VALUATION AND ITS PROCEDURES OF A LUMP SUM PROJECT IDENTIFICATION NUMBER: DATE: 1 TABLE OF CONTENTS 1. ABSTRACT ------------------------------------------------------------------------------ 4 2. INTRODUCTION ----------------------------------------------------------------------- 5 3. DEFINITION ---------------------------------------------------------------------------- 6 4. IMPORTANCE OF ACCURATE VALUATION ---------------------------------- 7 5. VALUATION PROCEDURE FOR CONSTRUCTION CONTRACTS -----5.1 VALUATION FOR ENGINEERING PART -------------------------- 7 8 5.2 VALUATION FOR PROCUREMENT PART ------------------------- 10 5.3 VALUATION FOR CONSTRUCTION PART ------------------------ 11 CASE STUDY – 1 ---------------------------------------------------------- 15 6. VERIFICATION OF VALUATION ------------------------------------------------- 20 7. CONCLUSION -------------------------------------------------------------------------- 21 8. LIST OF REFERENCES ---------------------------------------------------------------- 22 2 LIST OF TABLES Table No. 1 - Percentage completion for Engineering --------------------------------------------- 9 Table No. 2 - Percentage completion for Procurement --------------------------------------------- 11 Table No. 3 - Second level work package – Percentage completion ----------------------------- 16 Table No. 4 - First level work package – Percentage completion -------------------------------- 18 Table No. 5 - Project Percentage completion -------------------------------------------------------- 19 3 1. ABSTRACT The monthly valuation is one of the most important process in a project. A proper valuation ensures that the all the work effort such as manpower, machinery and material contributed by the contactor is converted into money. A project is being tendered based on the estimated value of the project. During the bidding stage, the cash flow for each month is calculated by the contractor. The execution of a project according to this planned cash flow stabilises the income and the expenditure in a project. The accurate monthly valuation ensures the proper cash flow. The proper valuation and the cash flow enable a contractor/consultant/client to utilize the revenue generated during each month in making a new investment. This new investment produces lot of job opportunities either to the employee in the same company or to a fresh employee thereby contributing itself in eradicating the unemployment crisis. Hence, the maintenance of this cyclic process directs us towards the developed and modern world. In a fixed price / lump sum project, the monthly valuation is calculated based on the percentage completion of a project. The percentage completion is calculated by allocating weighted percentage to the work packages and the activities. The weighted percentage of all work packages are distributed either by dividing the individual work package value or the man hours of the package. If the value or man hours are not available with the work package, the distribution shall be based on the expert judgement and historical data of the company. This thesis elaborates the importance and procedural approach of doing the monthly valuation of a fixed price/lump sum project. 4 2. INTRODUCTION: The first and foremost responsibility of a quantity surveyor or a cost Engineer in the construction field is to prepare the monthly valuation apart from highlighting the ways of controlling cost to the project team. The monthly valuation is prepared at the end of every month (with a cut-off date) based on the work completion in that project. The method of doing valuation depends upon the type of contract followed in the project. The valuation which is being described here is the monthly valuation prepared in the execution stage and not the valuation prepared in the bidding stage. Generally, during the execution stage, contractors in the construction field make payments to their vendors/sub-contractors with the payment received from their consultant/client. Hence it is very important for them to prepare accurate valuations in order to receive payment and issue payments to vendors/sub-contractors in time. This maintains a good cash flow in all the companies working for the project. The most popular “Pareto’s law” states that the 80% of the problems are due to 20% of the causes (80/20 Principle). In my point of view, the improper valuation covers under the 20% causes along with other causes. Hence, a proper valuation contributes to a smooth working platform in the project. 5 3. DEFINITION: In the Construction sector, Valuation is defined as the process of determining the actual value of the project for the present or particular period. In the finance sector, the same term “Valuation” is defined as the process of determining the actual value of an asset or liability. In the construction field, a value of a project is calculated if it is to be constructed, bought or sold. According to PMBOK (Project Management Body of knowledge – Fourth Edition), a project is defined as the temporary endeavour which produces an end result, product or service. Hence the term “project” in a construction field shall refer to all the outputs given in the above definition. During estimation stage, the forecast cost of a construction project is calculated based on the given scope of works (Drawings & Specifications or the bill of quantities), required time of completion & requirements such as safety regulations, quality & human resources/ workmanship. After calculating the forecast cost, the profit margin, additional Preliminaries, Contingency & management reserves are added to the forecast cost to obtain a value of a bidding project. This process of calculating valuation is defined as estimation or Tendering Valuation. During Construction stage, value of the completed project is calculated at the end of every month based on the percentage completion/Quantity completion of work. This monthly valuation is calculated by the owner or the contractor either for the monthly turn over or for the purpose of payment. This process of calculating valuation is defined as Interim Monthly Valuation or Interim Payment Valuation. 6 4. IMPORTANCE OF ACCURATE MONTHLY VALUATION: For the contractors, the accurate monthly valuation will ensure that the value for all the completed works is included in the valuation for the particular month. Based on this valuation and its subsequent approval from the consultant/client, the contractor will be entitled for payment. This enables the contractor to execute a project with the perfect cash flow system. The proper revenue generation from a project will ensure the portfolio management to utilize it according to their plan and this in turn ensures the smooth running of the company. Any inaccurate valuation will lead to the failure of cash flow system estimated during the bidding stage. This situation will direct the project manager/management to compensate the deficient value from the contingency or management reserve. The reserves in a project are generally included in the value to meet the unprecedented or unidentified risks in the tendering stage. If the reserves are utilised in this situation by the management, then the risk percentage of tackling unidentified risks in a project becomes higher. 5. VALUATION PROCEDURES FOR CONSTRUCTION CONTRACTS: The Valuation method for various types of contracts differs with each other. According to Skills & Knowledge of Cost Engineering (AACE International, USA), the major types of contract are as follows: a. Fixed Price / Lump sum Contracts b. Fixed Price / Unit Price Contracts c. Cost Reimbursable Contracts 7 In this thesis, the valuation procedure for a lump sum contract is alone elaborated. The valuation methods discussed under this fixed price/lump sum contract forms the baseline for the secondary classification of contracts. (For example: Fixed Price / Lump sum Contracts are further classified into Fixed Price with economic adjustments and Fixed Price with incentives). The lump sum contract in a construction sector generally consists of Engineering/Design, Procurement, Construction including testing & commissioning. The valuation for each month is calculated based on the percentage completion of the project. The best way to calculate the percentage completion of a project is through the weight factor analysis. This analysis will bring an agreeable opinion between a contractor and Consultant/client. 5.1 VALUATION FOR ENGINERING PART: The valuation for Engineering division/part is based on the status of the drawing. The drawings are prepared and submitted for approval by consultant/client. The drawings in this status are referred as “Issued for Review”. The drawings issued for review may get approval with or without comments/remarks. The commented drawing shall be re-submitted for approval. After the approval of the drawings, the contractor shall start his procurement or construction. The drawings in this status are referred as “Issued for Construction”. “As-built Drawings” are prepared after the completion of construction. The Overall weighted percentage (100%) shall be distributed to these three drawing status based on the estimated Value/man hours during the bidding stage. The formula followed to calculate weighted percentage is: Weighted percentage of “Issued For Review” drawings = Value /Man hours assigned for this drawings 100% Total Engineering value / man hours 8 The same formula shall be used to calculate the weighted percentage of all the other status. It is a known fact that in many projects, the detailed drawings may not be available during the bidding stage especially for a lump sum project. Hence the weighted percentage to the individual drawings shall be allocated based on the man hours assigned or the importance of the drawing. This shall be advised by experts or followed from the lessons learnt of the previous projects. In some major projects, the contractor may intend to classify the drawings such as civil, mechanical, electrical, plumbing and others. The methodology to calculate the weighted percentage for two or more work packages/divisions are explained in “5.3 valuation for Construction part”. TABLE NO. 1 (PERCENTAGE COMPLETION FOR ENGINEERING): The tabular column to calculate the percentage completion for engineering through weighted percentage is as follows: Sl. No. Discipline Drawing No. Description Weighted Drawing Issued Issued for As- Built Percentage % Status for Construction Drawings completion Review (55%) (5%) of drawing for drawing Remarks (40%) TOTAL ENGINEERING PERCENTAGE COMPLETION FOR THE MONTH OF MAY-2010 (Note: The methodology of calculating percentage completion in a tabular column is given in the Illustration – 1, section 5.3 “Valuation for Construction part”) If the engineering percentage completion for the month is calculated, then the Engineering value completed for the corresponding month is calculated by multiplying the percentage completion with the total engineering value of the project. 9 5.2 VALUATION FOR PROCUREMENT PART: The Valuation for procurement depends upon the status of order, manufacture status and the delivery of material to the project site. The material is ordered after its approval from the client/consultant. The material ordered in Overseas will generally take months to reach the project especially if the consignment delivery is through ships. In that case, the contractor may have to make some payment to the Vendor in order to get the delivery of the material from the manufacturer industry. This payment or some percentage of the total value of the corresponding product shall be claimed to the consultant/client as “Ex-factory” status on producing the valid supporting documents as mentioned in the contract. The balance percentage of money shall be claimed after delivering the material to site. The delivery at site is confirmed through material inspection by the consultant/client. The Overall weighted percentage (100%) shall be distributed to these three Procurement status based on the estimated Value during the bidding stage. The formula followed to calculate weighted percentage is: Weighted percentage of “Order of the material” = Value for this status 100% Total Procurement Value The same formula shall be used to calculate the weighted percentage of all other status. It is better to calculate the weighted percentage of procurement only through the value calculated in the bidding stage. In some projects, order & delivery of material may be through one or more repetitions. In that case, the weighted percentage shall be divided accordingly. The methodology to calculate the weighted percentage for two or more work packages/divisions are given in “5.3 valuation for Construction part”. 10 TABLE NO. 2 (PERCENTAGE COMPLETION OF PROCUREMENT): The tabular column to calculate the percentage completion of procurement through weighted percentage is as follows: Date Item No. Description Status Of Order Quantity Weighted % Enquiry Of Ex-factory Delivery Percentage Date Order Completion on of (10%) (80%) (10%) site Remarks Completion Total Procurement Percentage Completion (Note: The methodology of calculating percentage completion in a tabular column is given in the Illustration – 1, section 5.3 “Valuation for Construction part”) With the procurement percentage completion for the month is calculated, the Procurement value completed for the corresponding month is calculated by multiplying the percentage completion with the total Procurement value of the project. 5.3 VALUATION FOR CONSTRUCTION PART: Generally, in a civil construction field, construction takes more value when compared to engineering & procurement. In the bidding stage, the value of a lump sum contract is calculated based on the value of work packages. The weighted percentage of all individual packages shall be calculated or taken from any of the following ways: a. Bill of quantities included in the lump sum contract b. Total man hours planned for each work package in the contract It is generally better to calculate the actual weighted percentage from the bill of quantities available with the contract and the planned percentage from the total man hours estimated during 11 the bidding stage. However, any method shall be chosen after analysing type of the project & accuracy level required in it. As mentioned in Section 5.1 & 5.2, the project weighted percentage (100%) shall be distributed to all of the work packages based on the estimated Value. The formula followed to calculate weighted percentage of first level work package is: Weighted percentage of “Work Package No.1” Value of work package No. 1 100% = (First Level work package) Total Construction package Value It is worth to mention that any total value (engineering, Procurement or construction) should include the evenly distributed contingency, management and other reserves, if the reserves are included in the total value of the project. The same formula shall be used to calculate the weighted percentage of all other first level work packages. The accuracy of calculating percentage completion increases if it is calculated from the lowest possible activity level. In many projects, the further break down of first level work packages may not be available especially for a lump sum project. Hence the further calculation of the weighted percentage to the lowest level of work packages shall be based on the expert judgement and the company’s historical data. The lowest possible activity level shall also be taken from the work break down structure of the approved schedule followed in the project. The calculation of weighted percentage up to activity level (with two work packages) and the calculation of construction percentage completion of a project with the help of weighted percentage is explained through the below mentioned illustration No. 1. This methodology is common to calculate the percentage completion of Engineering & Procurement. 12 ILLUSTRATION 1: The abbreviations followed in this illustration are: a. CPV – Construction Project Value b. FLWP – First Level Work Package (Four packages are assumed) c. SLWP – Second Level Work Package (Three Packages are assumed) The weighted percentage of FLWP shall be calculated as mentioned in the above formula. For this illustration, let the weighted percentage shall be as follows: Weighted Percentage of FLWP No. 1 = 35 % of CPV Weighted Percentage of FLWP No. 2 = 25 % of CPV Weighted Percentage of FLWP No. 3 = 30 % of CPV ASSUMPTION No. 1 Weighted Percentage of FLWP No. 4 = 10 % of CPV TOTAL = 100% of CPV \ The weighted percentage of SLWP’s of FLWP No. 1 (for illustration - FLWP No. 1 alone is considered) shall be assumed as follows: Weighted Percentage of SLWP No. 1 = 35 % of FLWP No. 1 Weighted Percentage of SLWP No. 2 = 35 % of FLWP No. 1 ASSUMPTION No. 2 Weighted Percentage of SLWP No. 3 = 30 % of FLWP No. 1 TOTAL = 100% of FLWP No. 1 The SLWP No. 1 (for illustration - SLWP No. 1 alone is considered) shall be divided in to five activities. The weighted Percentage shall be as assumed as follows: 13 Weighted percentage of activity No. 1 = 15% of SLWP No.1 Weighted percentage of activity No. 2 = 10% of SLWP No.1 Weighted percentage of activity No. 3 = 25% of SLWP No.1 ASSUMPTION No. 3 Weighted percentage of activity No. 4 = 35% of SLWP No.1 Weighted percentage of activity No. 5 = 15% of SLWP No.1 TOTAL = 100% of SLWP No. 1 After assigning weighted percentage to all activities and work packages, percentage completion is calculated. The percentage completion is calculated from the activity level. The formula is: Work done quantity 100% Percentage completion of an activity = Total quantity It is evident from the formula that to calculate the percentage completion of an activity, the total quantity is required. The total quantity shall be calculated from the approved construction drawings. With the percentage completion of all activities, the percentage completion of SLWP No. 1 is calculated as follows (Refer Assumption 3) Percentage completion of SLWP No. 1 = (% completion of activity No. 1 x 15%) + (% completion of activity No. 2 x 10%) + (% completion of activity No. 3 x 25%) + (% completion of activity No. 4 x 35%) + (% completion of activity No. 5 x 10%) X 100% The same methodology shall be used to calculate the percentage completion of all SLWP’s. With the percentage completion of all activities, the percentage completion of SLWP No. 1 is calculated as follows (Refer Assumption 2) 14 Percentage completion of FLWP No. 1 = (% completion of SLWP No. 1 x 35%) + (% completion of SLWP No. 2 x 35%) + (% completion of SLWP No. 3 x 30%) X 100% The same methodology shall be used to calculate the percentage completion of all FLWP’s. With the percentage completion of all activities, the percentage completion of CPV is calculated as follows (Refer Assumption 1) Construction Percentage Completion = (% completion of FLWP No. 1 x 35%) + (% completion of FLWP No. 2 x 25%) + (% completion of FLWP No. 3 x 30%) + (% completion of FLWP No. 3 x 10%) X 100% The percentage completion calculated through this illustration is the most accurate way of calculating the progress completion in a lump sum project. This methodology is common for calculating engineering & Procurement percentage completion. With the percentage completion of Construction Percentage completion for the particular month, the construction value for the corresponding month shall be calculated by multiplying the percentage completion with the construction value of the project. CASE STUDY 1: Let us assume a lump sum contract awarded to ABC construction company (Contractor) for the Construction of a Hospital building. In this contract, engineering and procurement is directly executed by the client and the contractor has to do only construction. The available first level work packages with the contract shall be sub-structure, super-structure, MEP (Mechanical, Electrical & plumbing) works and External networks. The first level work package – sub-structure shall be divided into Footings, plinth beams and Grade slab. The second level work package – Footings shall be divided into Excavation, Concrete and Backfilling. The weighted percentages of all these work packages shall be assumed 15 and it is indicated in the respective tabular column shown below along with calculation of second level work package percentage completion: TABLE NO. 3 - SECOND LEVEL WORK PACKAGE - PERCENTAGE COMPLETION: (For Footings Only) Excavation (30%) Sl. Structure No. Quantity (m3) Weighted Volume Concrete (50%) Backfilling (20%) Progress Weighted Progress Weighted Progress Weighted Percentage % Progress % Progress % Progress completion Percentage % % % 1 Footing 1 2.0 20% 100% 20% 100% 20% 50% 10% 2 Footing 2 2.5 25% 100% 25% 100% 25% 50% 12.5% 3 Footing 3 1.5 15% 100% 15% 100% 15% 50% 7.5% 4 Footing 4 2.0 20% 100% 20% 100% 20% 50% 10% 5 Footing 5 2.0 20% 100% 20% 100% 20% 50% 10% 10 100% Total Total Percentage Completion 100% 100% 50% 30% 50% 10% 90% Explanation for Table No. 3: a. The First column indicates the serial number. b. The second column indicates the name of the structure as footing 1, footing 2 etc. c. The third column indicates the concrete quantity for each activity calculated based on the drawing. It is assumed in this case. It may also be calculated based on the excavation or backfilling quantity. The total of these quantities is 10 as shown in the same column. d. The fourth column indicates the weighted volume percentage of each footing. It is calculated as follows: 16 Weighted volume percentage = (Quantity of footing 1) x 100% Of footing 1 (total quantity of all footings) = (2.0/10.0) x 100% = 20%. In the same way the weighted percentage of all other footings are calculated. e. The fifth column indicates the activity – Excavation with the assumed weighted percentage of 30%. This column further splits as Progress % and weighted progress %. The column progress % shows the actual percentage of Progress in site. It is assume here. The column weighted progress % is calculated as follows: Weighted progress % = (weighted Volume % x corresponding Progress %) x 100% = (20% x 100%) x 100% = 20% In the same way the weighted percentage of all other footings and activities such as Concrete (sixth column) and Backfilling (Seventh Column) are calculated. f. With the help of summation of relevant weighted Progress %, the total percentage completion of each activity is calculated as follows: Percentage completion Of Excavation Summation of Excavation = weighted Progress % x Weighted Percentage x 100% of excavation = (100% x 30%) x 100% = 30% In the same way, the percentage completion of concrete & backfilling are calculated. The result is entered in the row named “Total” as shown in the table. g. With the percentage completion of each activity in Footing, the percentage completion of second level work package – Footing is calculated as follows: 17 Percentage (Percentage completion of excavation) + Completion = (Percentage completion of concrete) + Of footing (Percentage completion of backfilling) = 30% + 50% + 10% = 90% (Shown in the last row of last column). TABLE NO. 4 - FIRST LEVEL WORK PACKAGE - PERCENTAGE COMPLETION: (For Sub-structure only) Work package Second level No. work Weighted % % completed Planned Last Month This month Cumulative Progress % Progress % Progress % % packages completion 1 Footings 40% 90% 36% 15% 21% 36 % 2 Plinth Beam 30% 0% Nil Nil Nil Nil 3 Grade slab 30% 0% Nil Nil Nil Nil TOTAL PERCENTAGE COMPLETION 36% Explanation for Table No. 4: a. The first column indicates the work package number. b. The second column indicates the names of the second level work packages. c. The third column indicated the weighted % of work packages. It is assumed here. d. The fourth column indicates the % completion of each package. It is taken from the output of table No. 3. (Assume that footings are progressed in the project) e. The fifth column indicates the planned progress % for monitoring purpose. It is assumed here. f. The sixth & seventh column indicates the last month & this month progress %. The subtraction of last month % from cumulative % completion (Seventh column) gives 18 this month progress %. The cumulative % completion of sub-structure is calculated as follows: Cumulative % (% completion of footings x weighted % of footings) + Completion = (% completion of plinth beam x weighted % of plinth beam) + Of Sub-structure (% completion of Grade slab x weighted % of grade slab) X 100% = ((90% x 40%) + Nil + Nil) x 100% = 36% (as shown in the last row of the last column). TABLE NO. 5 - PROJECT PERCENTAGE COMPLETION: Work package First level No. work packages Weighted % % Planned Last Month This month Cumulative completed Progress % Progress % Progress % % completion 1 Sub-structure 20% 36% 7.2% 3% 4.2% 7.2 % 2 Super structure 40% 0% Nil Nil Nil Nil 3 MEP works 30% 0% Nil Nil Nil Nil 4 External works 10% 0% Nil Nil Nil Nil TOTAL PERCENTAGE COMPLETION OF PROJECT 7.2% Explanation for Table No. 5: The methodology followed in calculating percentage completion of first level work Package is followed here (Refer: Table No. 4 and its explanation). The result of the tabular column is the percentage completion of the project which is 7.2% (as shown in the last row of the last column). With this percentage completion of a project for a month, the valuation of the same month is obtained by multiplying this percentage completion with the total construction value of the project. 19 6. VERIFICATION OF VALUATION: The prepared valuation should be verified thoroughly before submitting to the management or the client/consultant. The percentage completion obtained through the mentioned above procedure shall be verified with the percentage completion obtained through the planning schedule. The value obtained for the particular month shall be verified with the value planned during bidding stage for the same month. This shall be analysed with the help of histogram with months on X-axis and the Value on Y-axis. The calculated value should be equal to the planned value if the project is on schedule. Any difference in the histogram should be analysed for reverification of prepared valuation or change in schedule. 30 million LEGEND: 20 million Planned Value 10 million Actual Value Mar-10 Apr-10 May-10 (FIGURE -1) 20 7. CONCLUSION: The preparation of monthly valuation should be given utmost importance by a Cost Engineer or a Quantity Surveyor. The above described method is the most accurate way of calculating the percentage completion of the activity, work packages and the project. The obtained percentage completion not only helps in preparing the monthly valuation but also utilized in tracking the cash flow of the project. All the leading consultants/client around the world (irrespective of their field) performs the cash flow monitoring system to track the progress of the project apart from the planning schedule. The calculation of the percentage completion through weighted percentage is being followed by the major contractors, the consultant and the client in the construction field around the world. The value calculated by this method brings an agreeable opinion between the consultant/client and the contractor thereby increasing the friendly co-ordination between them till the successful completion of the project. 21 8. LIST OF REFERENCES: 1. Information about valuation in www.wikipedia.com 2. Definition of Project (Section 3 Page 5 – Second paragraph in thesis) from “PMBOK – Project Management Body of Knowledge” (Fourth Edition – Chapter 1 Section 1.2 Page 5), Project Management Institute, USA. 3. Types of Contract (Section 5 Page 7 in thesis) from “Skills and Knowledge of Cost Engineering” (Fifth Edition – Chapter 25 page 25.4), AACE International, USA 22