Different Methods of Cost Planning during Construction

Cost Planning

Cost planning in construction is necessary since building a house is a very expensive thing to do and any mistakes can be very costly to the client. It is very important to know how to plan and to ensure that the building is suitable as far as the resources are concerned. All factors should be considered to ensure maximum value for your money. It is also important to note that a building should not cost more than what the client has budgeted for.

There are different methods of cost planning during construction which the client should be able to use for purposes of ensuring the budget is not overrun. These methods involve approximate estimation of the client’s budget. One method involves looking at similar structures erected within the resent time frame since costs do not differ very much within the same location. A developer should always consult on the prevalent costs before commencing building works.

The method of cost planning during construction we call comparative method involves taking similar structures done in recent past in the neighbour hood and making several adjustments. The adjustments involve size of the new building the client is undertaking. Other items to be considered include services like water, sewers or septic tanks, roads and also variations in prices of materials.

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In recent years various methods of cost planning have been evolved but to date there is no universal system which can be satisfactorily applied to every type of project. There are two main methods used for effective cost planning, they are Elemental cost planning system and the Comparative system.

Profit

Profit, is the difference between a firm’s total revenue and its opportunity costs. In classical economics profit is the return to the employer of capital stock, in any productive pursuit involving labour. These two definitions are actually the same.

In both instances economic profit is the return to an entrepreneur or a group of entrepreneurs. Economic profit is thus contrasted with economic interest which is the return to an owner of capital stock or money or bonds. In finance or accounting, profit is the increase in wealth that an investor realizes from making an investment, taking into consideration all costs associated with that investment including the opportunity cost associated with other investments. [1] 

Budget

A budget is generally a list of all planned expenses and revenues. It is a plan for saving and spending. A budget is an important concept in microeconomics, which uses a budget line to illustrate the trade-offs between two or more goods. In other terms, a budget is an organizational plan stated in monetary terms.

In summary, the purpose of budgeting is used to; provide a forecast of revenues and expenditures i.e. construct a model of how our business might perform financially speaking if certain strategies, events and plans are carried out. Enable the actual financial operation of the business to be measured against the forecast.

Return on Capital (ROC)

A Return on Capital is a measure of how effectively) a company uses the money (borrowed or owned invested in its operations. Return on Invested Capital is equal to the following:

A net operating income after taxes / [total assets minus cash and investments (except in strategic alliances) minus non-interest-bearing liabilities]. If the Return on Invested Capital of a company exceeds its WACC, then the company created value. If the Return on Invested Capital is less than the WACC, then the company destroyed value.

Here is the formula needed to work out the return on capital:

PAT .

ROC = BV of debt + BV of equity – Cash

Cost Value Reconciliation

Cost Value Reconciliation (CVR) brings together the established totals for cost and value to illustrate the profitability of a company. Its intention is to ensure that the profits shown in company accounts are accurate and realistically display the current financial position. In this respect, the purpose of CVR is twofold. Firstly, there is the requirement to provide statutory accounts, which is a legal obligation to provide certain financial information (Perceval, 1997), in addition to the Standard Statement of Accounting Practice number 9 (SSAP9), (ICAEW, 1998) which set out accounting recommendations and requirements for the construction industry. Secondly, and perhaps more importantly, is the provision of information which can have a direct bearing on the management of the operations within a company, at all levels (Perceval, 1997). This is of course dependent upon the information being properly and accurately provided and interpreted. Therefore, the information must be in a format that will enable management decisions to be made, taking influence from the figures displayed. [2] 

Cost Value Engineering

It is an organized approach to providing the necessary functions at the lowest cost from the beginning the concept of value engineering was seen to be cost validation exercise, which did not affect the quality of the product. The straight omission of an enhancement or finish would not be considered value engineering. This led to the second definition; It is an organized approach to the identification and elimination of unnecessary cost Unnecessary cost is Cost which provides neither use, nor life, nor quality, nor appearance, nor customer features.

Task 2 - Cost Control Systems

Cost Control is an obvious objective in Construction Management and Construction Scheduling. It should be recognized that no amount of paperwork achieves this construction cost control. The actual control is achieved through the ultimate decision of the manager that something should be done differently and the translation of that decision into practice. The paperwork provides guidance on what control actions should be taken and therefore it is rather a cost information system.

The elements of a cost control system are:

1. Observation
2. Comparison of observation with some desired standard
3. Corrective action to take if necessary.

A construction cost control system should enable a manager to observe current cost levels, compare them with a standard plan or norm, and institute corrective action to keep cost within acceptable bounds. 

Most construction cost control systems have an inordinately long response time. Even the best cost control system would provide information on what was happening last week or last month. Since, in construction projects some activities might finish in a week or a month, then nothing could be done if the performance of such activities was reported to overrun estimates of respective costs. [3] 

In recent years various methods of cost planning have been evolved but to date there is no universal system which can be satisfactorily applied to every type of project. There are two main methods used for effective cost planning, they are Elemental cost planning system and the Comparative system.

Elemental Cost Planning

In an elemental cost plan the estimate is broken down into a series of elements that can then be compared with later estimates, or with actual costs as the project progresses. For building projects, the most widely used breakdown of elements is that produced by the Building Cost Information Service (BCIS).

Typically, each element is treated as a cost centre, but money may be transferred between elements, provided a reasonable balance between elements is maintained and the overall target budget is not exceeded. The initial cost plan is likely to be based on approximate figures, which provide a fair basis for determining the validity of future estimates.

Control by the project manager is achieved by an ongoing review of estimates for each cost centre against its target budget. As design develops and costs have been made, any variance in cost from the cost plan is identified. Decisions are then taken on whether that element can be permitted to increase in cost, which would require a corresponding reduction elsewhere, or whether the element must be re-designed in order to keep within the budget.

Advantages of Elemental Cost Planning

An adaptable system which can be used with suitable adjustment at all stages of the design process, this can be a real advantage as it is flexible enough for most construction projects, and this is the main reason why it is the first choice that many people have in mind.

Their basic forms of analysis (the element) mean it is a system capable of being understood by parties. Due to the simplicity of this method it can be widely understood by all participating members. In addition to this the simplicity makes it an easier process to complete.

Comparisons between projects and between elements can be made rapidly, and each element can be adjusted individually. This is yet another great advantage, for if any reason there may be budget increase for improved services in the building, then it can be easily adjusted to handle the budget increase.

Elemental costs plans allow the design team members to gain elemental costs and to ascertain the costs implication during the early stages of the project; this allows greater control for other member of the design team.

Disadvantages of Elemental Cost Planning

Elemental cost plan require more time and effort in their preparation, but this investment should give better returns in aiding decisions-making. This process can be time consuming as each element must consider individually.

Extensive cost databases are required to ensure accuracy of costs; this can lead to high costs for software and training.

High levels of ability and expertise are required if elements are to be properly evaluated and adjusted. It can be expensive to find and hire suitable candidates with sufficient experience to manage cost control.

Comparative System

Comparative cost planning assumes that initial feasibility studies and cost advice have determined the general layout and arrangement of the building in the light of its total estimated or prescribed cost limit, and sets out to examine what could be described as a market of alternatives open to the designer in respect of each part of the building, and which are both feasible and acceptable to him. The study of alternative design solutions takes account of all the consequential effects of decisions on various parts of the building, relating to one particular part.

The information concerning alternatives is set out in a manner which enables the architect to make rational decisions in the light of their individual order of cost and their cumulative effect on total cost, before he starts developing his design. Having settled his design decisions he then develops them, and only if he changes from them should the cost plan need adjustment.

The comparative method does not seek to enforce rigid cost limits for the design of particular elements, but rather to maintain flexibility of choice of a combination of possible design solutions, that will serve the purpose to be achieved. It is more concerned with the comparison of alternative possibilities within a total sum, rather than attempting to control the design piecemeal in relation to targets for limited sections of the work. Its object is not necessarily to show how cheaply a building can be produced but to show the spread of costs over varies parts of the building and what economies are feasible. This enables the architect, within his cost terms of reference, to use the money to the best advantage in interpreting his design. This should lead to economy in design and will assist in comparison of elemental cost apportionment as between one building and another.

Advantages of Comparative System

The comparative system endeavours to show the architect the cost consequences of what they are doing and what they can do. This gives greater control to the architect, and due to the fact that they can foresee a problem and avoid it, thus saving time

Costs are also expressed a cost per square meter of gross floor area for ease of comparison. This makes it easy for everyone to understand as a ‘regular’ person would be able to understand it with a simple glance.

Cost of an element can be adjusted with out effecting the unit expression of others. This makes it a lot simpler to make those small changes with out worrying about the units.

Disadvantages of Comparative System

Drawing cannot be guaranteed to include each and every item that occurs in practise. This can be a major problem as each element is not taken into consideration.

It is always customary to add a sum at the end of a cost plan. This can be a lengthy and time consuming process.

When producing the cost plan the overall layout can often become complex making it complex for other to fully understand.

The two methods have their own advantages and disadvantages, Elemental Planning has its weak points, for example the architect must have a very high standard skills and abilities and some experience of costs to keep their design details within the cost plan framework. Also the Comparative System has its weak points, for example the architect will need to make very risky decisions at a very early stage.

In my opinion, the Elemental System is better suited for use with residential building where comparisons can be made with similar buildings which have much in common; however this does not apply to industrial buildings.