MANAGING COSTS: UNDERSTANDING THE ESTIMATE

maximum cost of the project will be for the contractor’s fulfilling all of the requirements set forth in the contract documents. While there are construction projects that are performed under contracts that do not contain such a provision, most contracts do contain this requirement; therefore, discussion in this chapter will proceed on this basis.

It follows, then, that contractors must have a method for determining what they believe their cost of performing the construction project will be. This is the only way they can guarantee that the contract requirements will be performed for a stipulated number of dollars, as required by the construction contract. This determination of the amount of money for which the contract requirements can be fulfilled is made by the contractor’s estimator and the estimating department. This is where construction costs are first envisioned and defined.

Whether the estimating department consists of one individual or a large number of people, the objective is invariably the same: to produce the best possible determination of the contractor’s cost of performing a construction project as the project is defined and described in the contract documents. Accordingly, the contractor’s estimate is often referred to as the cost estimate.

The cost estimate can be defined as the estimator’s best prediction of what the costs of performing a project will be, given the time and other resources available. Estimators take the construction documents and, through the application of their skills, produce this prediction, the cost estimate. This chapter will acquaint the supervisor with the estimating process.

Contractors produce different types of estimates for different purposes. For example, contractors sometimes produce estimates that are called factor estimates. Such estimates are intended to provide an approximation of construction costs on the basis of units, such as dollars per square foot, per cubic foot, per linear foot, per cubic yard, per fixture, or per some other unit of measure. Estimates of this kind are also referred to as parameter estimates, or as parametric estimates.

These factor or parametric estimates may be used to determine order-of-magnitude approximations of construction costs. Additionally, they may be used in feasibility studies. However, such estimates are seldom sufficiently accurate to be utilized to determine contract prices.

The type of estimate to be discussed further in this chapter is referred to as the detailed estimate. Detailed estimates provide the best estimate of construction costs. Detailed estimates are also the most time-consuming and the most costly to prepare.

Detailed estimates are used to prepare proposals that are submitted by a prime contractor to an owner, or in the case of a subcontractor, to prepare proposals for submittal to a prime contractor. Detailed estimates are also employed by prime contractors as well as by subcontractors, to prepare prices for change orders during the course of a construction project.

The fundamental purpose of a detailed estimate is to determine the number of dollars that a prime contractor or subcontractor is willing to enter into a proposal for the purpose of being selected to receive the award of a construction contract. The usual expectation is that if the contractor’s proposal is selected, the contractor will enter into a contract, and that the amount on the contract will be the same as the amount on the proposal. Therefore, in a very real sense, the amount of dollars that a contractor’s estimator derives in the estimate becomes the amount of money for which the contractor will be expected to perform the construction contract.

It is important for the supervisor to understand the estimating process for a number of reasons. First, it is in the estimate that the costs of performing the work on the construction project are first determined. As you will see, the supervisor will be working with these cost figures throughout the duration of every project he or she performs.

Additionally, the supervisor, in an indirect way, plays a very important role in the estimating process. When the supervisor manages a project during the course of its construction, he provides coded craft labor input regarding the labor costs on the project to the construction company home office. This information is compiled, and then is stored in a historical cost database that the company maintains. As you will see, the estimator utilizes this historical cost information in a meaningful way in the formulation of construction cost estimates. In a very real sense, then, the supervisor provides input that determines the estimated cost of future projects that the company will perform.

The estimate is extremely important in terms of its basic function as we have described it. It is also important for the supervisor to recognize that estimate is also part of a larger system in the contractor’s operations. This system is described as the cost determination (estimating), cost reporting, cost accounting, and cost control system that the contractor employs. This system operates as a continuous cycle within the construction company, as illustrated in Figure 12.1.

Estimating as a Career Option

Supervisors should also recognize that as their careers advance they might wish to become a project manager, or perhaps to join the construction office staff in the estimating department. In either of these roles, understanding the construction estimating process will prove to be an extremely valuable asset. Many contractors believe that the best estimators are those who have previously managed work on construction projects. In addition, most contractors consider their estimators to be among their most valuable assets. For a great many constructors, estimating is a very attractive career option.

•  SYSTEM OF COST CODES ESTABLISHED

•  INPUT TO THE SYSTEM VIA CODED LABOR TIME CARDS

•  PAYROLL PREPARES CRAFT LABOR CHECKS

•  PROJECT COST ACCOUNTING TO COST CODE CATEGORIES

•  COST REPORTS PREPARED THROUGHOUT PROJECT

•  MANAGEMENT COMPARISON TO PROJECT BUDGET

•  MANAGEMENT ANALYSIS

•  MANAGEMENT DECISION MAKING

COST

EXPERIENTIAL

DATABASE

COMPARISON

TO PROJECT

BUDGET

DURING EACH PROJECT

PROJECT MANAGEMENT INFORMATION AND DECISION

MAKING

FINAL i-¹—\ SUMMARY p¹—”^MANAGEMENT,-¹—\ I COST/

EXPERIENCE L_V AND L_V PROJECT 17′””L

REPORTING M REVIEW M EXPERIaENaTIA

DATABASE

The remainder of this chapter will outline, for the supervisor’s understanding, the process by which detailed estimates are prepared. While the fundamentals of the estimating process are consistent and do not change, it should also be recognized that every estimator has his or her unique approach to the estimating process, as well as his or her own subtle variations in procedure. In addition, the policies and

management decisions of the construction company will determine some aspects regarding the preparation of the estimate. It has been said, therefore, that estimating is partly art and partly science.

One way for the supervisor to envision the estimating process is to consider that the estimator builds the project in his or her mind. That is, the estimator envisions each activity to be performed in constructing the project. Then, using the tools and techniques described in this chapter, the estimator formulates the best prediction of the cost of performing each activity. The estimated project cost is the summation of the estimated costs of performing each activity in the construction of the project.

A prime contractor’s detailed estimate consists of six components. For a subcontractor, there will be five components, unless the subcontractor is planning to utilize sub-subcontractors to perform some of the work on the project. In this case, there will also be six components in the subcontractor’s detailed estimate.

The six components of a prime contractor’s detailed cost estimate are: materials, labor, equipment, subcontractor quotations, indirect costs, and markup. The estimators will determine their best prediction of the project cost for each of these components. The cost estimate, that is, the amount to be entered onto the proposal, will be the total of these six components. Figure 12.2 illustrates this process in graphic form.

Prior to beginning the preparation of the detailed estimate, the contractor’s estimating and management staff will make a determination of which items of work on the project the contractor will plan to perform with its own craft labor forces, called self-performed work, and which items of work the company plans to perform by subcontracting. For those items of work that the company plans to perform with its own craft labor, the materials, labor, and equipment costs will be estimated by the contractor. For those items that the company plans to perform by subcontracting, subcontractors’ proposals will be sought and will be incorporated

into the estimate. Whether lump sum or unit price subcontractor proposals are taken from the subcontractors, each subcontractor’s proposal is expected to include the subcontractor’s consideration of all materials, labor, equipment, indirect cost, and markup for the performance of the subcontractor’s portion of the work.

Additionally, prior to beginning the detailed estimating process, the estimating staff will carefully evaluate the project duration. This is the amount of time stated in the contract documents, in which the contractor must complete all of the requirements of the contract documents. Time is a very important provision of the construction contract. The project duration is a very important consideration in the estimating process.

In order to predict construction costs, the estimator must prepare at least a preliminary construction schedule, which is the contractor’s plan, on a timeline, for completing the project within the specified duration. If the project’s duration permits, the contractor will most likely plan to perform the work on a five days per week, eight hours per day schedule. However, as indicated by the duration and the amount of work to be performed in the project, the contractor may find it necessary to plan to work on weekends, and/or to work overtime, and perhaps even to work in consecutive shifts in order to complete the project on time. These determinations will have a profound effect on the construction costs and must, therefore, be reflected in the estimate.

Quantity Takeoff

The estimator’s first step in estimating materials is to identify each material that will be required in the performance of the work of constructing the project. This information will be determined from the estimator’s analysis of the drawings and the specifications for the project. Most of the materials that will be required in a building construction project are not called out in the contract documents in the form of a list or a table; rather, the drawings and specifications show and describe what the finished construction product will be. Therefore, the estimator must analyze the drawings and the specifications in order to identify all of the materials that will be required to construct the project and to fulfill the contract requirements.

When the requisite materials have been identified, the estimator will next determine the quality level required by the contract documents for each material that has been identified. Many construction materials, such as plywood, are available in different grades; others, such as Portland cement concrete, have varying compositions and proportions of ingredients, which define the quality of the concrete; others, such as metals, may have different metallurgical qualities or different finishes specified. The estimator must infer from the description of the materials in the specifications, and from information that is provided on the drawings, all of the pertinent elements of quality for each material that will be used in constructing the project.

The estimator’s next step will be to determine the quantity of each material that will be required for the project. This step in the estimating process is often referred to as the quantity takeoff, or QTO. Each material must be quantified in the unit of measure in which it is produced and marketed: cubic yards of cast in place concrete, square yards of carpet, sheets of plywood, bank cubic yards of excavated soil, squares of roofing, and so forth.

Some materials, such as concrete, excavated soil and fill soil, and so forth are quantified by calculation, based on the dimensions in the drawings. Others, of identical kind and description, such as door units, lighting fixtures, windows, and the like are determined by counting the number of identical items as indicated in different parts of the project, as shown in the drawings. These are referred to as count items in the estimate.

Following the quantification of each material in its appropriate unit of measure, the estimator will determine the amount of each material that will actually need to be purchased in order to complete the work. This is called determining a waste or overage allowance. For some materials, such as framing lumber, for example, the estimator must allow for the fact that stock lengths of lumber will be cut by the carpenters to the exact lengths required in the work in order to produce the pieces to be installed in the project. Thus, more lumber will need to be purchased than the precise quantity that has been calculated. For other materials, such as electrical switchgear, or air-handling units for the mechanical system, the waste or overage factor will be expected to be zero. The amount of waste or overage factor to be applied by the estimator will come from the estimator’s experience and judgment.

Materials Pricing

After determining the quantity and quality of each material that will need to be purchased, the estimator will next determine prices for each of the materials. The estimator will contact materials suppliers, distributors, or manufacturers and will solicit price quotations for each of the materials to be purchased. The estimator will furnish information to the materials suppliers regarding the exact description of each material, the quality level in which the material is needed, and the quantity of the material to be purchased.

Materials suppliers will provide price quotations in response to the estimator’s request, and the estimator will determine the best price for inclusion in the estimate for each material. The estimator will compile this information for each material and will then determine the dollar amount that the company will expect to pay for the material when the project is performed.

While this process appears straightforward and direct, there is actually a considerable degree of uncertainty and, therefore, risk, in this determination. Some materials prices are stable, while others fluctuate. Time will elapse between the taking of the price quotation from the supplier and the point in the future when the material is actually purchased for the project. Materials prices will often change during that time.

Sometimes materials suppliers will guarantee materials price quotations for a period of time following their initial price quotation, but often not. Therefore, the price that the estimator includes in the estimate at the time of its preparation must reflect, as nearly as possible, the price for which he or she expects the company to purchase the material on that date in the future when the material is actually purchased for the project.

Additionally, the estimator must include in the materials price determination, details such applicable taxes, shipping fees, delivery charges, and so forth. In addition, materials suppliers will often include the designation fob in their price quotations. The characters fob translate literally to “freight on board,” or to “free on board.” The fob designation in a price quotation will include some location or destination, as stipulated by the vendor (e.g., “fob my loading dock, Kansas City, Kansas.”). This location is the designated place where the supplier will have the product located for the contractor when the material is purchased. This location might be the supplier’s or the manufacturer’s location, or a warehouse, or a port facility. Or, it could be the contractor’s job site. This is also the location to which the supplier assumes responsibility, and the point at which the contractor assumes responsibility for the material or product at the price that has been quoted.

When all of the elements of the cost of each material have been finalized, all of the prices for all of the materials needed for the project are totaled by the estimator. This total becomes the materials cost subtotal in the estimate.

Estimating Labor Cost

As noted earlier, the estimator will calculate labor costs for the craft labor that the contractor plans to self-perform, that is, to perform with craft workers on his payroll. Having decided what parts of the work will be self-performed and what parts of the work will be performed by subcontracting, the estimating staff will determine the labor cost of the contractor’s craft labor forces performing work on the project.

While there are several approaches to the process of labor estimation, many estimators believe that the best approach for the estimator to employ is for the estimator to “build the job in his mind,” and to estimate labor cost in doing so. In the course of building the project in his mind, the estimator will first determine all of the activities that must be performed in order to complete the work. Activities are elements of work that are identifiable and quantifiable, and that consume resources.

Next, the estimator will envision the number and the classification—how many journeymen, apprentices, crew leaders, and so forth—of craft workers necessary to perform each activity. This is referred to in estimating terminology as making the work breakdown structure, or WBS.

The next crucial step is determining, literally estimating, the number of man-hours necessary for the crew and each of its craft workers to complete each activity that has been identified. This component of the labor estimate is both vitally important and, at the same time, filled with uncertainty.

This determination of craft labor hours is vitally important because this is where labor man-hours are quantified. Obviously, this determination will in turn form the

basis for the quantification of labor cost on the project. On building construction projects, labor cost is typically the largest single component of the total cost of a construction project.

At the same time that the quantification of craft labor man-hours and, therefore, labor cost forms the basis for the largest component of the cost of a project, this determination is also the most uncertain, and therefore the most risky, component of the estimate. This is true because estimating labor man-hours is based literally on estimating the productivity of the craft labor on the project. It is one of the ironies, and also one of the elements of difficulty associated with cost estimating, that labor is both the largest component of cost within an estimate and is at the same time the most difficult and, therefore, the most risky to estimate component of construction cost.

There are a great many factors that influence what the labor productivity will be on a construction project, and many of these factors are difficult to predict in advance. Additionally, their impact on labor productivity is difficult to quantify. A few examples will illustrate this point.

Weather has a profound influence on labor productivity. Hot and cold weather, high humidity, wind, and precipitation all have an influence on the rate at which craft labor can perform the work. While general weather trends can usually be predicted, the daily weather and its variability, as well as sudden and unforeseen weather events, such as storms or precipitation, certainly affect productivity but cannot be predicted with accuracy.

Additionally, factors such as geographic location of the project and the composition of the construction team—owner, architect, general contractor personnel, subcontractors, building officials, and so forth—have a bearing on the craft labor productivity on a project. Likewise, the composition and management abilities of the contractor’s team—the supervisor, superintendent, project manager, and office staff—have an influence. All of these various factors exert an influence on how craft labor does its work and on how productive the craft workers will be.

While other factors could be listed that impact labor productivity, it should now be clear that the estimator faces a daunting task in his or her endeavor to quantify and to determine the cost of craft labor and its performance of the construction work on a project. Nonetheless, the estimator must make the best prediction possible, given the time and other resources available, of the cost of labor to perform the project.

To accomplish this task, there are several different methodologies that may be employed. Both of the methods described here make extensive use of the historical cost information that the contractor’s cost estimating, cost accounting, cost control system has developed. This is, in fact, the very reason for the contractor’s compiling and maintaining this file of information.

The historical cost database is a tabulation of the contractor’s costs of performing work, by project and by activity, on past projects. This information is generated as each project is performed, and is stored in a systematic manner in the historical cost database. This database is one of the contractor’s most important and most closely-guarded assets.

By one estimating philosophy, estimators “build the job in their mind” and estimate construction costs as though this database of information did not exist. Estimators proceed with estimating labor as we have described, envisioning activities to be performed, determining the work breakdown structure, and estimating craft labor man-hours for the performance of the work. Periodically during the development of the estimate, or sometimes when the labor estimate is complete, estimators will then check the values derived in their estimates against labor man-hours for the same activities on similar or comparable projects that have been completed on the past, stored in the historical information database. This comparative analysis allows estimators to determine their comfort level with the derived values in this estimate as a function of how these values compare to the contractor’s experience on similar activities and projects in the past. Estimators may or may not modify their labor estimates as derived for the project they are currently estimating following their comparison of their current numbers with costs in the historical information database.

A second method for estimating labor is the converse of the first. In this approach, estimators consult the historical information first, and based on the activities to be performed, then extract from the historical information what the number of man-hours was in the performance of these activities on past projects. The estimate being prepared currently is then structured accordingly. Finally, the estimators adjust the man-hours or production rates in the current estimate in such a way as to reflect their best determination of what the man-hours or production rates will be on the project currently being estimated.

Certainly individual estimators, as well as different construction company owners, have their opinions regarding which method of estimating labor yields the best results. In the final analysis, however, the conclusion is the same—the estimators must utilize their skill and judgment, and the best tools available, including the historical information database, to estimate with the greatest degree of certainty attainable, the cost of the craft labor in performing the construction work on the project.

Following the determination of all the activities to be performed in completing the work on the project, and the estimation of the number of man-hours of craft work necessary to complete each activity, the estimator will develop totals for labor hours, totaled by craft and by skill level. The total number of master carpenter hours, journeyman carpenter hours, carpenter apprentice hours, ironworker hours, cement finisher hours, and so forth will be tallied.

The labor cost to be included in the estimate will then be determined by multiplying the craft labor man-hours estimated by the rate (dollars per hour) that that the craft and skill classification will be paid on the project. This product is called the direct labor dollars.

The total of labor dollars on the project will include the determination of both direct labor and indirect labor dollars. This determination is illustrated in Figure 12.3. Indirect labor is also frequently referred to as labor burden.

Indirect labor dollars are defined as dollars that the contractor must pay, expressed as a fraction or percentage in several different categories, for each direct

labor dollar of labor cost. Examples include: federal withholding taxes, Social Security taxes, workers’ compensation insurance premiums, unemployment insurance premiums, union fringe benefits, employee medical care, paid vacation time, and so on. Each of these elements of indirect labor cost is typically defined as a percentage of direct labor dollars. Most contractors will tabulate the total of all of the indirect labor components to be included for each craft and skill level, and will then apply that percentage as a multiplier to the direct labor for that craft and skill level. While the amount will vary by location and by contractor, the indirect labor is frequently in the range of 40% to 50% of the direct labor amount.

For the estimator’s purposes, the labor cost for a project is determined by multiplying the number of craft labor man-hours that have been estimated times dollars per hour of total labor cost (sum of direct labor and indirect labor) in order to determine the estimated labor cost for the project. This labor cost is then entered as a subtotal into the cost estimate.

It should also be noted that because of the importance of the labor cost determination, this component of the estimate is almost always subjected to several levels of review on the part of the contractor. The estimating staff will typically make the initial determination, followed by a review on the part of the head of the estimating department or by the chief estimator. In some companies, company management may conduct a final review of the labor cost determined by the head estimator prior to finalizing the proposal.

The estimation of equipment cost begins with the estimator determining what items of equipment will be necessary for the performance of the work. Equipment will be defined, in this sense, as machinery that is necessary for the contractor’s performance of the work.

Several elements of distinction should be noted here. First, there is sometimes confusion regarding the term equipment and its definition as machinery necessary for the performance of the work on a project, as contrasted with equipment that is to be installed in the project, such as heating, ventilating, and air conditioning equipment. Machinery necessary for the performance of the work may include cranes, backhoes, materials lifts, temporary elevators, track hoes, earthmoving

equipment, and so forth. This is the component of construction cost to be estimated here.

It should also be noted that the contractor will have done some decision making in the development of his estimating and cost accounting systems regarding his definition of equipment. Most contractors define equipment as noted above, with the additional element of definition to include the fact that equipment usually is defined as a capital expenditure, subject to depreciation.

In most contractors’ organizations, the concept of capital equipment is what distinguishes equipment from other similar elements necessary for the performance of the work, such as tools. While a pan scraper earthmoving machine would certainly be a capitalized piece of equipment, sledge hammers and other hand tools, as well as circular saws, electric drills, extension cords, and the like, would be most commonly be classified as tools.

Sometimes tax laws govern the determination of the classifications of capital equipment as contrasted with tools. When legislation does not provide the distinction, the contractor will make internal company definitions of equipment and tools classifications. Sometimes standard accounting practice will also indicate how these classifications are structured.

For the supervisor, it is important to know that, while both equipment and tools as described thus far have costs associated with their purchase and use, the matter of where and how the cost is tabulated and estimated is not as important for the supervisor’s understanding as is the realization that every component of cost, no matter its name or its classification in an accounting sense, is a component of cost and must be included in the contractor’s estimate. Many contractors utilize the expression, “If I need this item in order to perform the work, and if I do not have its cost included in the estimate, then I will be furnishing it to the project free.” This is hardly a good business procedure. Therefore, every effort is made by the estimator to include a cost in the estimate for everything that will be needed in order to perform the work on the project.

In determining what elements of equipment will be needed to perform the work, the estimator must carefully assess the exact characteristics that the equipment must have in order to effectively perform the work on the project being estimated. Factors such as lifting capacity, height or depth of reach, production rate, mobility, and a great many other factors determine the suitability of the equipment to meet the needs of the work to be done.

If the contractor owns the equipment with the characteristics needed, the estimator will proceed with determining its cost to the project by calculating the contractor’s ownership and operating costs for each piece of equipment and ascribing those costs to the project based on the amount of time the machine will be needed on the project. If the contractor does not own a piece of equipment whose need has been identified for a project, he may consider purchase, or he may rent or lease the necessary equipment. If a purchase decision is made, the estimator will proceed with determining ownership and operating costs.

If the contractor does not own the needed equipment and decides not to purchase it, then the equipment will be rented or leased for the project. While there

certainly are differences between equipment rental and lease agreements, for purposes of understanding the estimating process, the process of estimating the costs of equipment rental or leasing will be considered to be the same.

In this case, having determined the necessary characteristics for the machine to be rented or leased, the estimator will contact equipment rental or leasing agencies in order to obtain price quotations. These quotations are usually stated by rental or lease agencies as a rate—dollars per hour, per day, or per week, and so on. The estimator will determine the amount of time the equipment will be needed on the project and will multiply by the best rate quoted to determine the cost of the rented equipment for the project.

The estimator must add to the quoted equipment rate his or her consideration of the cost of other typical elements of the rental or lease agreement such as delivery and pickup charges, setup fees, loss and damage waivers, and so forth. Additionally, operating and maintenance costs, as well as the cost of the equipment operator, must usually be determined and included as additional elements of the cost of the rented equipment. The estimator will tabulate all of these elements of the cost for the rented machine and will include these costs in the estimate.

For equipment that the contractor already owns that is needed for a project, the estimator will determine the rate, also known as the internal rate. The internal rate is the sum of the contractor’s ownership and operating cost for the machine, and it is expressed as dollars per unit of time—dollars per hour, per day, per week, and so forth. Ownership and operating costs for equipment that the contractor owns will have been determined by the cost accounting system that the contractor has developed for his business.

Ownership costs can be defined as costs that continue to accrue, whether the machine is in use or not. Examples include: financing costs for buying the machine (or sinking fund contributions for replacing the machine at the end of its useful life) and depreciation. Operating costs, as their name indicates, include costs associated with the operation of the machine. Examples include: fuel, lube, hydraulic fluid, scheduled maintenance, repairs, and so forth.

To determine ownership and operating costs, most contractors utilize their historical cost database. Machine costs are tabulated over a period of time and are stored in the historical cost database; they are then converted to the internal rate.

The estimator will determine how long the piece of equipment is needed on the project whose cost he is estimating and will then multiply by the internal rate to determine the cost of utilizing that machine on the project. In the future, as the project is constructed, revenue received for the performance of the work will be allocated, on an internal accounting basis in the contractor’s office, to pay for the ownership and operating costs of the contractor’s owning this machine and furnishing it for use on this project. Additionally, as the project is constructed, the costs of the machine performing work on the project will be tabulated and will be stored in the historical information database.

The estimator will also determine the cost of the machine operator in the project cost estimate. The operator’s hourly rate will be multiplied by the time he or she

will spend operating the machine on the project, in order to determine dollars of operator cost for the estimate.

In a procedural note, the supervisor should know that, although equipment operator costs are estimated as noted, these costs are usually tabulated in the labor cost section of the estimate. Although it is logical to assume that the equipment cost should include equipment operator cost, the inclusion of operator costs in the labor cost section of the estimate simply facilitates calculations of indirect labor costs, which are based on labor payroll dollars.

Subcontractor Proposals

For those items of work on the project that contractors do not plan to perform with their own craft labor forces, they will plan to award subcontracts. Most contractors will maintain a file of subcontractors in a variety of specialty trades whom they know and have worked with in the past.

The estimator will inform subcontractors in trades whose work is included on this project that the contractor is planning to submit a proposal for the project, and will invite subcontractors to prepare and submit proposals for their part of the work to the contractor in advance of bid day. In addition, it is common for subcontractors who have learned of the existence of the project being proposed to inquire of a number of general contractors whether they are planning to submit a proposal, and whether they would accept a subcontractor proposal.

Each subcontractor will follow an estimating process parallel to the one being employed by the general contractor. The subcontractor will analyze the contract documents, primarily the drawings and specifications, for those elements of the project that pertain to the subcontractor’s trade. The activities or items of work to be performed by the subcontractor are referred to as the scope of work, often referred to simply as scope. The subcontractor’s estimator will estimate materials, labor, equipment, indirect cost, and markup, in order to arrive at a price to be entered onto a subcontract proposal for the subcontractor’s defined scope of work.

The subcontractor will prepare a subcontract proposal, which includes a scope statement, a listing of items of work included in the proposal, and items of work excluded from the proposal, along with the proposal amount, which is usually in lump sum. The scope statement will provide definition for the work the subcontractor will perform in descriptive format, and often will include a listing of Construction Specifications Institute (CSI) division numbers of the proposed work.

Subcontractors will submit their proposals to one or more general contractors, in time for the general contractor to include the subcontractor’s proposal in the estimate prior to the time the proposal is due to the owner. General contractors will receive all of the subcontractor proposals for each category of the work on the project that they do not plan to perform with their own craft labor forces. They will analyze each proposal, and will compare the proposals for each category of work, considering completeness of scope versus price for each subcontract proposal.

The general contractor will then select the proposal in each category of work that is the most complete and most competitive, and will include that proposal price in his

own estimate as the estimated price for that component of the work on the project. In this manner, the proposals of the plumbers; electricians; heating, ventilating, and air conditioning specialists; roofers; and all of the other subcontractors who will perform the work that the general contractor is not planning to perform with their craft labor will be entered into the general contractor’s estimate and will become a component of his proposal price.

Subsequently, when the general contractor’s proposal has been accepted by the owner and the prime contract has been formalized, the general contractor will notify those subcontractors whose proposals have been accepted. A subcontract agreement, commonly referred to as the subcontract, will be entered between the general contractor and each of the subcontractors who have been selected. The subcontract agreement will contain the scope of work and the subcontract price in accord with the proposal that the subcontractor submitted at the time of making the estimate.

Estimating Indirect Cost

Indirect costs are also referred toasoverhead costs. Indirect costs can be defined as costs that a contractor incurs and dollars that the contractor must pay for elements that do not contribute in a direct way to the completion of a project in the sense in which materials and labor and equipment do. Indirect costs are often referred to as costs for items that support the work being performed on the project.

Indirect costs are subdivided into two categories: project overhead and office overhead. Project overhead costs may also be referred to as general conditions costs or as project indirect. Office overhead costs may also be referred to as company overhead or as general overhead.

Examples of project overhead costs include: the job site office building, as well as equipment and utilities for the job site office; the job site fencing and gates; temporary lighting; temporary water; temporary heat; break areas for craft workers; drinking water; temporary parking; crushed stone travel ways on the job site; toilet facilities for workers; scaffolding; ladders; toolboxes (gang boxes); hand tools; and so on.

Usually the salaries of project supervision, foreman, and superintendent, are included in project overhead, and sometimes the project manager’s salary is included here as well. These project overhead costs for a project may be determined by direct estimation. More typically, however, these costs are extracted from the contractor’s historical cost database and are then included in the estimate.

A contractor’s office overhead includes the cost of owning or leasing the contractor’s home office; salaries of the home office staff, such as the company president, estimators, cost accountants, reception, and clerical workers; utilities and equipment for the home office; and so forth. Some companies include the salaries of project managers in the category of general overhead.

To facilitate estimating general overhead, the construction company typically tabulates the costs that have been defined as general overhead over a period such as a year. These costs are then apportioned to each project that the company

estimates on apro rata basis. Some companies apportion the cost of office overhead to each project being estimated based on the number of projects the company usually performs in a calendar year. Other firms pro rate the anticipated total cost of the project being estimated as a fraction of the company’s volume in a year and then include that fraction or percentage of yearly company overhead costs in the cost estimate for the project currently being estimated.

For the supervisor, it is not as important to understand the exact method of apportionment of company overhead costs, as it is to recognize what the components of these costs are and to know that the company must have some reasonable method of apportioning these costs and including them in the cost estimate for each project that the company will perform. After the company has been awarded a construction contract, as the work on the project is performed and revenue is generated, some of that revenue is utilized to pay the costs of the company’s general overhead.

Markup, also referred to as margin in some construction companies, refers to the number of dollars included in the estimate that the company plans to keep for itself as return for performing the work after all of the costs associated with the performance of the project have been paid. The markup determination is typically the last component to be determined when the estimate is finalized.

While some may refer to this component of the estimate as “profit,” others argue that the term profit refers to dollars that the company has earned after all project costs have been paid. At the time the estimate is being prepared, consideration is given to how many dollars the company would like to have earned or anticipates having earned, after all costs have been paid. This is the rationale for the usage of the term markup rather than profit for this component of the estimate.

The amount of the markup to be included in the estimate for the project is typically determined by the company’s executive management or by the chief estimator. The decision is momentous.

In a business sense, the company should expect to earn sufficient markup to justify the business enterprise and the effort and the risk of performing construction projects. In the competitive environment of the construction industry, however, the company cannot overprice its expected markup to the extent that it then is not sufficiently competitive to be awarded the contract.

Additionally, the markup determination is tempered by a number of other considerations. These include the amount of confidence that management or the chief estimator have in the other components of the estimate. This thought is based in the realization that if the company is awarded the construction contract, and if some component of construction cost exceeds the estimated amount when the work is performed, those additional costs can be recovered in only two ways. Either the construction of some other element of the project must be completed at a cost less than the estimated amount in order to compensate for the overage, or the

cost overrun must be compensated by reduction in the amount of the markup the company will receive.

Other factors that influence the markup determination include: composition of the project team, the owner and architect; who the other contractors are who are competing for the contract award (which the company may or may not know at the time of preparation of the estimate); the company’s assessment of how urgently it needs a contract award for a project in order to maintain its operations or to keep its key people employed. Also to be considered are the time of year and expected weather during the time the construction will be performed; market conditions relative to the availability of craft labor, materials, and subcontractors needed to construct the project; and numerous other elements.

The single concept that seems to best describe in summary fashion the factors that determine the amount of markup to be included in the estimate is risk. The greater the risk the contractor perceives in the project in all of its aspects, the greater the amount of markup he will include in the estimate in order to compensate for the risk.

When a total has been determined for each of the six components of the estimate, a summation of the six subtotals is made. This sum and the amount of money it represents is the contractor’s estimated dollar amount for the performance of the work on the project in such a manner as to comply with the requirements of the contract documents, and this is the amount that will be submitted on the general contractor’s proposal to the owner.

The contractor will double-check all of the components of his estimate for completeness and accuracy and will finalize the proposal before signing the proposal and submitting it to the owner. This process is referred to as “closing out” the estimate.

The proposal is completed in exact compliance with the stipulations set forth in the Instructions to Bidders, and it is then submitted to the owner. The general contractor’s proposal will be analyzed by the owner following its submittal, in competition with the proposals of the other contractors who are seeking the award of the contract for the construction of the project.

A prime contractor will be selected by the owner to receive the contract award and will sign the agreement, which formalizes the contract between the owner and the prime contractor or general contractor. The general contractor will then proceed with completing subcontract agreements and materials purchase orders.

Subsequently, the contractor will receive a letter of intent or a notice to proceed from the owner. These documents will authorize the contractor to occupy the site and to begin work, and they will denote the beginning of the project duration. The contractor will then immediately occupy the construction site and will commence work on the construction of the project.

During the performance of the work in the contract, the supervisor will perform his function of managing the work of the craft labor crew and coordinating the work of the subcontractors on the project. In addition, during the construction of the project the supervisor will contribute in a very significant way to the contractor’s cost determination, cost reporting, cost accounting, cost control system. These functions will be described and defined in the next chapter.

SUMMARY

The costs associated with the construction of a project are first defined and determined in the contractor’s estimating process. This chapter has described the process by which the estimate is prepared. It is important for the supervisor to understand all aspects of construction costs, including the cycle that was presented in Figure 12.1. Additionally, it is important for the supervisor to understand the elements of the estimating process and the process of preparing a detailed estimate for a construction project.

The costs that compose the estimate are the basis for the determination of which contractor will receive the contract award. As the next chapter will illustrate, after the contract is awarded, the actual costs of performing the work are tabulated as the project is performed and are closely compared to the estimated costs in the form of cost reports that are prepared by the contractor on a regular basis throughout the performance of the work on the project. The supervisor is a key participant in this process.

1. Learning more about costs and about the estimating process

Try to arrange to spend some time with an estimator in your company. Perhaps you can meet for lunch on occasion.

Visit with the estimator to learn more about how he or she goes about the process of estimating.

Ask about the specific methods he or she uses to quantify materials, and to estimate equipment, indirect costs, and labor.

Ask about how the estimator utilizes the historical cost information, or the production rates and productivity factors derived from historical cost, in preparing the estimate.

Ask the estimator how important it is for construction labor costs to be accurately reported in the field for inclusion in the historical cost information database.

2. One of the longest-running debates among construction company managers is whether it is better for estimators to be people who have worked extensively in the field before becoming estimators or not.

Sit down with an estimator, or project manager, or construction company executive whom you know, and discuss this matter so that you will have the benefit of their viewpoint.

3. Try to arrange to attend a bid opening, or to be an observer at a presentation in conjunction with a competitive sealed proposal where your company is submitting a proposal.

MANAGING COSTS— ELEMENTS OF COST CONTROL

I t is essential for the supervisor to have a firm understanding of construction costs, as well as a clear understanding of the cost reporting, cost accounting, and cost control system utilized by the contractor. This system provides a critically important function in the contractor’s operations, and since the supervisor is a direct participant in its operation, the supervisor absolutely must understand every aspect of this system.

For the supervisor, it is best to view the important matter of cost control not only as a vitally important function unto itself but also as a component of a larger operational system within the construction company. While details will vary somewhat from one construction company to another, most contractors have established a system whose functional components operate in the form of a continuous cycle. Figure 13.1 illustrates such a system.

COST

EXPERIENTIAL

DATABASE

U—y ESTIMATE

COST CODING

VIA CODED

TIME CARDS

ND INPUT TO|

THE SYSTEM

COMPARISON

TO PROJECT

BUDGET

DURING EACH

PROJECT

CONTINUED

REPORTING

AND

UPDATE

THROUGHOUT‘

CONTINUED

ANAGEMENT

ANAYSIS AND

ACTION

PROJECT

DURATION

FINAL SUMMARY

AND REPORTING

FINAL

K MaNAGemeNtJ__l\ HISTORICAL

^ P.™« W exp COST ential

REVIEW DATABASE

Central to the process, and fundamental for supervisors’ understanding, is the project cost accounting system. The key features of this system, which is at the heart of the cycle, is illustrated in Figure 13.2. The basic operational component of this system is a series of “cost codes,” which have been developed by the contractor to describe the activities that the company performs during the course of completing

•  SYSTEM OF COST CODES ESTABLISHED

•  INPUT TO THE SYSTEM VIA CODED LABOR TIME CARDS

•  PAYROLL PREPARES CRAFT LABOR CHECKS

•  PROJECT COST ACCOUNTING TO COST CODE CATEGORIES

•  COST REPORTS PREPARED THROUGHOUT PROJECT

•  MANAGEMENT COMPARISON TO PROJECT BUDGET

•  MANAGEMENT ANALYSIS

•  MANAGEMENT DECISION MAKING

its work on a construction project. Each activity has an assigned cost code number and a name. Typical examples of cost codes might be: “3117 Wall Forms,” “16124 Conduit in Framed Walls,” and “9256 5/8″ Fire Code Drywall on Ceilings.”

The contractor will prepare such a system of cost codes that describe the activities in the work to be performed. Some contractors develop their cost code numbers and activity descriptions themselves, in-house. Others utilize the Construction Specifications Institute’s (CSI) naming and numbering structure. Still others utilize a system developed by a contractors’ professional association. Whatever their derivation, once these cost code numbers and activity names have been developed by the contractor, they will be utilized on every project that the contractor performs.

Typically, once a contractor has developed and operationalized this set of cost codes, they will remain unchanged in terms of their basic structure and composition. At the same time, most cost-coding systems are established with sufficient inherent flexibility so as to accommodate changing technology and its effects on the work the contractor does. Clean room construction, fiber-optic cable installation, and photovoltaic glazing are examples of fairly recent technological developments whose construction activities were necessarily incorporated by contractors into their existing cost-coding systems.

The supervisor will utilize this cost-coding system on all of the work that he manages. He will be provided with the set of cost codes that the contractor utilizes in his system. As the construction work in the field is performed, the supervisor is expected to monitor the work, and on a daily basis is expected to complete a “coded time card” for each person under his supervision who worked on the project during that day. The supervisor will enter onto each construction craft worker’s time card, the number of hours which that person worked in performing various activities during the day, accompanied by the cost code number for each of those activities from the contractor’s cost-coding system.

Figure 13.3 illustrates a typical time card for a construction worker as prepared by the construction supervisor for a typical five-day work week. Note that, for each day’s work by Alfred during the week, the total number of hours worked that day is recorded on the time card. Additionally, and importantly, each activity on which this craft worker performed labor during each day is recorded on the time card by the activity cost code number for that activity. Each cost code number is accompanied by the number of hours that the worker spent working on that activity during the day.

The supervisor will prepare a time card in similar fashion for each person in the supervisor’s crew, for every work day throughout the duration of the project. This is referred to as “cost coding the work.” It is a critically important supervisory function.

Two points merit special emphasis here. First, it is very important for the supervisor to accurately record the cost codes for all of the activities on which each worker performed labor during each work day, by using the correct cost code number for each activity. If the supervisor fails to accurately cost code all of the construction labor, then the consequence is that inaccurate information is provided to the company’s cost accounting and cost control system, and to the historical information database, which were discussed in Chapter 12.

Additionally, it is very important that this cost coding be completed no later than the end of each work day. The supervisor must avoid the temptation to wait until some later time, or until the time when time cards are due for submittal to the company office for payroll purposes, to enter each worker’s cost codes on the time card. The accuracy of cost coding is sure to suffer if this practice is followed, and when labor costs are not accurately coded by the supervisor, a great number of problems surely will result, as will be pointed out in discussions that follow.

The supervisor enters cost codes and hours worked on each activity on the time cards for every craft worker on the project for every work day throughout the duration of the project. Once per week, or more often in some companies, these time cards are submitted to the contractor’s office. The payroll department in the company office will collate the hours of work performed during the week by each construction worker and will use this information to prepare a payroll check for each craft worker, usually on a weekly basis.

Additionally, the cost-coded information from each time card for each craft worker on the project will be tabulated into the cost-reporting system for the project. This system utilizes the project budget as a basis, accrues all of the costs associated with each construction activity, and compares cost to date against progress to date with project budget values. This important information is then reported by means of a series of periodic cost reports throughout the duration of the project. This process will be further discussed in the section that follows.

The project budget can be defined as a document that is prepared by the construction contractor for each project that the contractor performs. The project budget is an internal document, which is prepared for the contractor’s own use in tabulating and controlling his project costs on each project he constructs.

The contractor will incorporate into the project budget each element of construction cost on the project for which he wishes to monitor costs for the purpose of exercising management control during the construction of the project. While various elements of cost may be included in project budgets, the element of cost that is almost always included is construction labor cost.

As noted previously, on most construction projects, labor costs constitute the largest single component and also the largest percentage of the total project cost. Additionally, labor costs are highly variable, and they vary in response to a large number of factors. The productivity of individual craft workers, and of construction crews, varies on different projects and in different environments. In addition, labor costs are difficult to estimate, so there is uncertainty with regard to labor cost when construction estimates are prepared.

For all of these reasons, labor costs are a source of uncertainty and risk for the contractor on construction projects. Therefore, the construction contractor, as well as the supervisor, must make every effort to continuously monitor and to control labor costs throughout the duration of every project that the contractor performs. The management team absolutely must know on a regular basis throughout the life of the project whether labor costs are in line with the costs that were estimated and budgeted for the project. For this reason, labor costs are regularly tabulated and reported, so that the contractor’s management team can analyze the costs as they are incurred and can take management action if labor costs exceed the project labor budget amount. The supervisor plays a vital role in this entire process.

The project budget is the basis for the tabulations and cost reports as noted above. Following the formalizing of the construction contract and signing the agreement, and before commencing work on the project, the contractor will prepare the project budget, which, as has been noted, almost always includes the project labor budget. The project budget is the primary tool that will be utilized by the contractor’s management team, in the office as well as in the field, for monitoring and controlling project costs throughout the life of the project.

The project budget consists of a listing of the all of the activities that the contractor will perform in completing the work on the construction project. As noted previously, activities are defined as elements of work that can be identified and quantified and that consume resources. All of the activities that the contractor must complete, from start to finish on the project, are listed on the project budget. These activities are listed in roughly the same order in which they will be performed during the course of the work, and in an amount of detail to suit the management needs of the contractor.

Along with each activity is listed the amount of money, the number of labor man-hours, or the number of production units that the contractor has determined are required for the work that must be completed on the project. In a literal sense, the contractor quantifies on the project budget the amount of resources budgeted for the completion of each activity. These amounts are referred to as the budgeted amount for each activity in the project budget.

Additionally, the project budget will include the amount of each activity to be performed on the project. These quantities will be based in those determined during the preparation of the cost estimate that the contractor formulated in the course of bidding or negotiating for the contract award.

The activities, their quantities, and their budgeted amounts are usually listed in columnar form on the project budget. Two illustrative examples of project budgets are shown in Figure 13.4 and Figure 13.5.

Throughout the life of the construction project, the project budget, and the periodic project cost reports for which the project budget forms the basis, will be used by all levels of the contractor’s management team in order to monitor labor costs on the project. This information provides a continuous status report with regard to project costs for the contractor. The contractor simply must know,

on a regular recurring basis, what the status is on the project with respect to costs incurred as compared to costs that were estimated and budgeted. Additionally, and importantly, this information is utilized as the basis for management decision making and management action throughout the conduct of the work on the project.

The contractor’s cost control system will include a mechanism for the preparation, analysis, and use of periodic cost reports. Most contractors prepare cost reports on a weekly basis throughout the duration of each project. It should be noted that the information that appears in the labor cost reports is derived directly from the coded labor information that the supervisor has noted on each craft worker’s time card.

Project cost reports utilize the project budget as a basis with some additional columns added. Again, the project activities, their quantities, and their budgeted amounts are usually listed in columnar form on the cost report form. A series of additional columns are also included whose typical titles are: “cost this period,” “cost to date,” “percentage complete,” and “variance from budget.” Additionally, sometimes a column is included whose title is “projected cost to complete.” An illustrative example of a contractor’s cost report is shown in Figure 13.6. Another example of a contractor’s cost report form is illustrated in Figure 13.7.

As the work on the project is performed, at the end of each reporting period (usually weekly, as previously noted), labor costs for each activity on which work was performed during the reporting period are tabulated in the appropriate column on the cost report form. From this information, a mathematical determination is made, of total costs to date for that activity, and those values are entered onto the cost report form.

At the same time a determination is made, of the current percentage complete on the project for each activity. This percentage complete may be determined on the job site by counting, measurement, calculation, or estimation.

A calculation is performed of the percentage complete of the work on each activity compared to the percentage of the project budget amount that has been expended for that activity. The result is entered onto the cost report as “variance from budget.” A notation is also made on the cost report form to indicate whether a positive (+) variance means the work is costing more than the budgeted amount at this time or that a positive (+) variance indicates the activity is costing less than the budgeted amount and is, therefore, “ahead of budget.”

For example, if it is determined that the work on a certain activity is 60% complete, and 40% of the budgeted amount has been expended, it can be seen that the work is “ahead of budget” for this activity. Similarly, if the cost-reporting system indicates that the work on an activity is 20% complete, and 50% of the project budget amount has been expended, clearly the work on that activity is “over budget,” and management attention is warranted.

Additionally, cost reports often include a calculation of “projected cost to complete” for the activities. This is simply a mathematical calculation of what the cost to complete will be for each activity, on the current trend, and assuming a linear progression. This projection is sometime helpful in depicting what the final outcome may be for the work on each activity or for calling attention to the variance from budget for an activity.

Thus, it can be seen that the cost report provides a summary view of the status of each activity as of each cost report date, as compared to the project budget.

The cost report provides powerful information for the supervisor, as well as for all of the other members of the contractor’s management team. This information can be analyzed and discussed by the members of the team, and it can be used as the basis for management decision making.

For example, sometimes a change in crew size or a modification in crew composition may be indicated. Sometimes the need for developing an alternative work method, or the need for utilizing equipment, additional equipment, or different equipment, may be determined. In summary, cost reports are commonly used as the basis for management analysis and management decision making as the work is performed. Further, cost reports and the management action they initiate are

Detailed