Project Management 4A

Unit 5:
Operations, Cost Planning and
Monitoring Expenditure

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• Aim of this unit -
– To advocate the concept of linking the
organisational concept of “operations” into the
“corporative decision-making process.
– To focuses on the utilisation of concepts of
Financial Planning and Budgeting Control.
– To establish the importance of cash-flow
management.
– To explain the importance of regular
monitoring for effective and efficient control.
– To highlight the key activities of cash-flow
analysis, budgetary control and variance
analysis.
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• OPERATIONS STRATEGY
– Operational management: How organisation
delivers its services and products
– Construction is mainly operations driven with
most staff in operations function.
– Most capital and largest amount of fixed and
variable costs found in operations (on site).
– Maintaining and gaining competitive
advantage in industry is responsibility of
operations.
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– Operational Processes
• Projects
• Jobbing or once off items (made to order)
• Batch productions (larger volumes or sales)
• Line productions (dedicated process non-continuous)
• Continuous processes
– Choice of above processes
• Influenced by product or service
• Trade-off between volume and process change-
over costs (Study Figure 5.1)
• High volume or low volume requirements
• Learning curve phenomena (study Figure 5.2)
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 The Learning Curve
(Theodore P. Wright, 1936)

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– Managing resources
• The 5 M’s (Materials, Manpower, Machinery,
Money, Management)
• Must be available in required quantity & right mix
• Cost of resources can be as high as 80% of
operational cost
• Effective and efficient control of resources is
crucial
• Resource utilization determines competitiveness
and profitability of company
• Increasing profit. How? Reduce operational costs.

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– Operations conversion process (see Fig 5.3)

5M’s • Input Resources

Project
Job
• Conversion
Batch

Product
• Outputs
Services
Info

– Corporate strategy and objectives should

match with operational capacity to facilitate
sustainable conversion process (see Fig 5.4)
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– Business Process Re-engineering
(BPR)
• Aimed at providing improvement in organisational
performance
• To achieve & optimize organisational success in
respect of time, cost and quality
• View performance from a different angle to enhance
performance
• Incorporated with other management tools such as
TQM, ISO 9000 and JIT
• BPR concerned with process-oriented tasks while
TQM aims to improve effectiveness of business as a
whole. (see Table 5.3)
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– In construction BPR processes are aiming for;
• Re-engineering the entire construction process
• Establishing performance consistency (WHY??)
• Ensuring competitive advantage
• Allowing radical improvements (not 5% improvement
but 30% improvement!)
• Allowing & maintaining process focus
• Benchmarking
• Enforcing customer focus.
• Satisfying higher performance expectations
• Rethinking the way we do our business

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BPR – Rethinking the way we do
things!

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 Construction Performance ??
“A variety of factors such as construction
management effectiveness, client
sophistication, procurement system
adopted, and many more, have different
degrees of impact upon performance”
(Walker,1995)
“Inherent inefficiency of current construction
practices inevitable leads to time wasting”
(Mohamed & Tucker, 1996)
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– Fundamentals of BPR
• “A systematic methodology developed to help an
organisation make significant advances in the way
in which its business processes operate”
Harrington (1991)
• Fundamental Characteristics of BPR (Table 5.2)
– Time factors (once off or continuous change)
– Risk factors (moderate to high)
– People factors (resistance, discomfort)
– Primary enablers (management, technology, best practice)
– Range (start with clean slate, radical redesign of process)
– Tools (IT, Best practice benchmarking, process modelling)

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Interrelationships between BPR,
TQM and JIT

• BPR ? (Radical)
• TQM ? (Gradual and continuous)
• JIT ? (Processes - right quantities at the
right time)

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– Partnering (1st to 3rd Generation) (Table 5.4)
• Aim is to improve corporate performance
• Improve efficiency and effectiveness
• Approach to addressing the 30% cost reduction
requirement advocated for BPR
• Partnering is voluntary arrangement between
two or more partners to achieve mutual
business objectives resulting in a win-win
situation
• Partnering involves:
– Trust
– Mutual objectives
– Integrity
– Communication and feedback
– Review and evaluation

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 Partnering
(Samer el Barakeh)

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– Benefits of partnering (page 135)
• Changing attitudes
• Improving performance
• Reducing defects and re-work
• Reduction in cost of construction and ownership
• Less conflict, claims and litigation
• Alters the nature of construction firms
• Allows for close corporation between government,
customers, suppliers and manufacturers (PPP’s)
• Allows for supply chain partnership
• Focus on long-term benefits
• Economics of scale
• Allows for innovation and creativity
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 Question Time
• Do you believe that partnering provides
the way forward for construction in SA?
• How do you avoid choosing the wrong
partner?
• What about lack of trust between
partners? How do you built and maintain
trust?

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Financial Planning and Control (p141)
• Control is concerned with effective and efficient
utilisation of resources in accordance with a
specific plan.
• Control is exercised by feedback on actual
performance and acting on deviations from the
original plan.
• PDCA control cycle (Study Fig 5.15)
– Plan, do, check, act.
– Continuous improvement cycle

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– Psychology of Control
• Resistance to control
• Control should not be imposed
• Consultation and buy-in is essential
• Tact and acceptance
– Management by Objectives
– Management by Exception
– Control must be tight (but tactful to be
effective and efficient
– Cost control is a management technique or
function (not an accounting/surveying
technique!)
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 COST CONTROL
– Marginal Costing and Break-even Analysis
• Fixed and variable costs
• Time based costs vs activity based costs
– Time based e.g. rent, rates, interest: -
fixed costs as rent & rates remain payable.
– Activity based e.g. wages, sales commission,
power : – variable costs linked to production.
– Mixed time & activity based costs e.g.
maintenance and supervision

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– Total Costs (Tc)
• Tc = Fixed costs + variable costs
– Break-even charts (Activity vs money)
• Indicates cost lines:
– Fixed = horisontal line
– Variable = sloped line
• Indicated revenue/income lines
• Profit or loss = difference between total cost and
the resulting income.
• Break-even point = income and total cost is equal
at point where income line cross the expenditure
line
• Margin of Safety = difference between break-even
and selected activity past break-even point.
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– Importance of break-even point
• Marks the lowest level to which activity can drop
without putting life of company in jeopardy
• In general, company must operate above this level.

– Contribution (P)
• Contribution of option measures net gain to the
company because of that option.
• Contribution = Total revenue - marginal cost.
• Profit = Contribution – Total fixed costs
• Thus, select options with greatest contribution

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– Marginal costing analysis is used for:-
• Deciding prices during recession
• Compare results from different contracts
• Assessing profits following increase/decrease in
sales
• Assess suitability of selling below total cost for
limited period in order to retain market share or
staff.
– Marginal costing and Break-even analysis
• Work through example p 149 – 154.

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 Capital expenditure (p 155)
– Long term investment decisions (expensive
plant)
– Long term commitments
• May impact severely on company’s earning power,
liquidity and growth potential.
– Projects must be appraised by estimations of
cash flow associated with capital expenditure.
– Form of financing must be carefully
considered as it impacts on cash-flow
situation
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– Investment Appraisal Techniques
• Techniques used by accountants to analyse and
compare investment/revenue cash flows
• Payback period (PP)
• Average annual percentage return (AAPR)
• Net Present Value (NPV)
• Future value (FV)
• Internal Rate of Return (IRR)
• Equivalent annual cost method
(EAC)

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– Payback period
• Calculate time that must elapse before net cash
flow of project result in entire capital investment
being repaid.
• Shortest payback period is best choice
• Ignores the time value of money
• Does not consider cash flows after payack period
has been reached.

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– Average Annual Percentage Return
• Projects evaluated in terms of average return
earned per annum as percentage of investment
• Profitability is measured
• Easy to compare projects with each other.
• Ignores time-value of money.
• Distorted by unusual cash-flow patterns.
• Example: R100 000 investment leads to a five year
income of R25 000 per year. This AAPR = 25%

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– Equivalent annual cost method (EAC)
• Time value of money is taken into consideration
• Include both capital and recurrent investment over
full period of assessment
• Use of end-of-year convention (EOY)
• All payments and receipts are converted to
equivalent uniform annual cost using suitable rate
of return (minimum required rate of return)

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– Equivalent Annual cost or NPV methods?
• Both based on selection of suitable interest rate.
• Interest rate must equate the required rate of
return.
• Annual cost methods are commonly used in large
public-orientated organizations.
• Correct use of either one will lead to same answer.

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– Internal Rate of Return (IRR method)
• The NPV method discounts the cash flows at
selected rate to determine the net present value.
• Setting the nett value to zero (equating the positive
and negative cash flows) we can calculate the IRR
by trial and error method.
• The IRR is compared with minimum rate (cut off
rate) as determined by company strategy.

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• Economic Comparisons
– In PV & EAC analysis we assume rate of
return
– We can calculate the internal rate of return for
a proposal
– Use discounted cash flow techniques
– IRR method equates discounted cash flow
with initial investment to determine the
internal rate of return

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• Selecting projects
– Project comparisons using the PB, AARR,
NPV, EAC and IRR methods
– Estimating and sketching cash flow diagrams
– Work through example on p 157 – 164
– Make sure you understand the use of NPV
tables

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 Budgets
• Budget is a quantitative monetary based
plan agreed upon by management
• Budgetary control exercised at project
level and holistically by company
• Budgets are targets which should be
bettered or at least achieved.
• Budget is related to construction program
• Budget period is period of time for which
budget is deployed
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 Cash Flow
• Cash flow is phrase meaning actual movement of cash
in and out organisation
• Cash flow has positive (cash in) and negative (cash out)
components
• Net cash flow is difference between positive and
negative cash flow
• Cash flow analysis is monitoring movement of cash
compared to budget
• Construction projects lend itself to cash flow problems
• Cash flow analysis is key activity for effective and
efficient project control

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 Cash Flow Graphs
• Cash flow graph represents total cash flow
requirements for project
• Various projects cash-flow graphs can be
combined into one graph for use in
corporative decision-making process.

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 Variance Analyses
• Variances established after comparing
budgets with actual costs

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 Variance Analyses
• Work through example on p 165 – 170
• Use of S-curve techniques in variance
analyses
– Use time adjusted cumulative amounts (due
and cost) – see Figure 5.26
– S-curve cash flow diagram is used in pre-
tender planning and forms bases for PDCA
control cycle

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 Class Problem: Problem EV
Analysis
Given an activity in an advertising project
whose planned cost to date was
R12 000 but actual cost to date is R10 00
and the value of work completed is only
70%, calculate the cost and schedule
variances .

Will the client be pleased??????

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 Solution to class problem
• Earned value = 70% X R12 000 = R8 400
• Cost variance = BCWP- ACWP =
R8 400 - R10 000=(R1 600)
• Schedule variance = BCWP – BCWS =
R8 400 - R12 000 = (R3 600)
• CPI = BCWP/ACWP = 8 400/10 000 = 0,84
• SPI = BCWP/BCWS = 8 400/12 000 = 0,70
• CSI = CPI x SPI = 0,84 x 0,70 = 0,588
• Client will be very unhappy!

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 Conclusion
• Main purpose of cash-flow analysis,
budgetary control and variance analysis is
to enable the management function of
control to be exercised by construction
managers.
• Importance of PDCA process cannot be
overemphasised.

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 Summary
• It is important to understand the integrative
nature of operations
• Important to follow the “Plan, Do, Check
and Act” approach
• Tragic errors are made as a result of
failure to predetermine cash flows, monitor
them and deploy actions to correct
variations from planned costs/activities.
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