Without Cost Control, Project Profit May Be Misleading

A project can show positive cash in the bank and still be heading toward a weak final margin. The usual problem is not the arithmetic. It is that certified income, actual cost, committed cost and forecast cost are being compared as if they were the same type of information.

Professional cost control looks forward as well as backward. The HKIS practice note on cost control describes financial reporting as an up-to-date assessment of the contract position, including issued and anticipated variations and other adjustments that may affect the estimated final contract sum. A contractor needs the same discipline on the cost side.

Four figures that should not be mixed

1. Current recoverable value

Start with the original subcontract sum, then identify agreed additions, agreed omissions and other adjustments. Keep pending VO values separate from agreed value. A submitted VO is not automatically recoverable at the submitted amount.

2. Actual cost to date

This is what has already been paid or accrued for labour, materials, plant and subcontractors. It should be reconciled to invoices, payroll, purchase orders and subcontract payment records.

3. Committed cost

Committed cost includes orders and subcontract liabilities that have not yet been paid. Ignoring these commitments can make the current margin look stronger than it is.

4. Forecast cost to complete

Estimate the remaining labour, material, plant, supervision, testing, rectification and subcontract cost required to finish. The forecast should reflect current site conditions, not only the original tender allowance.

A useful control equation is: forecast final margin = forecast recoverable value minus actual cost, committed cost and forecast cost to complete.

Keep a status-based VO forecast

Do not put every VO into one total. A more reliable register separates:

• instructed but not yet measured;
• measured but not yet priced;
• priced but not yet submitted;
• submitted and under review;
• assessed but not agreed; and
• agreed or certified.

Apply a reasoned forecast to uncertain items and record why. The purpose is not to create an optimistic target. It is to show management what must happen for the expected margin to be achieved.

A simple monthly control cycle

1. Freeze a reporting date and use the same date for progress, income and cost.
2. Reconcile the latest payment application and certificate.
3. Update actual and committed costs from accounting and procurement records.
4. Review every open VO and change its status only when evidence supports the change.
5. Reforecast the cost to complete with the project manager or site supervisor.
6. Explain the movement from the previous month: new VO, rate change, delay, rework or procurement variance.
7. Assign an owner and deadline to each commercial action.

Fictional example

A fit-out subcontract has an original value of HK$2.40 million. The contractor has received certificates totalling HK$1.50 million and recorded HK$1.30 million of cost, so the project appears to have generated HK$200,000.

However, outstanding purchase orders and subcontract commitments total HK$420,000, and the remaining forecast labour and material cost is HK$630,000. The forecast final cost is therefore HK$2.35 million. If the reasoned forecast recoverable value, including supportable VO, is HK$2.55 million, the expected margin is around HK$200,000 before other business overheads. The current cash difference was not an additional margin.

Monthly review checklist

• Do income and cost use the same cut-off date?
• Are committed orders included?
• Are pending VO separated from agreed VO?
• Is the remaining cost based on current site information?
• Are omissions, contra charges and rectification risks recorded?
• Can every forecast movement be explained?
• Does each outstanding action have an owner and deadline?

When professional support may help

External QS support may be useful when payment, VO and cost records are held in different files, when the final margin changes substantially each month, or when management cannot reconcile the site forecast with the accounts. The first objective should be a reliable commercial position, followed by a practical action list.