an Operating Budget

The main components of an operations budget are outlined below. Each business is unique
and every industry has its nuances, but these items are general enough to apply to most
industries.

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1. Revenue
Revenue is usually broken down into its drivers and components. It’s possible to
forecast revenue on a year-over-year basis, but usually, more detail is required by
breaking revenue down into its underlying components.

Revenue drivers typically include:

• Volume (units, contracts, customers, products, etc.)

• Price (average price, per unit price, segment price, etc.)

2. Variable costs

After revenue, variable costs are typically deduced. These costs are called “variable”
because they depend on increase or decrease in use or activity and are often
calculated as a percentage of sales.

Variable costs often include:

• Cost of goods sold

• Direct selling costs

• Sales commissions

• Certain aspects of marketing

3. Fixed costs
After variable costs are deducted, fixed costs are usually next. These expenses do
not vary as much with changes in revenue and are mostly constant, at least within
the time frame of the operating budget.

Examples of fixed costs include:

• Rent

• Head office

• Insurance

• Telecommunication

• Management salaries and benefits

• Utilities

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 4. Non-cash expenses

An operating budget often includes non-cash expenses, such as depreciation and

amortization. Even though these expenses don’t impact cash flow (other than taxes),
they will impact financial reporting performance (i.e the figures a company reports
at the end of the year on their income statement).

5. Non-operating expenses

Non-operating expenses are those that fall below Earnings before Interest and Taxes
(EBIT) or Operating Income. Examples of expenses that may be included in a budget
are:
• Interest

• Non-operating activities

• Taxes

Operating Budgets enable control to be exercised by:

a) Measuring performance against plans (budget vs actual)

b) Focusing management attention

c) Predicting cash flows

d) Identifying unprofitable activity (variance)

e) Quantifying options

2.4.2 Capital Budgets

It often referred to as CAPEX. Compared to operating budgets, capital budgets may seem
rather static: they involve fewer cost types, less scrutiny, and longer terms. Expenditure
created is for purchase of a fixed asset.

Capital budgets are sensitive to how operating budgets are managed. For example,
preventive maintenance, if funded and practiced, will have a very beneficial long-term
impact on capital projects by extending the useful life of capital assets. Most preventive
maintenance programs can provide reasonable predictions of how long mechanical HVAC
equipment will last, enabling you to make some sober predictions about planned
equipment replacement, which is almost always a capital expense.

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There is one caveat, however: your company will realize these savings only if it remains in
the facility or uses the equipment long enough to reap the benefits. For this reason, such
financial arguments rarely make sense for leased space unless the lease is a long-term
triple-net lease.

Capital projects and investments usually require maintenance, care, and operation after
they are purchased or built. It is very important to examine capital expenditures for the
ongoing effects they will have on the operating budget. The most commonly used tool to
identify such costs is LCC (life cycle cost) analysis, which accounts for all costs associated
with an item over its expected life, including purchase, operation, maintenance, and
disposal. In many cases, large capital investments are approved on the basis of LCC claims
that they will reduce operating costs.

If such predictions turn out to be inaccurate or overstated, the facilities management

department will bear slightly higher ongoing operating costs higher maintenance or
housekeeping for each such project, for each year. Unless you can research life cycle cost
analyses for these projects and compare predicted figures with actual results, you may have
a difficult time proving why your costs keep increasing.

2.4.2.1 Budgeting Methods

Budgets are essential in controlling a company’s costs. Adherence to budgets requires

planning, on-going financial discipline, and constant adjustments. In deciding what the
appropriate annual operating budget for a facility is, there are several approaches.

These methods are based on typical organizations’ progression:

• Zero-Based
When a building or asset is first operated, there is little history available and few
benchmarks available for the specific operations incurred. The first year may well
become the baseline year to learn about the asset’s operating costs. It is used where
extent of FM activities and quality can be controlled. Starting from a zero-figure
building up the budget based on the costs of the activities planned for the next year.

• Historical-Based
Once an asset has been in operation for at least a year, a history is established. It is
commonplace to budget for next year’s asset operations based on the same or 5–
10% of last year’s budget.

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• Benchmarked-Unit Costing
To encourage continuous improvement in operating costs and to remain competitive
within their industry, many organizations are looking to benchmarking their costs
and setting their budgets accordingly. Benchmarked budgeting is an important first
step in pointing out areas for improvements. Underperforming areas are quickly
identified, and investigation and improvements can be started quickly. The
disadvantage is the difficulty of comparing one company’s unique internal customers
and operations with another.

One particular process in use (especially for capital projects) is unit costing. While
unit costing can yield competitive bids and can be useful in standardized systems
and projects, it can also be misleading when specialized custom projects and
services are needed.

• Activity-Based
Based on activity-based costing (ABC) and activity-based management (ABM)
general accounting principles, this activity-based budgeting focuses on each activity
within a process and allocates the actual incurred costs for each activity physically
being done. There is no “smearing” of overhead and indirect costs across the entire
company’s operations. ABC is an extremely long and cumbersome process, but the
payoff can be tremendous. Companies that have gone through ABC have raised their
competitiveness to a higher level.

• Asset-Based
Asset-based budgeting when used in conjunction with ABC is the most accurate and
best financial operational budgeting method. It is based on the current condition
history of all physical assets that the FM is responsible for and leaves little room for
error. It does require adequate resources and continual updating to provide value.

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2.5 Overall FM Budget Based on FM Department Operational Activities

2.5.1 Project Budget Preparation

Project Budget is a list of all planned expenses and revenues. Project Budget consists of the
following components:

1. Sales/revenues budget which provides the various sources of revenue lines and
how they would be achieved.

2. Cost of sales/direct cost budget which provides the associated cost directly
linked to the various revenue lines. The difference between the sales/revenues
budget and cost of sales/direct cost is the Gross Profit Margin.

3. Operating expenses budget which provides the details of the indirect operating
cost such staff salary, office rental, printing and stationery, telephone expense
and etc. Such expenses normally will be incurred regardless whether there are
sales/revenues.

4. Advertising & promotion budget which provides the various plans of how the
organization is going to promote its business. Example would be the
advertisement cost, product promotion cost and etc.

5. Capital budget which provides the details of the capital expenditures such as
office renovation, hardware investment cost and etc.

6. Cash flow budget which provides the funding requirements of the business
operations. It consists of the following components:

• Cash generated/used in operating activities.

• Cash from/used in investment activities.

• Cash from funding activities.

The cash flow budget focuses on the financial aspects of the business. It would tell whether
the business is cash self-sustaining or requires external cash funding from elsewhere.

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2.5.2 Sources of Data for Budget Preparation

• Previous Years’ budget

• Asset register

• Business plans

• Strategic forecasts

• Quotations for works/equipment

2.5.3 The Budgeting Process

The budgeting process usually begins when managers receive top management’s forecasts
and marketing project objectives for the coming year, along-with a time-table stating when
budgets must be completed. The forecasts and objectives provided by the top management
represent guidelines within which departments budgets are prepared.

Usually, the work on budgeting begins with the task of estimating sales because the total
activity of a firm depends on the sales. Preparation of sales estimate demands assessment
of the existing market situation and projection of one’s ideas as to what would be the
market position in the ensuing period for which the budget is proposed. Several internal as
well as external factors are taken into consideration.

The sales estimate prepared by the marketing manager is submitted to the budget
committee for consideration. The budget committee comprising of the top management
carefully considers the forecast in the light of the past results and the estimates of the
future as recommended by economists and statisticians and wherever necessary
recommends for changes in estimate or if necessary asks for complete restudy and revision.

Upon the recommendation of the budget committee, the Head of the organization accords
his approval to the sales estimate which then becomes sales budget of the organization. The
sales budget is accompanied by budget covering selling and distribution expenses. The two
budgets together give the net sales revenue expected to arrive in the coming year.

After the preparation of the sales budget and selling and distribution cost budget, Operation
Budget of the Company is prepared. The operation budget is based on the operation
forecasts which are made after taking into consideration sales budget and the FM planned
activities.

Materials cost budget shows expected cost of materials required for budgeted production
and sales purpose. Determination of material cost involves quantities to be used and the
rate per unit. The task of determining the quantities required is that of the production

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engineering department while the purchasing department has the responsibility of
deciding the rate.

Labor Cost Budget prognosticates the direct labor cost expected to be spent on carrying
into effect the targeted production. Preparation of this budget requires information
regarding the time required to do one unit of work and the wages to be paid for it.

Overheads Budget is a statement of expected overheads (comprising fixed and variable

overheads) which the firm will have to incur during the budget period. This budget is
prepared on the basis of overhead forecasts of all the departments of the firm.

Once materials cost budget, labor cost budget and overheads budget are prepared, a full
production cost budget can be drawn. This budget is generally presented in the form of a
cost sheet.

In order to achieve competitive edge over its rivals on sustainable basis, an organization
will have to develop new products or new processes for producing existing products at
minimum cost.

Capital Budget is prepared to estimate receipts and payments on capital account as

opposed to revenue account. Following the decision of the management about the capital
expenditure to be made during the budget period, capital budget is drawn up to show
month-wise receipts and payments on capital account. Capital budget often referred to as
CAPEX. Expenditure created for the purchase of an asset (fixed). Those assets will retain a
value for a medium to long period of time.

A Revenue Budget showing expected receipts and payments on revenue account is prepared
separately. It is used for the day to day costs of running the operation. Revenue budget can
be classified in to Fixed and Variable Revenue Costs. Fixed do not change with use, it always
present. Variable changes depending on increase or decrease in use or activity.

Once separate budgets for sales, production finance and other activities have been
prepared and finalized and the targeted sales, cost of sales, expenses are determined, the
targeted profit and loss account and balance sheet can be drawn. These statements together
are known as Master Budget. The budget process is shown below:

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2.5.4 Budget Planning Periods

In contrast to operating budget time frames, capital budget time frames are always
multiyear, typically spanning between two and ten years. (Governments are more likely to
use longer time frames.) Because time frames are long, the time value of money becomes a
significant factor in capital planning, particularly if capital funds are borrowed or acquired
through equity participation such as stock issues. Therefore, getting accurate cost estimates
on long-range projects is both difficult and critical. You may find it helpful to consult with
corporate financial planners on what long-range planning assumptions are being used by
other corporate departments in their capital requests.

Aside from applying present value and discounting techniques to individual capital
projects, applying present value to the entire capital budget over several years, through the
course of multiple projects, will change it substantially. The differences between present-
day and discounted dollars will be most evident in the future of the capital budget plan
when the diminished value of the dollar will have its greatest impact. These factors are very
important to corporate financial planners who must issue bonds or debentures or take on a
mortgage to raise capital funds for projects.

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2.6 Overall FM Budget for Management Team Approval

2.6.1 Format of the Budget

The budget should be prepared in the prescribed format, and should include among
others:-

a. Expected Sales

These are the expected sales for the year.

b. Employees.

These are costs that can be directly attributed to employees of the company e.g.
salaries, bonuses, medical costs etc.

c. Cost of Sales

Direct Expenses in relations to the services provided.

d. Administration Costs

Expenses in relations to the administration of the department/site.

The budget prepared must be attached with detailed working papers substantiating all
items included in the budget.

The facilities manager of any commercial office building should prepare a budget at least on
an annual basis. This budget is based on projected income and expenses for the property,
including both operating and capital figures, and is used as a means to organize the
property’s value and performance. In addition, annual budgeting allows the property
manager to discover trends in expenses, notice recurring or unusual items, and create
realistic future performance projections.

Steps in Creating Facility Budget

Through these steps, a facilities manager can create a facility budget:

1. Determine the gross potential income of the facility. This is the maximum
amount of income that a facilities manager can expect to gain from the project.

2. Itemize instances of miscellaneous income (if any). Unfortunately, these causes

are often not consistent incomes, and they can be very difficult to forecast and
add to the budget on a month-to-month or even yearly basis.

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3. Calculate the gross income. Once all of these determinations are in place, it is
possible to calculate the effective gross income that can be used for the overall
budget.

4. This is the amount of money that effectively comes into the project and that can
be used in the official facility budget.

5. Take into account the facility’s expenses. The effective gross income calculation
is just half of the budget. Once the total income for the project is known, it is
time to take the expenditures into account. The facilities manager should begin
with the Cost of sales element. These are the direct costs that are attributable in
completion of the activity or assets. After determining the Cost of sales element,
we will derive at the gross profit or loss for the particular project.

6. Then, calculate basic operating expenses for the facility. These are all the costs
that are associated with the maintenance and use of the entire project. For
example, the cost of materials, tools, the costs for the building’s utilities
including electricity, water, Internet, and telephone, should all be included. In
addition, the facilities manager must try to estimate the average repair and
maintenance costs for the facility. This includes taxes, insurance, and any other
management fees incurred by the office building. Finally, expenditures
associated with the administration and payroll of those who handle the entire
commercial property must be taken into consideration.

7. Next, we can determine the facility’s net operating profit or loss.

Once the facilities manager has overall calculations for the effective gross profit
and operating expenses, it is possible to find the net profit or loss. The net profit
or loss is calculated by subtracting the operating expenses from the effective
gross profit or loss derived earlier part of the budget. A positive figure indicates
that the facility budget is working effectively.

8. Find the facility’s capital expenditures (CAPEX). Capital expenditures are costs
associated with improvements that will affect the appearance and functionality
of the property, such as a new heating system or a renovated façade. These are
one-time expenses, unlike operating expenses. It is advisable that some money
be put away into one of these accounts each month as a type of security system.

9. Keep detailed reports and records for future use. An effective facilities manager
keeps meticulous records for the current and future budgetary needs of the
commercial property. A chart for accounts should be kept each month that
itemizes the different types and amounts of income and operating expenses. Not
only will this help with tracking the monetary amounts, but it will also make it
clear when income needs to be increased or expenses cut. The facilities manager

16
 should also maintain a monthly operating statement that demonstrates the
month’s actual income and operating expenses in a side-by-side comparison to
the projected budget.

In a particular FM contract, materials cost and outsourcing cost contributes a large

fraction of the overall operation cost. Second to the manpower cost, the materials cost
if not managed diligently will drastically affect the ability of the FM contractor to
perform their duties.

Tools and materials procurement should be anticipated and budgeted. The followings
are some examples of important planning factors:

• Quantities of material

Correct material quantities based on work program requirement must be ensured.

• Rate/price for materials, tools and services

It is vital to get suppliers who provide not only the best price but also with good
reputation, efficient service and attractive terms of payment.

• Manpower/labour cost

A good FM contractor will be able to carry out innovative practices such as

selection of materials and tools that are not labour intensive in order to keep
overall cost low.

• Plants & machineries requirement

FM contractor should consistently observe on specific requirements that may turn

out to be fatal if neglected in the tools and materials procurement planning.

• Contingency sum
A good FM budget will include allocations for unforeseen circumstances that may
occur during execution of work program.

17
 XYZ COMPLEX
Facilities Management Budget
1st Year 2nd Year 1st Year 2nd Year
Yearly Yearly Monthly Monthly
Budget Budget budget budget
SALES/REVENUE
XYZ Complex FM Contract
VO Work / LCC
Other Income
Total Sales/Revenue

COST OF SALES
1- Preliminaries
Bank Guarantee
Insurance
Levy
Pre-requisite Machineries &
Equipment
Sub-Total Preliminaries

2- Manpower
Direct Labour
Sub-Total Manpower

3- Material &
Consumable
Material - Civil
Material - Electrical
Material - Mechanical
Sub-Total Material &
Consumable

4- Tools

18
 XYZ COMPLEX
Facilities Management Budget
1st Year 2nd Year 1st Year 2nd Year
Yearly Yearly Monthly Monthly
Budget Budget budget budget
Hand Tools
Shared & Special Tools
Sub-Total Tools

5- Services
Subcontract Services
Ad-hoc Services
Sub-Total Services

6- Operating Expenses
Administration Cost
- Bank Charges
- Brochures
- Entertainment
- General Insurance
- Office Supplies
- Interest Charges
- Licence - Walkie Talkie
- Licence - Genset
- Magazines &
periodicals
- Meeting refreshments
Utility
- Electricity
- Water
- Fixed Line
- Broadband

19
 XYZ COMPLEX
Facilities Management Budget
1st Year 2nd Year 1st Year 2nd Year
Yearly Yearly Monthly Monthly
Budget Budget budget budget
Travelling
- Flights
- Mileage & Fleet Card
- Parking & Toll Fees
Sub-Total Operating
Expenses

7- Capital Expenditures
Office Renovation
Testing Equipment
Sub-Total Capital
Expenditures

8- Contingency Sum

TOTAL COST OF SALES

GROSS PROFIT
GP MARGIN, %

NET PROFIT
NP MARGIN, %

Table 1: Budget Plan for Facilities Manager Template

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3.0 PREPARE FINANCIAL MANAGEMENT PLANNING (FMP)

3.1 Fundamental Principles of Financial Management

Financing is all about creating value. It is about making smart decisions and leveraging
assets to allow an organization’s workers to be productive without disruption. Facilities
Management’s (FM’s) overall goal is to take care of the physical assets of the organization,
avoid disruption to ongoing business operations, and leverage (extend the life of) assets.

Leveraging involves financial management skills and, in the facility world, focuses on two
main areas: capital project evaluations and operating budgets. Within these areas a wide
array of financial analysis and decision-making principles and tools can be applied to FM.
Facility renovation projects are always competing for capital dollars with other
departments’ projects. Facilities managers constantly evaluate the best buy between
competing alternatives. Difficult repair or replace decisions need to be made before a costly
repair is authorized. The return on investment for a new database or computer-integrated
facilities management (CIFM) system needs to be detailed. Many other facility applications
require financial analysis and management skills.

Most facilities managers report the operating and financial side of their organizations to the
Chief Financial Officer (CFO). It is the responsibility of the CFO to increase cash flow as
much as possible while reducing risk. If an asset is not continuously producing cash flow or
adding value, the CFO must take action. Underperforming assets can contribute to poor
overall performance and make an organization vulnerable. It is therefore essential that the
FM function be aligned with the overall organizational goals and with the CFO’s business
objectives.

Financial analysis must be done with a proper perspective. Although the financial side takes
priority in many cases, there are other considerations and priorities, such as operational,
safety, and political issues that may have higher priority than financial returns. It makes
absolutely no sense to do full-cost accounting and life cycle analysis for a project on a
building whose lease expires in the next two years. An important concept in all financial
analysis is the concept of the time value of money. This means that today’s liquid cash can
be put to work earning income and will be more valuable in the future than it is today. This
is the basic concept of economics that drives today’s financial markets.

21
3.2 What is Financial Planning?

Financial Planning is the task of determining how a business will achieve its strategic
goals and objectives. Usually, a company creates a Financial Plan immediately after
the strategic goals and objectives have been set. The Financial Plan describes each of the
activities, resources, equipment and materials that are needed to achieve these objectives,
as well as the timeframes involved.

The Financial Planning activity involves the following tasks:

• Assess the business environment

• Confirm the business vision and objectives

• Identify the types of resources needed to achieve these objectives

• Quantify the amount of resource (labor, equipment, materials)

• Calculate the total cost of each type of resource

• Summarize the costs to create a budget

• Identify any risks and issues with the budget set.

Performing Financial Planning is critical to the success of any organization. It provides the
Business Plan with rigor, by confirming that the objectives set are achievable from a
financial point of view. It also helps the CEO to set financial targets for the organization, and
reward staff for meeting objectives within the budget set.

The role of financial planning includes three categories:

1. Strategic role of financial management

2. Objectives of financial management

3. The planning cycle

When drafting a financial plan, the company should establish the planning horizon, which
is the time period of the plan, whether it is on a short-term (usually 12 months) or long-
term (2–5 years) basis. Also, the individual projects and investment proposals of each
operational unit within the company should be totaled and treated as one large project.

22
Project Financial Management includes the processes to acquire and manage the financial
resources for the project and, compared to cost management, is more concerned with revenue
sources and monitoring net cash flows for the construction project than with managing day-
to-day costs.

The processes of project financial management are:

• Financial planning,

• Financial control,

• Administration and records.

The Importance of Financial Management in Facilities Management

Financial management in any business is the key to success. In facilities management, not
allowing the budget to run away with itself, planning and reviewing spending is important.
There are many ways to keep tight financial control; these are our top 8 tips:

1. Have a business plan

There is no substitute for understanding where your money will need to be

targeted, how much of an emergency fund you will need and so on. The importance
of financial management is such that planned expenditure always means savings
over ad hoc expenditure.

2. Monitor your financial position

Once you have planned your expenditure, apportioned sub-budgets and the like,
you now need to monitor expenditure. If there is consistent over-spend on one
area, there is obvious need for change. Don’t forget facilities management will not
stay the same, thus your budget will need to change too.

3. Credit control

Cash flow is important in facilities management; if it stops flowing, it presents

significant issues. Credit control is more than just checking people have paid. It
should also be about being pro-active in reducing customer debts rather than
waiting for payment that may never come.

4. Knowing day-to-day costs

Facilities Managers should have a firm grasp on the day to day operational costs
they are responsible for. One key way to do this is to ensure all external costs via
suppliers are clearly agreed within a contract.

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 5. Up-to-date financial records

If you cannot lay your hands or eyes on the latest spreadsheet that gives you an
immediate financial snapshot of the business, then you are divorced from financial
reality. Of all the activities within the background running of your business, pro-
activeness when it comes to keeping financial records is without doubt, top
priority.

6. Increase efficiency in overheads

Every business has overheads and when the budget starts to bite, controlling
overheads can be the fastest way of saving money. Look at the average costs of
heating, lighting, and air conditioning etc., checking you has the best deals. Don’t be
lazy always check for better deals via benchmarking and competitive negotiations
with suppliers.

7. Tackle financial problems as they arise

Allowing financial difficulties to fester is clearly not the best means of financially
supporting and evolving facilities management. If there is a problem, deal with it.

8. Become financial astute

This means including financial management training as part of your own

professional development, and that of your employees.

In Summary

As a facilities manager it is likely that you will be responsible for the financial management
of the services you manage. Whether it be budgeting, forecasting, or reconciliation, to be
successful you need to be confident that you are managing the monetary aspects of your
services.

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3.3 Estimated FM Cost from FM Overall Budget Plan

3.3.1 The Goals of Finance and Accounting Principles

The goals of finance and accounting principles are to provide standardized tools that all
companies and finance managers can use, enabling comparisons between different
departments and companies. Success in decision making is enhanced by understanding the
financial impacts of various alternatives. While most companies have unique and
confidential financial goals, there are some financial goals that are common to all for-profit
companies:

• Lowest operating costs

• Highest revenue

• Maximize returns and profits

• Reduce risks

• Conserve capital

• Minimum turnover

Facilities managers must know and understand their company’s overall business plan their
role in the overall company’s goals. They must leverage their company’s physical assets in
pursuit of, and to add value to, these goals.

Many facilities management professionals view financial planning merely as an exercise in

preparing the annual operating budget and nothing more. However, the term financial
planning has more to do with predicting the return on an investment and preparing an
investment strategy than with allocating the existing budget to existing needs.

In general, facilities financial performance means how well a facility performs as a financial
asset. Measuring this performance will hinge on the approach you take to financial
planning. Your approach well help you establish a set of assumptions about what
constitutes good financial performance; these assumptions must relate to the facilities
function as well as to the financial structure of your company. Even slight changes to these
assumptions can create large differences in overall performance and how it is measured.

The approaches described below are not always mutually exclusive and can often be used
in conjunction with each other. Planning any major facilities proposal should include an
analysis of each method to see how it performs from each perspective.

25
3.3.2 Lowest First Cost Analysis

While other approaches to financial planning are based on the criterion of time, the lowest
first cost approach entails finding the lowest-priced item that meets your specifications at
the time you need it. This approach works best for a narrow set of circumstances.

• Many vendors supply the commodity you need and most brands are identical in
all major respects, such as size and quantity of pieces per package (for example,
white latex paint).

• Many vendors compete in a fairly stable market to ensure a steady source of

supply.

• Substitution of one brand for another can be made easily (for example, several
brands of paper towels fit in the same model of dispenser).

• An item can be precisely specified.

• The economic life cycle of the desired item is short or nonexistent. If an item
needs to last no more than two years but is built to last for 10 or 15 years, that
extra durability may not be of any value for its probable higher cost.

• There is no maintenance or operating costs associated with the item.

Common sense tells you when the lowest first cost strategy is the best choice. However, it is
not sufficient for all planning needs. Virtually any activity involving the provision of human
services involves quality issues that are almost impossible to quantify into an ironclad
specification. If quality matters, the lowest first cost approach cannot be relied on to
provide satisfactory results. Therefore, the specifications for such a facility must be well
defined and accepted to maintain a certain minimum standard of performance.

Yet, in a slow economy this approach becomes very appealing. If operating cash is scarce,
corporate executives may consider this the only viable approach. However, it almost always
results in higher long-term operating costs and higher total life cycle costs. For example,
buying the cheapest paint may justify lowest first cost from an accounting standpoint, but
buying higher-priced, more durable paint that will lower future maintenance and
housekeeping costs may make more sense functionally. These considerations are part of life
cycle cost analysis, which is discussed below.

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3.3.3 Life Cycle Cost Analysis

Life cycle cost analysis (LCC) is a construction-based decision method, not an accounting
method. There are three major cost categories in a life cycle cost analysis.

• Initial costs of acquisition of the asset - such as purchase, design, delivery,

installation, testing, reconstruction, and moving

• Ongoing expenses - such as utility, servicing, and maintenance costs that

continue throughout the life of system operation

• One-time future expenses - such as system calibration after commencing

operation, and major upgrades or overhauls that occur infrequently and
predictably during the life of the asset

Life cycle cost analysis should account for all costs and returns associated with an item over
its entire (economic) life cycle, including cost of removal and any salvage value obtained
when the asset is disposed of. It should also address associated personnel, energy,
maintenance, replacement, and other costs affected by the investment.

In addition to total costs, the life cycle cost approach considers the effect of time. It
considers the effects of inflation and the cost of any funding borrowed to acquire the asset if
the ROI (return on investment) is to be predicted accurately. This approach works best
when you compare the total lifetime costs of several options for solving a problem.
Therefore, this approach is valid for analyzing investments when long-term payback is a
major factor. The shorter the asset life, the less useful this method becomes.

When calculating life cycle costs, many factors are considered:

• determine the life expectancy of any product or project

• assess all costs and discounts, plus tax ramifications

• identify costs that are capitalized and those that are expensed

• estimate the inflation rate that will occur during the life of the project

• estimate the real interest rate during the life of the project

Installing complex or compound assets such as energy management systems can best be
justified by using life cycle costing. The cost of an energy management system is added to
standard electrical and mechanical equipment costs. To justify the additional cost, quantify
the savings that are produced in associated areas. Energy management systems and other
such products produce cost avoidance or cost savings after the payback period (explained
below).

27
Life cycle costing is also useful for producing documented information about longer-term
savings. Most products require some amount of maintenance to operate effectively over the
long term. Therefore, such costs must be considered when making a final product decision.

3.3.4 Cost-Benefit Analysis

Cost-benefit analysis asks: “Are the benefits of a project worth its costs?” Cost-benefit
analysis should be the method of choice if you must compare quantifiable (measurable)
with qualitative factors. It is not difficult to see that decisions made on the basis of
quantifiable costs or savings (avoided costs) are easier. This method is useful when
analyzing projects that involve physical improvements to tenant space but do not affect the
market or asset value of the property as a whole. It can even be used to support trade-offs
between cost related and qualitative factors. It should not be confused with life cycle cost
analysis, in which costs are assessed over an investments useful life, but not against its
benefits.

Not every quantifiable issue relates to cost. For example, specifications for computer
systems include many measurable elements that do not relate directly to cost, such as
amount of RAM, megabytes of disk space, and the clock speed of a chip, as well as software
features, such as the inclusion of automatic spell checking or advanced graphing capability.

To conduct a numerical comparison of hard and soft costs, you will need to apply relative-
weighted numeric values to qualitative factors and to costs. These numbers can be
manipulated to derive an overall score that indicates how well a given project or proposal
fulfills the department or company’s stated objectives.

When you begin any cost-benefit analysis, consider the following issues:

• Specifically, what is the project intended to accomplish?

• What conditions constrain or affect the project?

• What conditions might exist after the project is completed?

• Which conditions are controllable, and which are not?

• What performance requirements or time and cost criteria will be used to

evaluate effective project performance?

• What is the minimum acceptable level of performance in each category?

28
3.3.5 Hard Costs and Soft Costs

Hard costs are those associated directly with actual construction, leasing, maintenance, and
upkeep. Hard benefits are savings on revenues generated directly from these activities. Soft
costs and benefits are those related to the management of construction, leasing, and
maintenance and upkeep, such as overhead, fees, and management time. These distinctions
are not accounting or budgetary conventions but may figure prominently in the thinking of
executives who may be reviewing the project. As you plan for facilities projects, keep in
mind that the argument for some costs is more persuasive than for others.

• Most persuasive are hard costs or benefits that can be measured and attributed
directly to a specific activity, account, or client and charged and reimbursed (for
example, tenant improvement construction costs or savings for a specific space
or lease), especially if charged against gross sales to reduce tax liability.

• Also persuasive are hard costs or benefits that can be measured and are billable
but are not attributed directly to a specific project or customer and therefore are
allocated on a prorated basis and reimbursed (for example, overhead costs).

• Less persuasive are tangible but immeasurable soft costs or savings (for
example, projected savings in staff time that cannot be tracked or verified in a
practical way).

• Least persuasive are intangible and immeasurable soft costs or savings (for
example, improved quality of service) because evaluations are often subjective
or inconsistent.

It is more difficult to compare hard (quantitative) costs/savings to soft (qualitative)

costs/savings than to compare hard costs and savings to each other. The less measurable
something is and the more one mixes bases for evaluation (cost vs. time vs. quality, for
example), the more difficult comparison becomes. Consequently, project justifications often
present the strongest possible case in cost numbers first and treat other justifications as
secondary arguments.

The emphasis placed on the importance of hard or soft costs/savings depends on the
attitude of senior management. All cost analysis studies must be conservative. Even so,
many managers, while acknowledging that some projects do have soft costs and savings
associated with them, will discount them entirely because they are not as concrete as hard
costs or savings.

Facilities managers must understand many important financial concepts in order to

communicate effectively with corporate executives. Along with a thorough understanding
of the core business, these financial concepts are vital if facilities managers are to speak the

29
language of business and gain the confidence of corporate executives as genuine
contributors to corporate profitability and well-being.

3.4 Internal and External Financing Sources

3.4.1 Sources Of Funding

There are several options available in today’s market for source of funding, it includes:-

3.4.1.1 Overdraft (OD)

An overdraft is a facility given by a bank allowing a borrower to overdraw the current

account up to a pre-arranged limit for business use.

Usage - To meet working capital needs such as payment of salaries, purchases, utilities etc.

Features:

• Made available via current account.

• Interest is calculated on a daily basis on outstanding balance at the end of each

business day.

• A commitment fee of 1% is charged on the unutilized portion of the facility.

Benefits - Flexibility in funds management provided the facilities are properly conducted
and the business continues to operate satisfactorily Able to obtain a lower purchase price of
the goods and longer payment terms.

3.4.1.2 Factoring

Factoring is a flexible facility that allows business to convert credit sales into cash sales by
selling the invoices to a factoring company for immediate payment. With factoring, a
business can improve its short term cash flow.

Usage - To obtain short term financing of trade debts (sale of goods or services to
customers on credit terms). It is a method of raising funds against an invoice as soon as it is
raised rather than waiting the 30/60/90/120 days for the customer to pay.

Features - Financial institution purchases client’s trade invoices at a discount from the face
value of the invoices and provides cash advances for business purposes. The factor will
advances up to 80% of the value of the invoices factored. Interest of 2%-7% is calculated on
a daily basis on outstanding balance at the end of each business day.

30
Benefits:

• Quick and easy cash advances.

• No collateral required.

• Able to sell on more competitive terms to credit customers.

3.4.1.3 Letter of Credit (LC)

Letter of Credit is a letter from a bank guaranteeing that a buyer's payment to a seller will
be received on time and for the correct amount. In the event that the buyer is unable to
make payment on the purchase, the bank will be required to cover the full or remaining
amount of the purchase.

Usage - For import or local purchases of goods, materials or equipment

Features - A written undertaking by a financial institution to pay a seller a given amount of

money subject to the following conditions:

• On presentation of specified documents as set out in the terms and conditions of

the LC.

• Within a specified time limit.

• At a specified place.

Benefits

• Assures payment is made to the beneficiary.

• Able to obtain a lower purchase price of the goods and longer payment terms.

• Documents presented will be examined by trade financing specialists.

• Less communication with the foreign seller as the whole transaction will be
routed and handled by the financial institution.

31
3.4.1.4 Bankers Acceptance

Bankers Acceptance is a bill of exchange drawn by customers to their order, payable on a

specific future date and accepted by the bank on behalf of their client for the purpose of
financing trade transactions. It is a discounting instrument and interest is paid upfront by
deducting from the principal amount.

Usage - Financing of a bona fide trade such as export, import or domestic trade transaction.

Features

• A draft drawn by customers to their order, payable on a specific future date and
accepted by the financial institution.

• Minimum amount of financing is RM50,000 and in multiples of RM1,000.

Benefits

• Provides cash flow before proceeds for sale of goods on credit can be collected
or to finance purchases of raw materials for production.

• Can be sold at the prevailing market rate should the customer need immediate
funds.

• Provides two-way financing.

3.4.1.5 Revolving Credit (RC)

Revolving Credit is a line of credit that has a determined and agreed repayment period.
Upon maturity of each drawdown, repayment can be made in full or it can be rollover for
the amount and tenor required subject to servicing of interest.

Usage - Short-term in nature to meet short-term working capital requirements

Features:

• A form of loan granted for a fixed period usually 1 to 6 months.

• Convenient for companies with good financial standing

• Drawdown by means of letter from the company to the financial institution

stating the period of the loan required

• Company can either repay the full amount upon maturity or renew the loan
tenure by servicing the interest at the end of the loan period.

32
Benefits:

• Lower financing costs.

• Continuous availability of funds.

• RC does not have commitment fee on the unutilized portion.

3.4.1.6 Term Loan (TL)

Term loan is a fixed amount of loan granted for a period of time and repayable in fixed
installments. Term loan is suitable for asset acquisition.

Usage - To acquire fixed assets such as land and buildings as well as commercial vehicles
and machineries to be used for the contract.

Features - A loan granted for predetermined length of time with repayments by

installments.

Benefits - Facilitate management of funds as repayment amount is predetermined.

3.4.1.7 Leasing

Leasing is defined as a written contract entered into between a lessor (the leasing
company) and the lessee (user of the equipment) where the lessee agrees to pay the lessor
a specified sum of rental over a period of time in consideration for the use of equipment
owned by the lessor. There are two kinds of leases. A capital lease is long-term and
ownership of the asset transfers to the lessee at the end of the lease. An operating lease, on
the other hand, is short-term and the lessor retains all rights of ownership at all times.

Usage - To acquire capital assets such as equipment and machineries

Features - Enable Company to have access to the equipment without having to purchase
the equipment in return for regular lease payments over a specified period.

Benefits:

• Facilitate management of funds as leasing installment amount is predetermined.

• Installments paid are eligible for full tax relief.

33
3.4.1.8 Banker’s Guarantee (BG)

Banker’s Guarantee is a promise made by a bank (guarantor) to pay the beneficiary a

certain sum of money within a specified period if the applicant (principal) fails to fulfill the
contractual or other obligations of an underlying transaction.

Usage - Provides guarantee favoring a third party for performance, payment, etc.

Features -

Typical types of guarantees:

• Tender Guarantee or Bid Bond

• Performance Guarantee

• Advance Payment Guarantee

• Warranty of Maintenance Guarantee

• Retention Guarantee

• Security Guarantee

Benefits:

• Shows the customer's/applicant's capability to perform work as specified in the

contract.

• Able to obtain more favorable trade terms from the beneficiary if a BG is

produced.

• No necessity to raise cash to meet deposit requirements and funds could be used
to support working capital requirements.

• Allows customers to have access to funds especially where BG is issued for

advance payment or release of retention funds under contracts.

• It has low charges from 0.6% - 2.25% p.a.

34
3.4.1.9 Accounts Payable (AP)

Account Payable is money which a company owes to vendors for products and services
purchased on credit. Accounts payable are current liabilities incurred in the normal course
of business and appear on the balance sheet.

Usage

AP is a recurring financing source for credit-worthy companies since it comes from normal
operations by stretching payment to suppliers.

Features:

• Accounts Payable is balances owed by the company to suppliers.

• Least expensive form of financing activity.

Benefits - It is readily available, requires no collateral and interest charge.

3.4.2 Loan Application Process

Generally there are three stages in the loan application process:

Stage 1:

Preparing the business plan

Business plan helps to provide the financial institution with full and complete information
of the company. Business plan should be clear, simple and concise.

Stage 2:

The application processes

Each financial institution has a different loan application forms and loan application
checklist. It is important that the forms are duly completed and all relevant documents
required are available before submission to the bank.

Stage 3:

Assessment of the loan application

After submission of the required documents, the financial institution will assess the loan
application.

35
3.5 Cost of Financing According to FM Scope of Services

Cost of funds is the cost associated with borrowing moneys. The effective cost of fund
includes processing fees, interest rate and incidental costs i.e. professional fees and stamp
duty.

The interest rate is the lender's charge for the use of their money. The interest rate is
usually expressed in terms of a percentage of the amount loaned on a per annum (p.a.)
basis. The interest charged is mostly on a compounding basis (i.e. interest-on-interest) and
could be either on an annual/monthly/daily compounding basis (another term used is
yearly/monthly/daily rest.)

There are two different types of interest rates: fixed or variable.

Fixed rates are: fixed and unchanging. If your fixed interest rate is 6% p.a., it will be 6%p.a.
for the entire tenure of the loan.

Variable rates can change over time and are usually pegged on a standard market rate, such
as the Base Lending Rate, BLR (current BLR = 6.75%). For instance, you may take out a loan
with a variable rate at BLR + 1%. This means that you'll pay one percent more than the BLR,
or a total of 7.75% p.a. Base Lending Rate (BLR) is a base interest rate calculated by
financial institutions according to a formula which takes into account the institutions cost
of funds and other administrative costs.

3.6 FM Revenue Trend Planned According to FM O&M Activity

3.6.1 On-going Facility Finances

Not only can capital and major repair projects benefit from LCC and ROI analyses, the daily
operations of the facility can also benefit from financial analyses. Conversely, daily FM
operations need to accurately track and provide good data for major repair and capital
project financial analyses.

Three major areas that impact financial analysis and are important for FMs in keeping
accurate data are:

• Asset inventories

• Computer-integrated facilities management (CIFM)

• Contracts

36
3.6.2 Updating Asset Inventories

A fundamental part of ongoing facilities management is maintaining an accurate inventory

of physical assets. Keeping the asset database updated is fundamental to conducting valid
condition assessments and essential in providing data for all financial budgeting and
analysis. The physical workplace is a dynamic, ever-changing world. Physical assets are
continually being switched around, replaced, removed, or eliminated. Some of these
changes are minor, others are major most changes are insidious. Changes to physical assets
occur during renovation projects and during major repairs. Facilities managers need to
track these asset inventory changes on a continual basis. Consider these two on-going
changes:

• When a 100’ x 100’ turf area in the landscaping is converted to a patio or

parking area that’s a 10,000 sq. ft. reduction in turf maintenance and a 10,000
sq. ft. increase in sweeping or pavement care inventory.

• One of the most insidious inventory changes occur when electricians add duplex
outlets or other minor electrical changes for customers these small changes can
add up to electrical phase imbalances and potentially overload circuitry.

While this change may not seem significant, it is the constant repetition of these small
changes that end up as major changes to your asset inventory. Unless the facilities manager
keeps track of all these small changes, the accuracy of the physical assets database is
reduced and eventually will be so inaccurate that it is rendered useless and would require
an overall asset inventory count to be retaken a timely and expensive process.

As stated in asset inventory, a process to update the physical assets needs to be in place.
For small facilities, this is relatively straightforward. For large conglomerates, this is a time-
consuming process, but even more important. This updating process needs to be kept going
throughout the life of the facilities to ensure proper replacement cycles and reliable
operation. The updating process can include simple changes, such as including physical
asset coding on work orders and contractor invoices. It may involve bar coding and
scanning technology.

3.6.3 Contract Pricing Issues

Every facility requires some contract labor to keep it operational. Whether the function is
entirely outsourced, or only one general contractor is used for special, occasional work;
supplier management and contract issues require some knowledge of pricing.

There comes a time in every contract negotiation or outsourcing initiative when pricing and
financial issues are considered. Sometimes special financial analysts are brought in internal
support analysts, auditors, or third party external analysts. The overall intent of contract

37
financial analysis needs to be clearly stated up front: What is the goal or purpose? Is this
analysis being performed before, during, or after a contract or outsourcing service is
provided? If before, then the intent may be to compare internal to external costs and will
influence the outsourcing initiative. If during an ongoing contract, then the intent may be to
compare cost savings and benefits, or to verify contract performance. If after, then the
intent may be to focus on the contract renewal pricing and work scopes, or to perform a
post mortem of lessons learned.

a. Getting Started

The basic steps in any facility financial analysis are to collect internal and external
costs, total them, compare them, and project them along their life-cycle future costs.
As discussed earlier in this chapter, in the initial collection stage it is important to pull
together ALL costs that are associated with a specific work activity or service. There
are many hidden and unassociated costs that are impacted by facility operations and
these may need to be included as well.

The next step is to decide: For what time period will data be reviewed? Will it be for
the previous fiscal year (most common)? Will it be for the last six months or three
months? Whatever time period is chosen, internal and external operational data
collection need to follow these minimum criteria:

• Substantially stable operation over entire period

• Complete financial data and details available

• Data accurately captured over entire period

• Consistent operation throughout the period (no work stoppages, etc.)

Once the time decision is made, the work scope boundaries need to be specified.
Financial analysts may collect the above data for each specific trade or work activity.
This is usually very cumbersome and difficult. Most organizations do not track
detailed costs for each separate work activity. Costs are usually lumped into general
categories such as HVAC, electrical, carpentry, workstations, general administration,
and so forth. If the categories cannot be compared fairly to external services, then it
will be difficult to have a fair and equitable outsourcing analysis. Some companies use
their CIFM systems to provide this detail and embark on a 3–6 months’ time period in
which they collect all the data and required details.

38
Next, for the selected time period the following are added together for the specified
work scope:

Internal

• Labor costs

• Material and equipment costs (purchases, leases, rentals)

• Stores inventory (carrying costs)

• Travel (fleet costs if applicable)

• Warranty costs

• Training

• Administrative

• Insurance

External

• Supplier labor costs

• Material and equipment

• Mark-ups and profit margins

• Subcontractor costs

• Bonding, insurance

Support

• Occupancy costs ($/sq. ft.)

• CIFM maintenance

• Purchasing, procurement

• Administrative

39
 The reason to break down the costs in detail is to allow for easier comparisons now
and in the future. It is difficult to go back and break down lump costs unless they were
rolled up initially. For example, labor costs may be comparatively similar, but support
cost comparisons may be way out of line and warrant further investigation.

b. Crank and Grind

Once financial analysts have prepared this data collection then it is time to crank and
grind. First, they look at the current proposals from outsourcers or what the current
outsourcer’s performance has been, and then look at comparative internal
performance. Comparative analysis can include straight-line analysis; that is,
subtracting one from the other over time, or could involve NPV (net present value)
and RONA (return on net asset) conversions.

c. The Downside

For those in the FM operations business, there is one major downside to financial
analysis: it deals strictly with the financial risk. It does not take into account health
and safety risks or operational risks. Seldom is any consideration given to market and
competitive conditions or to customer satisfaction. Most financial analysts do not
know the difference between an HVAC and a UPS system nor what is the right amount
of preventive maintenance for either system at different usage and aging patterns. It is
the facilities manager’s responsibility to make sure that these issues are not drowned
out by the financial background noise. Internal costs are sometimes misleading. They
do not take into account market conditions and are hamstrung by internal overhead
and administrative loading. External costs can also be misleading: a supplier may not
be billing the true cost of providing the service (loss leaders, etc.).

3.7 Financial Management Planning (FMP)

The financial model is a technique for risk analysis and “what-if” method that is used to
calculate, forecast or estimate financial numbers that helps the company in making decision
regarding investment in a project. The model is also needed for day-to-day operational and
tactical decisions for immediate planning problems. Spreadsheet like Microsoft Excel and
computer-based financial modeling software are being widely utilized because of its many
mathematical formula features and built-in financial functions for budgeting and planning
to speed up the budgeting process and allow budget planners and nonfinancial managers to
investigate the effects of changes in budget assumptions and scenarios.

40
Financial models are normally used for:

• Projecting financial results under any given set of assumptions, evaluating the
financial impact of various assumptions and alternative strategies, and
preparing long-range forecasts.

• Forecasting the balance sheet and income statement with emphasis on

alternatives for the investment securities portfolio.

• Projecting operating results and various financing needs, such as new projects
and financing requirements.

• Generating profitability reports of various sites.

• Projecting financial implications of capital investment programs.

• Showing the effect of various volume and activity levels on budget and cash flow.

• Forecasting corporate sales, costs, and income by division or and by month.

• Determining pro forma cash flow for future projects.

• Analyzing the impact of an acquisition on company earnings.

• Determining economic attractiveness of new projects.

• Evaluating alternatives of leasing or buying equipment.

• Generating income statements, cash flow, present value, and discounted rate of
return for potential sales forecasts.

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4.0 MANAGE PROJECT PROFIT AND LOSS (P&L)

4.1 Introduction to Basic Accounting

Accounting is the art of recording, summarizing, reporting and analysis of financial

transactions of a business. Accounting, it can be a complete record of all the activities of a
business, providing details of every aspect of the business, allowing the analysis of business
trends, and providing insight into future prospects.

Analyze
Recording
financial
data
transactions

THE BASIC OF
ACCOUNTING
CYCLE

Reporting
financial Summarize
statement data

Figure 1: The Basic of Accounting Cycle

The accounting cycle is typically one year. An accounting cycle may not equal one year for
newly formed companies or companies changing the ending date of their fiscal year.

Project accounting (sometimes referred to as job cost accounting) is the practice of creating
financial reports specifically designed to track the financial status of projects, which can
then be used by managers to manage the project.

Project accounting is commonly use for contractors, where the ability to account for
revenue & costs by project. This project financial data can be used for monitoring and
analyze progress for each project.

Some of the basic accounting terminologies are as follows:

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4.1.1 Balance Sheet

Balance sheet is the summary of assets, liabilities and equity of the business at a particular
point of time. It shows the business resource structure and its capital structure. It is used to
measure liquidity, solvency, financial flexibility, risks and the sources of funds for the
assets.

Part 1 – Assets

Assets consist of Current Assets and Long Term Assets. Assets are financed by Liabilities
and Equity. Assets are presented in descending order of liquidity.

Current Assets – Assets that could be reasonably converted into cash within the normal
operating cycle or one year. Current Assets include cash, accounts receivable, short term
deposits, inventories and other liquid assets.

Long Term Assets – Assets that cannot be readily turned into cash or mature more than a
year in the future. It usually has a long-term useful life that a company uses to make its
products or provide its services. Long Term Assets include Fixed Assets, Long Term
Investments and intangible Assets e.g. goodwill and patent.

Part 2 – Liabilities

Liabilities consist of Current Liabilities and Long Term Liabilities. It is presented in

ascending order of time to maturity.

Current Liabilities – Liabilities that the company expects to pay within the normal
operating cycle or one year. It is usually paid by utilizing Current Assets. Current Liabilities
include accounts payable, accrued expenses, advances, overdraft and other short term
payable. The portion of long term liability that is due within one year is also included as
current liabilities.

Long Term Liabilities – Liabilities that must be paid over a period beyond one year. It
includes lease, hire purchase, bank loans, bond repayments and other items due in more
than one year.

Part 3 – Equity

Equities are the owners’ interest in the company. Ownership is represented by share capital
and retained earnings. Share capital is the amount for which the shareholder initially
purchased. Retained earnings are the portion of net income which is retained by the
company rather than distributed to its owners as dividends.

43
4.1.2 Profit and Loss

Profit and Loss is the summary of revenues and expenses of a business over an accounting
period of one year. It shows the result of the company’s normal operations and gains or
losses from other activities. It indicates how the revenue is transformed into the net
income. The purpose of the Profit and Loss is to show managers and investors whether the
company made profit or loss during the reported period.

Part 1 – Revenue

Also known as sales or turnover is income that a company receives from its normal
business activities. In the case of Facilities Management, it is the invoice amount of Services
rendered to customer. There are some cases that FM can get income from extra services
rendered through Variation orders. A variation order is work that is added or omitted to the
original scope of work of a contract, which alters the original contract amount or
completion date. A variation order provides flexibility to the original contract so that
unforeseeable tasks or events can be addressed in a legally binding way. It enables
contractors and Facilities Manager to complete a job in a way that is mutually desirable to
both parties. Variation orders must be confirmed in writing and are therefore just as legally
binding as the original contract.

Part 2 – Cost of Sales

Represents the cost of services rendered including direct labor, materials, outsource
services, tools and other direct cost.

Gross profit - represents the difference between revenue and the cost of sales.

Part 3 – Expenses

Administrative Expenses - Administrative Expenses account comprises a company's

operational expenses. It is the sum of all direct and indirect selling expenses and all general
and administrative expenses of a company. Management generally exercises a great deal of
control over this expense category. The trend of administrative expenses, as a percentage of
sales, is monitored closely to detect signs, of managerial efficiency.

Finance Costs - This item reflects the costs of a company's borrowings.

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4.1.3 Cash Flow

A financial statement that is prepared using various assumptions to show how cash flow in
and flow out over a specified period of time to indicate whether the cash receipts is
sufficient to cover the cash disbursements.

The Cash Flow Statement shows how cash has flowed in and out of the business. In other
words, it describes the cash flow that has occurred in the past.

4.1.4 Debtors and Creditors

Debtors or Accounts Receivable represent cash amounts due to be paid by customers who
have purchased goods/services from the company. Lower “Debtor days” means cash is
being received faster from customers. Debtors are classified as current assets assuming
that they are due within one year.

Creditors or Accounts Payable refers to customers/suppliers to which cash is owed. Higher

“Creditor days” means cash remains in the company for longer. Creditor’s entry is found on
a balance sheet under the heading current liabilities.

Debtors and Creditors ageing show the number of months of outstanding payment from/to
the debtors and creditors. It also shows the last payment received and made respectively.

4.1.5 Variance Analysis

Variance analysis is a report used to analyze actual against budget. The report is used by
management to monitor the project financial status. A negative variance in revenue
portions indicate that project revenue for that particular period is less than the budgeted. A
negative variance in cost of sales and administration expense portion indicate saving. This
analysis is prepared for Profit & Loss and Cash Flow statement.

4.1.6 Horizontal Analysis

Income statements and balance sheets report on either a 12-month period or a single date
in time. As a facilities manager, you should be able to look at any single year and
understand what the expense ratio of, for example, maintenance costs is to total revenues
of the business.

But knowing a single year is not enough. Calculating that ratio for prior years is also
important. Knowing the level of maintenance expense to total revenue of your business is
helpful, but you also want to know whether or not you’ve improved in that area over time.

45
4.1.7 Understanding Common Ratios

Three categories of ratios are important to understand in order to be an effective financial

communicator and to be able to talk the common language of finance.

The first category is the revenue ratio, also called a turnover ratio. Some examples include
revenues per unit, revenues per employee, and revenues to total fixed assets.

The second category is the margin ratios, or profitability ratios. One example of a margin
ratio is an expense ratio, where an income item, such as maintenance and repairs, is divided
into total revenues.

Return ratios are the third type of ratio. These are the ultimate way that people judge
businesses. Three universally accepted formulas are used to measure overall financial
performance:

• ROA (Return on Assets) is the net profit after taxes divided by the total value of
assets employed to generate income. This calculation does not consider interest
paid to creditors and therefore works best for owned assets with no financing.

• ROI (Return on Investment) is the total profit divided by the total amount
originally invested to gain a profit. This method gauges performance of an
investment based on total money invested, including both direct capital
contributions and borrowed funds.

• ROE (Return on Equity) is the net profit after taxes divided by the net worth,
yielding the total percentage of equity gained through an investment. This
method shows the earning power of the shareholder’s book investment and is
frequently used to compare overall corporate performance when an investor is
considering which stock to buy.

Although these methods evaluate overall performance, in practice, investors are concerned
about different aspects of performance, depending on their needs and circumstances.
Several more detailed tools are used to evaluate actual financial performance. Even from
these simple formulas, it is apparent that there are many ways to measure return
(investment performance). Facilities managers striving to obtain funding for major
initiatives will have greater chances of success if they know and understand which methods
are most accepted and meaningful to those evaluating proposals.

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4.1.8 Ratios Simplified

Ratios do not have to be complicated. The key is to make the number on the top as big as
possible and the number on the bottom as small as possible to get the best results. You can
create all kinds of ratios to figure out what’s important in your business and drive it that
way.

Be creative. Figure out different ways to clearly quantify your facilities operations. From an
operational perspective, janitorial cost per square foot may not be as relevant as janitorial
cost to the number of people in the building. Applying the right ratio can give you an
entirely different way to manage a particular line item. You may then be able to come back
and show that even though the janitorial expense is going up per square foot, the fact that
you’ve been able to fit twice as many people in that building actually means the janitorial
costs per employee in that building has gone down.

As a facilities manager, you can be a business hero by showing that you are driving up the
profits that you already have or reducing the amount of assets that it takes to generate
those profits.

4.2 Project Profit and Loss Projected Based on Project Activity

As a company owner, you need a profit and loss statement that conveys information in a
format that will identify how much you are truly making as a profit. The best format is a
construction profit and loss statement identifying contract revenues, direct costs, indirect
costs and the overhead expenses.

At the end of the day, it is about the profit you make to your company. This format will
point out where the problem is located and where the best performance occurs. When we
look at a P&L, we want to quickly identify issues and concerns and get them addressed. If
we use this format along with the project accounting reports, not only will we quickly
discover any problems, but we can actually pin point the underlying issues and get them
resolved. This will add thousands of dollars to our bottom line.

The profit and loss statement has four major sections: revenue, direct costs, indirect costs
and overhead. Each section is described below and the profit and loss statement is
illustrated as each section is described.
• Revenues
• Direct Costs
• Indirect Costs
• Overhead

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4.3 Revenues

There are two methods to recognize revenue. The first is the percentage of completion
method and the second is the completed contract method. Both are acceptable methods
and each has their own respective advantages.

4.3.1 Progress Claim Method

As the contract progress, the FM recognizes the revenue as he completes certain milestones
(normally progress claim statement will be stated in the contract). If the project is 20%
complete, then we will recognize 20% of the revenue for the project and then recognizes
20% of the associated costs. This is a bit more difficult to manage as it requires a more
sophisticated form of accounting and a higher level accountant to compile the dollar values
associated with this method.

4.3.2 Completion of Contract Method

This method recognizes all the revenue based on completion of the contract. This method
posts the revenue and direct costs to the profit and loss statement at the termination of the
project. This method keeps the accounting simple and there is no need to hire or retain
highly educated staff to perform accounting duties. This is really the best method for really
small construction contractors.

4.4 Direct Costs (COS)

Direct costs are those costs that can be directly identified to a project. There are five
subsections of direct costs, they are as follows:

• Materials – self-explanatory and directly assignable to a particular project

• Sub-Contractors – to make this easier for accounting purposes, have the sub
send a separate invoice for each project he works

• Labor – in-house labor assigned to a project

• Other –preliminary expenses, travelling, interest charges from the bank, direct
insurance assignable to the project, bonds, and other

It is important to understand that these are costs that were directly incurred because of this
project. Be sure to include the gas for the generator used on site, the port a john, and re-
inspection fees in the ‘other’ line. Any cost that can be directly traced to a particular project
should be included in direct costs.

48
Notice that direct profit is total revenues less direct costs. This should be similar to what
your estimating software has as the profit on the project. If they are not closely aligned,
then you should identify the discrepancies in order to make changes and improve the
company’s bottom line.

4.5 Indirect Costs

This is one of the more difficult areas for most contractors to understand. Simply put, those
costs incurred to get more than one project done i.e. directly benefit the project and are not
office related, are considered indirect costs. The following identify and describe the
respective types of costs:

• Management – your personal payroll and the payroll of project managers if they
manage more than one project at a time are included here. If the project manager’s
time can be directly assignable to the project, then his payroll costs should be in the
labor section of direct costs.

• Payroll Taxes and Benefits – those taxes and benefits directly associated with the
labor in the field.

• Transportation – all costs associated with the vehicles and trucks broken out into
sub accounts as follows:
o Depreciation
o Fuel
o Repairs and Maintenance
o Insurance

• Communications – cell phones, internet, regular phone lines.

• Equipment – the depreciation and the direct costs of the equipment used in the
field; rental equipment is included in other direct costs because that piece should be
easily identified to the project.

• Insurance – workman’s compensation, general liability, bonds (general bonds, if the

bond is directly associated with a project it should be in the other direct costs
above).

• Tooling & Supplies – general tools purchased for the company and general supplies
that are used several times over in different projects. Examples include the
environmental barriers, signs, stakes, yard tools etc.

49
The key difference between direct and indirect is the sharing element. If the cost cannot be
directly associated with a single project, then it is shared among two or more projects and
therefore is considered an indirect cost.

4.6 Overhead

These costs are general in nature and usual involve those costs associated with the front
office. These include the payroll associated with the office, secretary, bookkeeper, cleaning
staff etc. Other costs include rent, utilities at the office, professional services from the
lawyer (not contract related), the accountant, banking fees, office supplies, postage, and
marketing.

The final report should identify the four major sections and the associated costs. The
bottom line reports the final profit earned from the operations of the company. The final
report will look similar to the following example:

XXX SDN BHD

PROFIT AND LOSS STATEMENT
FOR THE YEAR ENDED YYY

Sales -
Facilities Management Service- Contracted ZZZ
Variation Order Work ZZ
Total Sales ZZZZ
Less: COST OF SALES
Direct Labour HHH
Materials HH
Tools -
Services - Adhoc HH
Travelling HH
Sub Con Services-Monthly Contracted HHH
HHHH
GROSS PROFIT/(LOSS) WWWW
OTHER INCOMES
Interest Income -
Others -

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 -
OPERATING EXPENSES
Administration Expenses UUU
Utility UU
Human Resources UUUU
Travelling -
Interest Expenses & Bank Charges -
Depreciation UU
UUU
NET PROFIT/(LOSS) SSSS
TAXATION
Taxation -
NET PROFIT/(LOSS) AFTER TAXATION SSSS

4.7 Revenue and Expenditure Management

Expenses are center stage in daily operations, budgeting, planning, and financial reporting.

Expense is an accounting and budgeting term used commonly to refer to anything that
causes spending. More precisely and more broadly, however, accountants define expense as
a decrease in owner’s equity caused by using up assets. Spending on employee wages, for
instance, is an expense because it uses up cash assets.

The broader definition also covers non-cash expenses, such as depreciation or bad debt
expenses. However, every expense event cash or non cash calls for an impact on an expense
category account.

Sections below further define, explain, and illustrate expense. Note especially that the term
appears in context with related terms and concepts from the fields of budgeting, cost
accounting, and financial accounting, including the following:

• Expenses

• Cost

• Operating Expense OPEX

• Depreciation Expense

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 • Bad Debt Expense

• Cost of Goods Sold

• Operating Expenses

• Financial Expense

• Capital Expenditure CAPEX

Budgeting is the most effective way to control your cash flow, allowing you to invest in new
opportunities at the appropriate time.

If your business is growing, you may not always be able to be hands-on with every part of it.
You may have to split your budget up between different areas such as sales, production,
marketing etc. You'll find that money starts to move in many different directions through
your organization - budgets are a vital tool in ensuring that you stay in control of
expenditure.

A budget is a plan to:

• control your finances

• ensure you can continue to fund your current commitments

• enable you to make confident financial decisions and meet your objectives

• ensure you have enough money for your future projects

It outlines what you will spend your money on and how that spending will be financed.
However, it is not a forecast. A forecast is a prediction of the future whereas a budget is
a planned outcome of the future - defined by your plan that your business wants to
achieve.

4.8 Creating a Budget

Creating, monitoring and managing a budget is key to business success. It should help you
allocate resources where they are needed, so that your business remains profitable and
successful. It need not be complicated. You simply need to work out what you are likely to
earn and spend in the budget period.

Begin by asking these questions:

• What are the projected sales for the budget period? Be realistic - if you
overestimate, it will cause you problems in the future.

52
 • What are the direct costs of sales – i.e. costs of materials, components or
subcontractors to make the product or supply the service?

• What are the fixed costs or overheads?

• You should break down the fixed costs and overheads by type, e.g.:

• Cost of premises, including rent, municipal taxes and service charges

• Staff costs –e.g. wages, benefits, Insurance Plan premiums and contributions to
the Pension Plan

• Utilities – e.g. water, electricity, telephone

• Printing, postage and stationery

• Vehicle expenses

• Equipment costs

• Advertising and promotion

• Travel and subsistence expenses

• Legal and professional costs, including insurance.

Your business may have different types of expenses, and you may need to divide up the
budget by department. Don't forget to add in how much you need to pay yourself and
include an allowance for tax.

Your business plan should help in establishing projected sales, cost of sales, fixed costs and
overheads, so it would be worthwhile preparing this first. See the page in this guide on
planning for business success.

Once you've got figures for income and expenditure, you can work out how much money
you're making. You can look at costs and work out ways to reduce them. You can see if you
are likely to have cash flow problems, giving yourself time to do something about them.

When you've made a budget, you should stick to it as far as possible, but review and revise
it as needed. Successful businesses often have a rolling budget, so that they are continually
budgeting, e.g. for a year in advance.

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4.9 Corrective Action Planned According to Activity Report

Variance report analysis is the quantitative investigation of the difference between

actual and planned behavior. This analysis is used to maintain control over a business.
For example, if you budget for sales to be $10,000 and actual sales are $8,000, variance
analysis yields a difference of $2,000. Variance analysis is especially effective when you
review the amount of a variance on a trend line, so that sudden changes in the variance
level from month to month are more readily apparent. Variance analysis also involves
the investigation of these differences, so that the outcome is a statement of the
difference from expectations, and an interpretation of why the variance occurred. To
continue with the example, a complete analysis of the sales variance would be:

"Sales during the month were $2,000 lower than the budget of $10,000. This variance
was primarily caused by the loss of ABC customer at the end of the preceding month,
which usually buys $1,800 per month from the company. We lost ABC customer
because we had several instances of late deliveries to it over the past few months."

This level of detailed variance analysis allows management to understand why

fluctuations occur in its business, and what it can do to change the situation.

Here are the most commonly-derived causes of variances in Facilities Management:

• Inefficiency of operation

• Inappropriate use of overtime/agency staff

• Original budget bid/costing was incorrect

• Contract/service over specified

• Increase in supplier costs

• Poor communication of budgetary goals

• Action of other departments and external forces

• Random fluctuations (clerical or typographical errors)

It is not necessary to track all of the preceding variances. In many organizations, it m ay

be sufficient to review just one or two variances. For example, a services organization
(such as a consulting business) might be solely concerned with the labor efficiency
variance, while a manufacturing business in a highly competitive market might be
mostly concerned with the purchase price variance. In other words, put most of the
variance analysis effort into those variances that make the most difference to the
company if the underlying issues can be rectified.

54
Many companies prefer to use horizontal analysis, rather than variance analysis, to
investigate and interpret their financial results. Under this approach, the results of
multiple periods are listed side-by-side, so that trends can be easily discerned.

4.9.1 Horizontal Analysis Overview

Horizontal analysis is the comparison of historical financial information over a series of

reporting periods, or of the ratios derived from this financial information. The intent is
to see if any numbers are unusually high or low in comparison to the information for
bracketing periods, which may then trigger a detailed investigation of the reason for
the difference. The analysis is most commonly a simple grouping of information that is
sorted by period, but the numbers in each succeeding period can also be expressed as a
percentage of the amount in the baseline year, with the baseline amount being listed as
100%.

A common problem with horizontal analysis is that the aggregation of information in

the financial statements may have changed over time, due to ongoing changes in
the chart of accounts, so that revenues, expenses, assets, or liabilities may shift
between different accounts and therefore appear to cause variances when comparing
account balances from one period to the next.

When conducting a horizontal analysis, it is useful to conduct the analysis for all of the
financial statements at the same time, so that you can see the complete impact of
operational results on a company's financial condition over the review period. For
example, in the two examples below, the income statement analysis shows a company
having an excellent second year, but the related balance sheet analysis shows that it is
having trouble funding growth, given the decline in cash, increase in accounts payable,
and increase in debt.

4.9.2 Horizontal Analysis of the Income Statement

Horizontal analysis of the income statement is usually in a two-year format, such as the
one shown below, with a variance also shown that states the difference between the
two years for each line item. An alternative format is to simply add as many years as
will fit on the page, without showing a variance, so that you can see general changes by
account over multiple years. A third format is to include a vertical analysis of each year
in the report, so that each year shows expenses as a percentage of the total revenue in
that year.

55
 20X1 20X2 Variance

Sales $1,000,000 $1,500,000 $500,000

Cost of goods sold 400,000 600,000 (200,000)

Gross margin 600,000 900,000 300,000

Salaries and wages 250,000 375,000 (125,000)

Office rent 50,000 80,000 (30,000)

Supplies 10,000 20,000 (10,000)

Utilities 20,000 30,000 (10,000)

Other expenses 90,000 110,000 (20,000)

Total Expenses 420,000 615,000 (195,000)

Net Profit $180,000 $285,000 $105,000

Horizontal analysis can be miss-used to report skewed findings. This can happen when
the analyst modifies the number of comparison periods used to make the results
appear unusually good or bad. For example, the current period's profits may appear
excellent when only compared with those of the previous month but are actually quite
poor when compared to the results for the same month in the preceding year.
Consistent use of comparison periods can mitigate this problem.

What actions can the FM take to rectify budget variance? Actions and remedies as
follows:

• Review operation to increase efficiencies and eradicate loss making activities .

• Recruitment &Selection process to reduce need for overtime/agency staff or

review service delivery.

• Re-bid budget difference at budget mid-year review.

• Renegotiate supplier costs/review alternative suppliers.

• Review channels & methods of communication.

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5.0 MANAGE PROCUREMENT METHOD/APPROACH

5.1 What is Strategic Sourcing?

Strategic sourcing is an institutional procurement process that continuously improves and

re-evaluates the purchasing activities of a company. Strategic sourcing techniques are also
applied to nontraditional areas such as services or capital. The goal of the strategic sourcing
process is to lower costs, improve quality, and reduce risks.

Steps to Strategic Sourcing

a) Analyze current spend and supply sources

• Get spend detail from accounting

• Group spending into broad categories

• Look for:
- What are the largest categories of spend?
- How many different suppliers per category?
- What are the pricing variations for the same product or service?

• Create list of target areas for improvement

b) Categorize suppliers
• Categorize suppliers by risk impact on facility
- Downtime
- Occupational hazards/safety
- Liability
- Loss of business opportunities

• Categorize suppliers by cost impact on facility

- Cost does not equal expensive

- Cost does not equal price
c) Implement appropriate sourcing strategies
• Use the Kraljic Portfolio Procurement Model
- Blanket PO
- Competitive Bidding

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 - Partnerships
- Secure Supply

• Contrast with current processes

d) Execute sourcing strategy

• Develop goals for each supplier segment/spend category

• Develop tactics for each goal

• Continuously assess suppliers and strategy

• Use technology where appropriate

Kriljic’s Procurement Strategies

Leverage Suppliers Strategic Suppliers

Many competitors Critical for product ‘s cost price

Commodity products / services Dependent upon supplier

Low switching costs

Cost Impact

Competitive Bidding / eSourcing Partnership

Routine Suppliers Bottleneck Suppliers

Large product variety Relatively low value

Low value per product Few alternative

High labor transaction costs Monopolistic market

Blanket PO / eProcurement Secure Supply + Find Alternatives

Risk Impact

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5.1.1 Common Sourcing Goals

Tactic 1: Supplier ID and Pre-qualification

• Centralize supplier (and potential supplier) information

• Implement multi-dimensional supplier prequalification

o Financial

o References

o Verification of licenses and insurance

• Implement public supplier registration

Tactic 2: Competitive Sourcing

• Requests for Proposal (RFP)

o Multi-dimension decision process

o Performance based criteria
o Focus more on “what” rather than “how”
o Scored responses
• Request for Quote (RFQ)

o Most common for commodity items

o Focus on “what”
o Include all cost dimensions
• Use “pre-qualification” process

Guidelines for Competition:

- Develop specifications not based upon single supplier’s capabilities

- Define objective supplier criteria before sourcing event
- Share the selection criteria
- Set a reasonable deadline for all suppliers
- Share Q&A with all suppliers
- Do not share bid information with suppliers until after the award

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 - Do not negotiate with lower scoring supplier without giving favorably
scored supplier the same opportunity
- Stick to your own rules
Tactic 3: Supplier Assessment

• Periodically evaluate the quality of suppliers

• Define Key Performance Indicators (KPI)

• Invite different stakeholders to “score” suppliers on KPI

• Create a place for people to log relevant supplier information

• Make results available to decision makers

• Periodically evaluate performance for each supplier segment

Tactic 4: Use Appropriate Software

• Supplier Management
o Central vendor information
o Supplier approval
o Tracking Key Performance Indicators (KPI)
• eSourcing
o Automate sourcing processes
o Ensure competition
o Reporting and feedback
• eProcurement
o Catalog purchasing
o Verified pricing agreements
o Automated transaction processing

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5.2 Scope of Goods and Services for Procurement Activity

Facilities managers are involved in both strategic planning and day-to-day operations,
particularly in relation to buildings and premises. Likely areas of responsibility include:

• building and grounds maintenance;

• cleaning;

• catering and vending;

• health and safety;

• procurement and contract management;

• security;

• space management;

• utilities and communications infrastructure.

Your duties will probably vary depending on the nature of the organization, but will
generally focus on using best business practice to improve efficiency, by reducing operating
costs while increasing productivity.

A facilities manager can be employed in all sectors and industries and the diversity of the
work is reflected in the range of job titles, for example operations, estates, technical
services and asset or property manager.

5.3 Responsibilities

Responsibilities often cover several departments, as well as central services that link to all
the teams in the organization. In smaller companies, duties may include more practical and
hands-on tasks.

Many facilities managers are responsible for either one or many sites. Some organizations
outsource their facilities management services and use specialist facilities management
providers. In these cases, facilities managers may work for a firm offering all services or
one that offers specific services such as catering (F&B).

Typical tasks may include:

• preparing documents to put out tenders for contractors;

• project management and supervising and coordinating the work of contractors;

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• investigating availability and suitability of options for new premises;

• calculating and comparing costs for required goods or services to achieve

maximum value for money;

• planning for future development in line with strategic business objectives;

• managing and leading change to ensure minimum disruption to core activities;

• directing, coordinating and planning essential central services such as reception,

security, maintenance, mail, archiving, cleaning, catering, waste disposal and
recycling;

• ensuring the building meets health and safety requirements and that facilities
comply with legislation;

• keeping staff safe;

• planning best allocation and utilization of space and resources for new
buildings, or re-organizing current premises;

• checking that agreed work by staff or contractors has been completed

satisfactorily and following up on any deficiencies;

• coordinating and leading one or more teams to cover various areas of

responsibility;

• using performance management techniques to monitor and demonstrate

achievement of agreed service levels and to lead on improvement;

• responding appropriately to emergencies or urgent issues as they arise and

dealing with the consequences.

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5.4 Impact and Urgency to Core Business According to O&M Schedule

Facilities management is of significance to organizations of all kinds and, as an emerging

discipline, it has become the focus for the important issues of best value and customer
satisfaction within the management of supporting services. Well-managed services enable
an organization to function at its most efficient and effective level, offering real added value
improvements to the organization’s core business. Facilities management is being elevated
to a strategic level of importance and is therefore being given the task and opportunity to
contribute to business success and to aid the delivery of competitive advantage. Indeed, in
recent years, the range of services covered within the remit of facilities management has
become more complex, as facilities management has moved into the core operational
functions of client organizations. It is necessary for facilities management service providers
and their customers to acknowledge the role of facilities management in the organization’s
strategic operations. This article presents the core concepts of facilities management with
particular attention being given to the role of outsourcing.

5.5 What is Facilities Management?

Most real estate represents substantial investment for organizations and has to
accommodate and support a range of activities, often taking into account competing needs.
Within those activities is the owner or tenant organization’s core business, for which an
appropriate environment must be created in buildings that may not have been designed for
the purposes for which they are now used. Yet, no matter how well focused an organization
might be on its core business, it must not lose sight of the supporting services – its non-core
business. Facilities management places the non-core business at the service of the core
business in such a way as to protect an organization’s capital investment in real estate and
helps turn a cost item into one of added value.

Organizations may have already considered the distinction between their core business and
non-core business (such as security, HVAC maintenance and cleaning) as part of the drive
to deliver and achieve best value and customer satisfaction. Since running costs account for
a significant part of annual expenditure, second only to payroll, there will be pressure to
look for savings in non-core business areas. Cutting operating budgets may be an attractive,
or financially expedient, short-term measure but may not foster the organization’s long-
term development. Since the running of an organization involves complex, co-ordinate
processes and activities, it is necessary to take an integrated view. A piecemeal approach to
cutting costs is unlikely to produce the required savings and may harm the organization’s
ability to deliver the most appropriate services. For facilities management to offer
maximum support to core business activities, the organization must, therefore, recognize
that cost and quality are inextricably linked and should not be considered separately.

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Facilities management can accordingly be summarized as creating the optimal environment
for the organization’s primary functions, taking an integrated view of the business
infrastructure, and using this to deliver customer satisfaction and best value through
support for and enhancement of the core business. Thus, facilities management can be
described as something that will:

• deliver effective and responsive services;

• enable changes in the use of space in the future;

• sweat the assets, i.e. make them highly cost effective;

• create competitive advantage for the organization’s core business; and

• enhance the organization’s culture and image.

5.6 Strategy Overview

Managing facilities efficiently and effectively requires that a robust strategy is developed
within the context of the organization’s business plan and space/accommodation strategy.
These should involve development of strategic objectives and a plan for the facilities
management, with proper reference to the overall business plan and space/accommodation
strategy within which it might be contained. A strategy (or business plan) for facilities
management should:

• consider the needs of the organization, differentiating between core and non-
core business activities;

• identify and establish effective and manageable processes for meeting those
needs;

• establish the appropriate resource needs for providing services, whether

obtained internally or externally;

• identify the source of the means to finance the strategy and its practical
implications;

• establish a budget covering short term needs and best value over the long term;
and recognize that management of information is key to providing a basis for
effective control of facilities management.

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The three main stages in the development and achievement of a workable strategy for
facilities management are:
1. analyzing requirements – top level analysis;
2. developing solutions – finding the best option; and
3. implementing solutions – putting the plan to work.

5.7 Selecting a Strategy

The starting point for managing facilities is, as previously noted, the organization’s business
plan and its real estate (or space/accommodation) strategy. These should be kept up-to-
date and used to determine the nature and level of services support. The facilities
management strategy must reflect the organization’s business objectives, needs and
policies, as well as practicalities, such as its current real estate in general and space in
particular. This formal strategy should include descriptions of the approach to measuring
how the business objectives and needs have been met.

The selection of the approach through which service provision will take place should be
based on the ability of that approach to satisfy those attributes that an organization
considers most important to its success. However, as the circumstances, which the
organization is subjected to, are subject to change, the most appropriate option will be the
one that can also accommodate change. Naturally, there will be advantages and
disadvantages in providing services either in house or by outsourcing. The organization
must, therefore, decide the route that provides best value for itself in the long term. This is
achieved by taking full account of the implications especially the true cost of all options.

Debate on the benefits or otherwise of outsourcing has been running for decades. Although
it is now generally agreed that outsourcing can stimulate innovation and can present cost
savings through the harsh realities of competition, it cannot be assumed to be the best
approach in all cases. The merits of outsourcing each service must be considered until the
optimal mix of outsourced and in-house provision is attained.

The decision to outsource or provide services in house must take into account both the
capability of service providers and the effort required to manage them. An organization
that takes the decision to outsource can delegate the direct supervision of work and service
operatives to the provider. The role for the organization’s representative then becomes one
of managing the output from the service provider. The representative should act as an
informed client managing performance against service specifications and service level
agreements (SLA). Organizations need to consider their approach to this new management
role carefully.

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5.8 Cost Factors

5.8.1 Indirect Cost

In choosing the approach to service provision, total cost is often under-reported. In

evaluating the comparative cost between in-house or outsourced service provision,
organizations should identify all costs, both direct and indirect. A common mistake is for
only the direct costs to be reported. Indirect costs include those incurred in the internal
management of external contracts and the ongoing training and development of in-house
personnel. Furthermore, the full administration of the services such as permit-to-work
procedures, competent and approved person regimes, together with the technology to
operate them, all attract a cost that must be recorded.

Organizations also need to consider the costs of financial administration. For instance, a
small number of labor and material contracts means that invoices can be processed more
cost-effectively than in situations where invoices are many and frequent. Clearly, the
method of procurement has an implication for the accounting function.

5.8.2 Direct Cost

By contrast, direct cost is easier to ascertain. In the case of an outsourced provision the
contract sum is a figure that is readily available. For in-house provision, the direct cost
calculation would include salaries, including benefits. As noted above, these more obvious
costs should not be looked at in isolation from the associated indirect costs.

5.8.3 Control

Linked closely to the management variable is the issue of control. For many organizations
considering outsourcing, the greatest concern is that of a perceived loss of control. The level
of control that can be achieved is closely correlated with the method of procurement and
the contractual relationship established between the organization and the service provider.
Through a more traditional contract the level of control is limited. For more control, a
partnering arrangement may be appropriate.

Whatever arrangement is put in place, technology has a part to play in the delivery of
reliable management information. It is through available and accessible information that
many of the control issues can be solved. In so doing, value can also be added if the
management information is delivered as a consequence of service provision and is
therefore available without cost or, at least, for a nominal sum.

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5.8.4 Implications of Outsourcing

Any significant change in the number of services that are outsourced will have an impact on
the structure of the department or organization; in the case of outsourcing all real estate
services, a small core management team is required to control and co-ordinate the activities
of the external parties. In this instance, the role of management changes from direct
management to the management of the output of others: the performance measurement of
deliverables. The main tasks then become the management of the respective contracts and
the definition and development of policy and procedures. These, along with relevant
standards, are vital if the respective contracts are to meet the expectations of customers
and are not to encourage malpractice or other kind of irregularity.

The most appropriate management structure will be the one that ensures both economy
and control for the organization over its facilities. Clearly, the management of contractors is
different to the supervision of directly employed personnel and should not demand as high
a level of resources. It is acceptable that some personnel will have to be retained even
where the organization has opted for total facilities management by a single contractor
since the informed client function (ICF) must be maintained. This should be a major factor
in the drive to have personnel who are trained to act as competent client representatives
and, if organizations find such expertise lacking, they should adopt recruitment policies
that recognize the specialization of facilities management and seek individuals who have
undergone appropriate education and training. The role of managing the client-contractor
interface includes the following duties:

• maintaining and enhancing the informed client function;

• defining real estate and space standard policies and monitoring space
utilization;

• understanding and monitoring customer requirements and keeping customers

informed;

• planning projects involving new or additional works; and

• managing the approvals process and payments to the contractor.

Where services are retained in house, it is essential to ensure that the management
structure facilitates a split between purchaser and provider, with the purchaser acting as
the objective and informed client in order to monitor the performance of in-house service
delivery. Policies and procedures must be formalized within this management structure to
ensure that customer expectations are met and malpractice and other kinds of irregularity
are actively deterred. The most appropriate management structure will be the one that
ensures both economy and control for the organization over its facilities. This means that

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organizations will need to determine exactly the number of personnel and their functions
for managing the provision of services.

5.8.5 Conclusions

If buildings and other facilities are not managed, they can begin to impact upon an
organization’s performance. Conversely, buildings and facilities have the potential to
enhance performance by contributing towards the provision of the optimal work and
business environment. There is no universal approach to managing facilities. Each
organization – even within the same sector – will have different needs. Understanding those
needs is the key to effective facilities management measured in terms of providing best
value. Furthermore, once established the facilities management strategy should be a
cornerstone of an organization’s accommodation strategy, not adjunct to it.

In choosing the most appropriate solution consideration must be given to direct and
indirect costs of both in-house and outsourced service provision so that a complete
financial picture is gained, with comparison made on a like-for-like basis to enable a
decision to be taken on best value grounds. A long-term and integrated view of service
provision is essential to effective facilities management.

5.9 Procurement Cost Based on Scope of Goods and Services

Many organizations struggle with competing measures of success. These competing

metrics, objectives and expectations can create conflicts among departments, often
hindering an organization's overall success.

The process of specifying products offers a revealing example of this struggle. An

organization's procurement department might achieve success by purchasing materials at
the lowest available cost. By comparison, minimizing the total cost of ownership (TCO)
often drives the maintenance and engineering department. That difference is the conflict:
Minimizing the TCO might not involve purchasing the lowest-cost materials. In fact, it can
even help managers make the case for purchasing products with higher initial costs.

5.9.1 Conflicting Views

First, consider the procurement view. The procurement department bases its decisions
mostly on such factors as delivery, handling, marginal benefit and price fluctuations. The
group's financial objectives are based on reducing single-item costs or costs per stock-
keeping unit (SKU).

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The bottom line for the department is having functional materials available for users and
achieving that goal at the lowest cost to the organization. If the department achieves those
goals, it often receives recognition.

Now consider the view of the maintenance and engineering department. Managers try to
extend the life of the organization's assets and minimize TCO. Managers use factors such as
mean time between failures (MTBF) and mean time to repair (MTTR) to identify
opportunities and determine the success of their efforts.

Formally, TCO involves determining the costs associated with buying and using a product
or service. Calculating TCO takes an item's purchase cost into account, but it also considers
related costs, such as ordering, delivery, subsequent use and maintenance, supplier costs,
and post-delivery costs.

Consider the case of pump specification. A manager might find a pump that meets the
expected specifications on paper, but its actual performance might differ. Pumped materials
might attack or create greater wear than anticipated in components, causing premature
failure.

When looking at the reasons for failure, the purchase cost of a lower-quality pump could be
insignificant maybe 5-10 percent less but the costs to operate and maintain that pump
might be substantially higher sometimes 10-15 times.

The performance characteristics of lower-cost materials also can create risks or other
problems for the business that managers must consider in determining TCO, including:

• Environmental risks, including spills and releases

• Injury risks, due to the increased need for technicians to intervene

• Regulatory risks involving fines and business interruptions

• Performance risks, including shorter MTBF or longer MTTR

• Higher maintenance costs

• Lost revenue. Downtime associated with poor performance of a low-cost

component decreases productivity

Clearly, it is important to incorporate TCO principles when creating metrics for the
procurement department's performance.

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5.9.2 Focus on TCO

Now that managers understand the struggles between procurement and maintenance that
create risks and cost implications for their organizations, how can they overcome this
unhealthy situation and keep the focus on TCO? I recommend the following steps:

a. Set a vision and direction.

Leadership, from the top of the organization down to department-level managers,

needs to set expectations and make it important to manage both parties in the
purchasing equation. Leadership needs to set the expectations across the
organizational silos to prevent any disparity. This process starts with establishing
vision, alignment and clear direction, as well as recognizing results.

b. Establish a team approach and collaborated metrics.

To effectively control both elements in the procurement equation — obtaining the

lowest cost to purchase while also minimizing TCO — different groups must
collaborate. I have seen the word team defined as "together everyone achieves
more." That definition best summarizes this collaborative approach. Managers need
to establish cross-functional metrics, make sure everyone clearly understands
expectations, and tie accountability for metrics into the performance-management
system.

A great example of the team approach occurred recently at a client site. We

performed a study of equipment bearings and discovered the total cost of
replacement for the lowest-cost bearings the sum of bearing costs, labor costs, asset
downtime, and number of replacements within a two-year period — was at least 10
times higher than the cost of purchasing high-quality bearings at a 30-50 percent
higher price. Using the higher-quality bearings resulted in no failures after two
years.

This is an example of applying TCO principles to the decision-making process to

arrive at a budget-savvy specification decision.

c. Remain diligent.

The final step in obtaining the lowest TCO is to create a culture that maintains focus
and sustains expectations. To foster a proactive and positive environment, managers
must keep the focus on identifying issues, applying effective root-cause analysis, and
eliminating the causes of asset-reliability problems.

Organizations also can create a structure and systems that promote a proactive
approach to maintenance and engineering activities by:

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 • developing staff competencies

• defining roles and responsibilities clearly

• measuring performance

• providing feedback and counseling

• promoting a focus on quality and precision

• ensuring adequate facilities and resources.

Often, obtaining the lowest TCO requires paying a higher initial price. But as long as
managers minimize the TCO, it does not matter if the initial cost is higher than desired. The
alignment of goals comes from having all parties judged by the same criterion, which is
lowest TCO.

Managers who act on these recommendations can help address the ongoing struggle to
lower TCO, regardless of the product in question. By setting a vision and direction, creating
a collaborative team environment focused on the right metrics, and remaining diligent,
managers can succeed in minimizing TCO.

5.9.3 Outsourcing Strategy in Relation to Procurement Process

Strategic outsourcing is the alternative way for the company to accomplish its value chain
activities rather than performing the entire value chain activities. In the current market
place there are quiet a good number of companies that are specialized in some activities.
Outsourcing these activities to the specialized companies strengthen the companies’
business model either by improving the efficiency by decreasing the cost or by enhancing
the effectiveness by creating differentiating advantage in terms of quality, variety, speed etc

What to Outsource?

With customer being the key focus in these present dynamic environments, companies’
keeps on trying to increase the total value generated to the customers by increasing the gap
between customer willingness to pay and costs associated with the product. To achieve this
companies outsource activities that they think the specialized company will generate more
value by performing that activity. In the environment of growing customer demand for
supply chain efficiency and effectiveness it is recommended for the company to perform the
supply chain activities that it has distinctive competence and outsource the rest of
activities. Yet, not all processes are outsourced. Outsourcing the wrong process could be
counterproductive, expensive, or even fatal to a company.

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Core vs. Non-Core

The most crucial aspect of outsourcing is in making the distinction between the core
competencies, which should be kept in-house, and the non-core activities, which are
candidates for outsourcing. Becoming excessively dependent on partners reduces the
strategic options available to a company. Processes that nurture the core, protect the core,
or help the company exploit its core competencies are also held internally. Companies need
to think carefully about what they wish to sow, nurture, and reap in-house in order to
harvest long-term profits.

Five-Stage Model

Five variables that predict the wisdom of in-sourcing vs. outsourcing.

• Modularity of components/processes: Modular elements are potential

candidates for outsourcing than integral elements of a product or business

• Quantity of providers: The fewer the number of providers, the less outsourcing
makes sense

• Clock speed: The faster the clock speed, the more you want to in-source.

• Importance to customer: If the customer cares about it, don't outsource it.

• Benchmark performance level: if you have best-in-class performance on the

process, don't outsource it.

Value Equation

A value equation used by Unilever to evaluate the added value generated by outsourcing
activities is

“Net Value = Internal Value from Focus + External Value from Provider - Transaction Costs”

This equation helps only quantitatively where as many qualitative parameters like whether
the activity is core or non-core should also be considered. For activities that are non-core,
the equation helps the company assess the value of outsourcing that non-core activity.

Value Equation: Internal Value from Focus

With outsourcing, management and employees can focus more on what is important. So
organizations create more value by focusing their valuable resources on their core activities
and thus increase the value to the customer.

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Value Equation: External Value from Provider

Providers can create value by being more efficient, more effective, or more innovative than
the internal counterpart. This value is the key part of the value proposition. The source of
the provider's value can fall into one of two categories:

• Value from high economies of scale

• Value from high levels of expertise.

Specialist provider achieves scale economies by aggregating volumes of activities from

multiple companies through standardization and decreases the unit costs across the supply
network. Value from high levels of expertise occurs when the provider can accumulate
large quantities of knowledge that would be hard for each client company to replicate.

Value Equation: Transaction Costs

Transaction costs are inevitable in the outsourcing. Costs of internal transactions which are
in general informal are very low and hidden where as the transaction costs with the
outsourced company are visible and substantial. Extra transaction costs arise from having
to formally specify what the partner is to do, managing that external activity. Companies
decompose transaction costs into 3 categories:

• Oversight costs: Cost of managing the relationship, performance, information

exchange etc.

• Switching costs: Cost of changing from in-sourcing to outsourcing

• Risk: The potential costs of problems associated with the outsourcing arrangement

5.9.4 Benefits of Out-Sourcing

• Cost reduction and cost savings

Out-sourcing reduces the costs if the price you are paying for the company is less
than the costs that you incur if the same activities are performed in-house.
Specialist companies are able to perform activities at a lower cost as they can
realize economies of scale by performing the same kind of activity for various
companies. These specialized companies invest more in efficient-scale
manufacturing facilities/processes to spread the costs against large volumes and
bring down unit costs.

Specialists also save costs through learning effects more rapidly than the clients.
These companies learn fast how to operate the processes more efficiently

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 compared to its clients. Since most of the out-sourced companies are based at low-
cost global locations, costs can easily drive down.

• Enhanced Differentiation
Companies should be able to differentiate its final products by out-sourcing certain
noncore activities. These companies can provide more reliable products by
strongly focusing and achieving competence in that activity thus decreasing the
defect rate. Most of these specialized companies have adopted Six Sigma
methodologies and bring down error rates, thereby increasing the reliability of
product.

For example carmakers outsource specific kinds of vehicle component design

activities such as microchips and headlights to the specialists who have earned
reputation for design excellence.

• Focus on core business

Strategic out-sourcing makes the managers to focus their energies and companies
resources in performing the core activities that can create sustainable have more
potential to create value and competitive advantage. By this companies enhance
their competence and push out the value creation frontier and create more value
for their customers.

• Flexibility
Companies gain access to new technologies and use supplier’s technology to
accelerate new product development. Companies can also adapt to changing
business environments by changing suppliers if the existing suppliers using
technologies that are obsolete. Thus companies mitigate the risk of investing in
resources/technologies that have short life cycles.

• Access to knowledge pool

Out-sourcing activities across the borders enables companies to access to
knowledge pool connected with products, processes and management strategies
that prove to be effective and efficient. It also makes the organization use new
advanced technologies in product and process development. By out-sourcing some
of the value creating activities to Japan, many US companies exploited the benefits
of lean manufacturing that they cannot realize in the home country.

• Additional Capacity
Out-sourcing helps the companies to adapt to seasonal fluctuations in demand by
out-sourcing the need for extra products beyond the capacity of the organization
rather that going for Green-field expansions. In periods of low demand companies

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 uses its resources in satisfying customer needs and out-source the extra demand to
out-sourced company in periods of high demand.

• Demand Uncertainty (Risk Pooling)

In periods of demand uncertainty organizations finds it difficult to manage
additional costs associated with high inventory, lack of material in case of peak
demands etc. By out-sourcing, uncertainty in the demand can be reduced because
of aggregating uncertainties across many companies, supplier decreases the total
uncertainty thus save these costs for the companies

Other than these, companies reluctant to make high capital investments, companies
operating in product categories with short product life cycles, companies planning
to be quicker to the market in already established industries out-source so as to
decrease risks. Sometimes overhead costs of performing some back office functions
are more considering out-sourcing these functions thus controlling the costs.

5.9.5 Risks of Out-sourcing

1. Lacking control of operations

Once the processes are out-sourced, the companies won’t have a complete control
mechanism to deliver the value as the out-sourced activities are out of company
bounds. The vendor for some reasons may fail to deliver leading to disturbance in
the flow of activities that fulfill customer order. So companies should have a
contingency plan for these uncertainties.

2. Loss of Competitive Knowledge

Organizations by out-sourcing activities lose the knowledgeable resources they

possess. They also lose their hold and competence on activity that they out-source.
IBM by outsourcing most of its activities in PC industry became the market leader
at a faster pace. Later its strategy was followed by other competitors like Compaq
which out-sourced activities to the same suppliers and this resulted in decrease in
IBM market share from 40% to 8% in span of 10 years.

Companies must preserve and nurture some form of competitive advantage in the
form of core competencies. Most of the presenters stressed the importance of
identifying a company's strategic core competencies before outsourcing or
partnering.

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 3. Risk of Holdup

It is the risk associated with the dependence of the out-sourcing company for the
specialized value-added activities. Increase in dependence tends to decrease the
bargaining power of the parent company. So, a better alternative to mitigate this
risk is to adapt a parallel sourcing policy, having different specialist providers.

4. Loss of Vital Information

Organizations out-sourcing important functions which get them in direct touch with
customers may lose important competitive information from the customer feedback.
A good flow of communication between the out-sourced and out-sourcing company
can prevent this loss of information.

It sometimes becomes mandatory for the company to share vital confidential

information with the out-sourced company. It can lead to leakage of valuable
information the company shares in order to achieve efficiency in supply chain
operations.

5.9.6 Conclusion

Strategic outsourcing is increasingly becoming an important part of overall corporate

strategy, as a way to grow product and service offerings, develop new markets and leverage
technology for effective integration among various partners of supply chain. In these
dynamic environments with shorter product life cycles and decreases duration of
technological competence, strategic outsourcing is no longer a strategic option but a
necessity for organizations. Many global companies have multiple alliances, some global,
requiring coordination with numerous partners. Companies are also finding benefits to
partnership with competitors.

Strategic alliances are an indispensable tool in today’s competitive business environment.

No longer can companies afford ad hoc approaches to alliance formation and management,
any more than they can rely on a small number of talented alliance managers. New insights
on alliance management tools and strategies, focusing on: leveraging differences with
partners to create value, dealing with the internal challenges of making your partnerships
succeed, managing the day-to-day challenges of alliances with competitors.

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5.10 Suitable Procurement Method

The procuring department is responsible for acquiring goods and services for a business.
This may involve shopping for goods at competitive prices, handling all legal procedures
associated with obtaining a contract, budgeting costs for the goods and studying financial
trends to ensure that company money is being spent wisely.

5.10.1 Obtaining Quality Goods and Services

Generally speaking, there are six procurement methods used by the procurement team in a
company. The actual names of these could vary depending on your company and industry,
but the process remains the same. The six times of procurement are open tendering,
restricted tendering, request for proposal, two-stage tendering, request for quotations and
single-source procurement.

5.10.2 Open Tendering

Open tendering is shorthand for competitive bidding. It allows companies to bid on goods
in an open competition or open solicitation manner. Open tendering requirements call for
the company to:
1. Advertise locally
2. Have unbiased and coherent technical specifications
3. Have objective evaluation measures
4. Be open to all qualified bidders
5. Be granted to the least cost provider sans contract negotiations

Arguably, the open tendering method of procurement encourages effective competition to

obtain goods with an emphasis on the value for money. However, considering this is a
procedures based method a lot of procurement experts feels that this method is not very
suitable for large or complex acquisitions due to the intense focus on the output process
instead of stringent obedience to standards. In this Quality Management course learn about
the ways to evaluate quality products on incoming orders, and to create quality products
for sale.

There are course also disadvantages to this kind of procurement method including:
1. Complex requirements are typically not suited for this method
2. The timeline for needing the goods
3. Complications in defining the exact needs of the requirement by the procuring
company

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5.10.3 Restricted Tendering

Unlike open tendering, restricted tendering only places a limit on the amount of request for
tenders that can be sent by a supplier or service provider. Because of this selective process,
restricted tendering is also sometimes referred to as selective tendering. Like open
tendering, restricted tendering is considered a competitive procurement method, however,
the competition is limited to agencies that are invited by the procuring team. The procuring
entity should establish a set of guidelines to use when selecting the suppliers and service
providers that will be on the invitation list. Randomized selections will not bode well for
procuring. This method is selective to find the best-suited and most qualified agencies to
procure goods and services from. It’s also employed as a way for the procuring team to save
time and money during the selection process.

5.10.4 Request for Proposals (RFP)

Request for Proposal is a term that is used all across the business world. Social media
managers receive RFP’s from potential clients all the time when a client is seeking a new
manager of their venture. This kind of proposal is a compelling and unique document
stating why the business is the best fit for the type of project at and. Similarly, in the
procurement world, a RFP is a method used when suppliers or service providers are
proposing their good or service to a procurement team for review. If you’re a supplier,
understanding the in’s and out’s of quality service management is key to winning your bid.
Read more about this in service quality management.

Procurement teams are often on the hunt for the best valued, most marketable items to
bring into circulation. A client may feel they have all of the qualifications to fit the needs of
fulfilling a specific requirement of a procurement team – but they have to prove it. The
agencies writing the RFP’s should submit a two-envelope proposal to the procurement
manager. The two-envelope process allows the procurers’ to review the proposal through
and through without knowing the financial component. The financial proposal is sealed in
the second envelope and should only be opened after the content of the first-envelope
proposal is approved or rejected. This eliminates any persuasion by cost and allows an
objective lens to look through when analyzing a good fit. The proposal with the best fit
qualifications and best price will be selected. If a lesser qualified (yet still qualified)
selection has a lesser price, no contract should be negotiated. The most qualified and
appropriate proposal, regardless of price, should be selected.

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5.10.5 Two Stage Tendering

There are two procedures that are used under the two stage tendering method. Each one of
the procedures has a two stage process. This can be disadvantageous for some
procurement teams if there is a time limit on securing a contract. In the same vein, this
option is more flexible for both parties, allowing more room for discussion to meet mutual
needs.

The first procedure is very similar to the RFP method as discussed above. The procurement
team receives a proposal with two envelopes – one with the proposal itself and one with
the associated financial information. The difference is the bidder is required to submit a
technical proposal that highlights their solutions to fulfilling the requirements as specified
by the procuring department. This proposal is scored according to the relevance of the
solution to the needs of the procurer. The highest scored proposal is invited for further
discussion in an attempt to reach an agreement. After the final agreement for the technical
proposal is reached, the bidder is invited to submit their financial proposal and then further
discussions ensue to negotiate a contract.

The second procedure is much like the above; however, instead of the bidder submitting a
fully-completed technical proposal, a partial proposal is submitted. The methodology and
technical specifications will be included but not to the fullest extent. This allows room for
even more customization and discussion. Once the highest qualified bidder is selected, they
will be invited to submit a thorough technical proposal along with a financial proposal. The
technical proposal will be evaluated and only then will the financial proposal be opened.
The combined score of both the technical proposal and the financial proposal are the
grounds on which a bidder is contracted.

5.10.6 Request for Quotations

This procurement method is used for small-valued goods or services. Request for quotation
is by far the least complex procurement method available. If you have the option, use this
method to ensure a fast procurement process and not a lot of paperwork. There is no
formal proposal drafted from either party in this method. Essentially, the procurement
entity selects a minimum of three suppliers or service providers that they wish to get
quotes from. A comparison of quotes is analyzed and the best selection determined by
requirement compliance is chosen.

5.10.7 Single-Source

Single source procurement is a non-competitive method that should only be used under
specific circumstances. Single source procurement occurs when the procuring entity
intends to acquire goods or services from a sole provider. This method should undergo a

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strict approval process from management before being used. The circumstances which call
for this method are:
• Emergencies
• If only one supplier is available and qualified to fulfill the requirements
• If the advantages of using a certain supplier are abundantly clear
• If the procurer requires a certain product or service that is only available from
one supplier
• For the continuation of work that cannot be reproduced by another supplier

In the end, the type of procurement method you choose to use is highly relative to the
conditions of the procurement effort and the type of good or service being acquired. All
procurement methods follow tight legal frameworks to ensure all standards are being met
and quality in the selection process exists.

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5.11 Procurement Activity Implemented

5.11.1 Procurement and Supply Cycle

Procurement Activity implemented based on scope of goods and services requirements.

The Procurement Cycle is the cyclical process of key steps when procuring goods or
services. This interactive tool has been developed to guide us through the procurement
process with links to relevant knowledge to support our every step of the way through your
procurement journey.

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5.11.2 Purchasing Process Flowchart

Flowchart below is established to ensure that all purchases made are authorized, approved
and committed as per purchasing procedures.

Established Specification for the required

Product/Service on the PR/ AR Form

No Yes
CAPEX?

Issue PR Issue AR

Fixed Price
No
Supplier? No
Value >
1 Quotation fr. AVL
1K?

Yes
Yes

No
Tender? No Urgent? Yes
Yes
No

Yes
Tender Process 3 Quotation fr. AVL

No
No
Result ok? Result ok? Single Sourcing

Yes Yes

Post Tender Process Negotiate Terms

Select/recommend Supplier

Issue CMMS-Purchase Request

and Approval by HOD in CMMS
Purchasing Module System

CMMS-Purchase Order raised

by Site/HO Purchasing
Employee and issued to supplier

Update CMMS-Purchasing
Module

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