Facility Management
Professional ™
Finance and Business
Leadership and Strategy
Operations and Maintenance
Project Management
Finance and Business
Contents
Introduction ................................................................................................................................................. 1
Chapter 1: Finance and Business in the Facility Organization
Topic 1: The Importance of Being Finance- and Business-Aware......................................................... 3
Topic 2: Financial Terminology ............................................................................................................. 4
Topic 3: Fundamental Accounting Concepts ...................................................................................... 10
Chapter 2: Financial Management of the Facility Organization
Topic 1: Budgets and Budgeting Basics ............................................................................................... 33
Topic 2: Financial Statements .............................................................................................................. 59
Topic 3: Business Cases, Supporting Documentation and Financial Reports ...................................... 83
Topic 4: Fundamental Cost Concepts................................................................................................. 104
Topic 5: Analyzing and Interpreting Financial Documents ............................................................... 118
Topic 6: Cost-Containment Strategies................................................................................................ 126
Topic 7: Chargebacks ......................................................................................................................... 129
Chapter 3: Procurement in the Facility Organization
Topic 1: Procurement Procedures ...................................................................................................... 136
Topic 2: Procurement and Facility Management Outsourcing ........................................................... 143
Chapter 4: Contracts in the Facility Organization
Topic 1: Contract Development, Management and Oversight ........................................................... 153
Topic 2: Contract Administration....................................................................................................... 172
Topic 3: Analyzing and Interpreting Financial Contract Elements .................................................... 186
Topic 4: Resolving Vendor Conflicts ................................................................................................. 198
Bibliography ............................................................................................................................................ 206
Index ......................................................................................................................................................... 209
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Acknowledgments
The references in this course have been selected solely on the basis of their educational value to the IFMA
FMP Credential Program and on the content of the material. IFMA does not endorse any services or other
materials that may be offered or recommended by the authors or publishers of the books and publications
listed in this course.
Every effort has been made to ensure that all information is current and correct. However, laws and
regulations are constantly changing. Therefore, this program is distributed with the understanding that the
publisher and authors are not offering legal or professional services.
We would like to thank the following dedicated subject matter experts (SMEs) who shared their time,
experience and insights during the development of the IFMA FMP Credential Program.
Content Development SMEs
Content Analysis SMEs
Donna Byrom, CFM
Charles N. Claar, P.E., CFM, CFMJ (deceased)
Steven Ee, CFM, RegSO, FSM
John Furman, P.E., CFM
Steven J. Jones, CFM
Robert Kleimenhagen, Jr., CFM
Jim Loesch, P.E., CFM, IFMA Fellow
Patricia Moonier, CFM, CFMJ
Cameron C. Oskvig, CFM
Edmond P. Rondeau, CFM, AIA, IFMA Fellow
Ian G. Wallace, CFM
Frederick Weiss, CFM, IFMA Fellow
James P. Whittaker, P.E., CFM, EFP, FRICS
David Wilson, CFM, PGDipMgt, MBIFM
Robert L. Blakey, CFM, CEM, LEED-AP
Stephen Brown, CFM, FMP, CPE, CBCP, REM
William T. Conley, CFM, CFMJ, IFMA Fellow
Richard Fanelli, CFM, AIA, IFMA Fellow
David Henrichon, CFM, CFMJ, FMP, MS, CPE
Yvonne Holland, CFM, CFMJ, ARP
Christopher P. Hodges, P.E., CFM, IFMA Fellow
John Huffman, CFM, FMA
Barbara Jo Kane, CFM
Jon Mackay, CFM
Ira A. Marcus, CFM, IFMA Fellow
Jon E. Martens, CFM, CFMJ, IFMA Fellow
David Martinez, Ph.D.
Phyllis Meng, CFM IFMA Fellow
Kathryn Nelson, CM/CFM
Bryan K. Neuhaus, CFM, LEED Green Associate
Patrick H. Okamura, CFM, CSS, CIAQM, LEEDT
Don M. Rogers, CFM
Mark R. Sekula, CFM, LEED-AP
Teena G. Shouse, CFM, IFMA Fellow
Mary L. Speed-Perri, CFM
Kit A. Tuveson, CFM, IFMA Fellow (deceased)
Introduction
In 2009, the International Facility Management Association (IFMA) conducted a global job task analysis
(GJTA) to identify the tasks and knowledge that are important for competent performance by facility
managers across the world. As part of that effort, IFMA identified finance and business as a competency
area, described the role of the facility manager as related to finance and business, and identified key tasks,
knowledge statements and competencies that support finance and business.
IFMA FMP
Credential
Program
IFMA’s Facility Management Professional (FMP) credential is an
assessment-based certificate program demonstrating a proven
comprehension of the foundations of facility management (FM). In
September 2010, the FMP credential was updated and enhanced to align
with the most recent IFMA global job task analysis, ensuring that it teaches
and tests the knowledge demanded by today’s global employers in a
convenient print and online self-study program.
The FMP Credential Program teaches and assesses your comprehension of
topics in these four knowledge domains:
•
•
Operations and maintenance
Project management
•
•
Finance and business
Leadership and strategy
This course focuses on the area of finance and business. Combine this print
manual with the online study tools (including quizzes, case studies,
Flashcards, progress reports and more) to help you apply and retain the FMP
concepts. Successfully complete all four FMP courses and final assessments,
submit your FMP application to IFMA for approval and receive your
credential.
Role of facility
managers as
related to
finance and
business
© 2015 IFMA
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According to the IFMA GJTA:
Facility managers manage/oversee aspects of the entire
organization that represent significant financial investment in
technology, buildings, structures, interiors, exteriors and grounds.
The entire organization may choose to contract for services.
Facility managers typically are responsible for the oversight,
operation and maintenance of the buildings and grounds as well
as service contracts.
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Finance and Business
Due to the ever-changing global environment, finance and business
management is a complex undertaking for any manager, not just facility
managers. Reduced to its essentials, finance and business in facility
management involves:
•
Being able to manage/oversee the financial management of the facility
organization.
•
Administering procurement.
•
Administering and managing/overseeing the finances associated with
contracts.
A facility manager’s role in each of these areas is, of course, shaped by the
policies, practices and norms of the organizational environment.
In this Finance and Business course, the goal is to present essential concepts
underpinning finance and business appropriate for facility managers. The
information provided is intended to be reasonably self-contained so a facility
manager with little or only a modest background in finance and business can
understand its contents.
Although the perspective presented combines descriptive and prescriptive
information, this course is not meant to be an end-all in finance and business
management for facility managers. Finance and business, as is facility
management, is an integrated organizational function, not a stand-alone
activity. As such, facility managers will need to engage finance, legal,
procurement, risk managers and others in their organizations to make valuemaximizing decisions.
This course aims to provide proficiency and guidance. As you read through
the course, reflect on the culture of your organization and consider how this
information applies.
Note on term
“entire
organization”
© 2015 IFMA
All rights reserved
The term “entire organization” is used throughout this course to apply to the
facility management organization’s parent or client organization (corporation,
government body, nonprofit, etc.).
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Chapter 1: Finance and Business in the Facility
Organization
After completing this chapter, students will be able to:
•
Summarize the reasons why finance and business management are key ingredients in the
success of facility management.
•
•
Define key finance terms prevalent in facility management.
Explain basic accounting principles and practices that underpin facility management
operations.
Topic 1: The Importance of Being Finance- and
Business-Aware
Finance and business play a critical role in every organization. Without money
and its successful management, few organizations survive, much less grow
and prosper.
Finance is the use, interpretation and management of information related to the
financial operation of the facility. This includes the development, use and
interpretation of financial data in any form, e.g., reports, spreadsheets, computer
printouts, budgets, pro formas, cost statements, ratios and more. Finance is also
the ability to provide information to and understand information from the
organization within which the facility operation exists. In some cases, this may
be two organizations: the client and the facilities contractor.
Business is the use, interpretation and management of documents related to
the administration and management of contracts, service providers and leases,
including lease agreements, business cases, chargebacks and procurement
policies and procedures.
Some facility managers may find the idea of finance and business intimidating
and cringe at the mere thought of dealing with numbers. But the reality is, in
any organization, the duties and responsibilities of the facility manager are farreaching, and almost all facility management decisions have financial and
business implications. Financial decisions in an organization are not limited to
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Finance and Business
the chief operating officer, the chief financial officer, the finance director, or
other finance specialists.
For most facility managers, a key responsibility is to prepare and manage
budgets to the standards required by the organization.
Think about it. As building managers, FM professionals are typically entrusted
with one of the most expensive assets of an organization—real estate. Managing
the vast majority of FM operations without simultaneously considering the
related finance and business implications is a potential way to a disaster. With
one single decision, a facility manager can save or cost an organization more
than that manager makes in annual salary. One ill-advised purchase can cause
unnecessary expense for years to come. At the very least, deficiencies in basic
finance and business knowledge can impede a facility manager from
contributing fully to discussions and conversations about departmental and
organizational strategy.
In most organizations—whether public, not-for profit, government,
nongovernmental organization (NGO), associations, educational institutions,
partnerships or sole proprietorships—management employees of all types are
expected to have a strong understanding of how their jobs impact organizational
profitability. They are also expected to be able to work within their areas to
improve profitability. Some facility managers may lament, “I don’t do
numbers.” But whether they want to or not, in FM an understanding of finance
and business basics is a key driver for success. FM budgets are one of the key
discretionary spend areas in non-core business activity and thus offer one of the
best options to improve net profitability in the short term.
The good news is that becoming finance- and business-aware need not be
daunting. This chapter provides the foundation and explains basic finance
terminology and essential accounting concepts for facility managers. With this
information we will proceed to explore additional core finance and business
topics in facility management through subsequent chapters.
Topic 2: Financial Terminology
Facility management is grounded in a clear understanding of property and FM
needs—what resources and services are required to have adequate funding for
projects, services, operations, maintenance, repairs and the like. Collectively,
these needs become the budget requirements for efficient and effective facility
management.
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Chapter 1: Finance and Business in the Facility Organization
Just as facility management has its own specialized terminology, so does
finance. Thus, we begin with a primer of financial terms. Why? Understanding
fundamental terms that are part of senior management’s financial vocabulary is
a prerequisite to have FM needs and suggestions heard, accepted and funded.
An overview of basic financial terms and definitions follows in Exhibit 1-1.
Note that these terms will be explained in more detail in subsequent content.
Along the way, additional terms and concepts will be introduced.
The terms are presented in alphabetical order, and the list is not intended to be
all-inclusive. Think of the list as a baseline reference of common terms found
throughout this Finance and Business course. Also, keep in mind that these
terms may be defined slightly differently across organizations. Here we simply
lay the foundation for the in-depth content that lies ahead.
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term
Definition
Accounting
A monetary reporting system used to inform interested parties about a firm’s
business transactions.
Accrual basis
accounting
Revenues recorded when earned and expenses recorded when incurred.
Amortization
The systematic reduction of a lump-sum amount; the expense applies to intangible
assets (such as patents, franchises, leaseholds and goodwill) in the same way
depreciation applies to physical assets.
Asset
Something that retains value for a period of time after purchase such as a building or
a piece of equipment.
Balance sheet
A “snap shot” of a firm’s financial position at a specific point in time.
Budget
A formal, numerical expression of how an organization expects to operate for a
defined period of time. Identifies the resources and commitments needed to satisfy
the identified goals over a period as well as the sources of the funding to provide
those resources.
Capital asset
A depreciable item whose cost is significant to the company and whose expected life
is longer than one accounting period and often much longer.
Capital budget
Shows financial impacts resulting from major, long-term, non-routine expenditures for
items like property, plant and equipment.
Cash flow
Net cash before financing, including acquisitions.
Chart of
accounts
Numerical list of all standard items that an accounting system tracks: assets,
liabilities, net assets, revenues, expenses.
Closing fiscal
period
Process of transferring account balances from sub-ledgers to trial balance account at
the end of an accounting period; typically associated with income statement
accounts.
Cost
The price paid for acquisition, maintenance, production or use of materials or
services.
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Finance and Business
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term
Definition
Cost-benefit ratio
Ratio in which the net present value of an investment or project is divided by the
investment’s or project’s initial cost; a ratio of greater than one indicates that the
investment or project is viable.
Cost center
An organizational unit in which budgetary funding is used to sustain operations.
Cost of operation
The total costs associated with the daily operation of a facility. It includes all
maintenance and repair costs (both fixed and variable), administrative costs
(clerical, time-keeping, general supervision), labor costs, janitorial, housekeeping
and other cleaning costs, utility costs and indirect costs (e.g., all costs associated
with roadways and grounds). Could also include the amortized or depreciation
costs of capital assets.
Cost of
ownership
The cost to the owner of owning the building, servicing the existing debt, and
receiving a return on equity. This also includes the cost of capital improvements,
maintenance and repair, operations, and disposal.
Credit
Positive cash entries in a bank account; an amount due to be paid to, or already
residing in, an account. The opposite of debit.
Creditor
A lender of money or one to whom funds are owed.
Currency
conversion factor
The net rate at which the organization converts revenues and expenses from one
currency into another. Often an internally agreed rate set at the start of the budget
year so as to remove the effect of currency fluctuations from operational budgets;
almost never the same as the nominal exchange rate.
Debit
An amount due to be paid from, or already paid from, an account. The opposite of
credit.
Debtor
An individual, company or other organization that owes debt to another individual,
company or organization (the creditor). Almost always compensates a creditor with
a certain amount of interest, representing the time value of money.
Depreciation
A noncash charge against assets, such as cost of property, plant and equipment
over the asset’s useful life. An expense associated with spreading (allocating) the
cost of a physical asset over its useful life.
Discount rate
The rate at which future cash flows are discounted because of the time value of
money; the interest rate used to compute a present value amount.
Double-entry
accounting
An accounting system in which each transaction is recorded in at least two places:
a debit to one account and a credit to another account. Also known as dual-entry
accounting.
Earnings before
interest and
taxes (EBIT)
A measure of an organization’s earning power from ongoing operations, equal to
earnings before deduction of interest payments and income taxes.
Earnings before
interest, tax,
depreciation and
amortization
(EBITDA)
An approximate measure of an organization’s operating cash flow based on data
from the organization’s income statement. Calculated by looking at earnings
before the deduction of interest expenses, taxes, depreciation and amortization.
Equity
The residual ownership interest in an organization’s assets after deducting all of its
liabilities. Can also be the issued shared capital of the organization.
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Chapter 1: Finance and Business in the Facility Organization
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term
Definition
Equivalent annual
cost (EAC)
The cost per year of owning and operating an asset over its entire life span. This
measure facilitates comparisons of the cost-effectiveness of various assets.
Expenses
Money outflow that represents goods and services consumed in the course of
business operations.
Feasibility study
Study of a planned scheme or development, the practicality of its achievement,
and its projected financial outcome.
Financial
accounting
Relates to the preparation of financial statements for the organization as a
whole. May be used by owners and other internal parties but primarily intended
for external parties such as creditors, investors, government agencies, unions
and suppliers. Information is developed according to specific accounting
standards.
Financial
Accounting
Standards Board
(FASB)
The primary financial reporting standards-setting body in the United States; an
independent, nonprofit group under the authority of the U.S. Securities and
Exchange Commission (SEC).
Financial leverage
Refers to the use of borrowed money in acquiring an asset.
Financial ratios
Analytical tools examining the relationship of one quantity to another. Used to
show underlying financial conditions and to help judge the financial health of an
organization.
Financial reporting
The process of presenting information about an entity’s financial position,
operating performance, and cash flow for a specified period.
Financial
statements
Documents (e.g., balance sheet, income statement, statement of cash flows,
statement of retained earnings) that report financial information about an
organization.
Fixed asset
An asset, such as property, plant or equipment, that has a long life and cannot
be expensed in a single year or cannot be easily converted into cash.
Fixed costs
Costs that remain unchanged in total for a given time period, despite wide
changes in the related level of total activity, for example, a licensing fee or taxes.
Fixed expenses
Expenses over which a company has little control.
Generally accepted
accounting
principles (GAAP)
In the United States, rules, procedures and conventions used to help govern an
organization’s accounting operations and the preparation of financial statements.
Income statement
Accounting document that represents the company’s revenue and expense
transactions for the reporting period.
Incremental
budgeting
A budget method that extrapolates from historical data; next year’s budget is
constructed by starting with the current year’s budget as a baseline and then
adjusting each line item for expected changes.
Insurance
A system to protect persons, groups or businesses against large financial loss by
transferring the risks to an insurance company or other large group who agrees
to share the financial losses in exchange for premium payments.
Intangible assets
Assets that have no physical substance. Intellectual property (items such as
patents, trademarks, copyrights, business methodologies), goodwill and brand
recognition are all common intangible assets.
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Finance and Business
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term
Definition
Internal rate of return
(IRR)
The interest rate at which lifetime dollar savings equal lifetime dollar
costs, after the time value of money is taken into account. This rate is
then compared to the minimum acceptable corporate rate of return to
determine if the investment is desirable. This is one of the most
important tools for facility managers because it is used frequently to
compare competing investment proposals.
International Financial
Reporting Standards
(IFRS)
A set of international accounting and reporting guidelines and rules that
organizations can follow when compiling financial statements.
Journal
A daily, chronological record of business transactions.
Journal entry
An entry to the journal, recording a financial transaction (as a debit and
then as a credit) by date. Journal entries are eventually posted to a
ledger.
Lease
A contract between the owner of real property (lessor) and another party
(lessee) for the possession and use of the property for a specified term in
return for rent or other valuable consideration.
Ledger
Accounting book of final entry, recording journal transactions under
separate accounts. Sub-ledgers provide more detailed information about
individual accounts.
Liabilities
Debts a business incurs that are expected to result in future negative
cash flows to the firm (for example, salaries and tax liabilities). Can also
include an assessment of net risk items (e.g., bad debts).
License
Distinguished from a lease, a license is the degree of real property
interest the signer has in a property. A lease provides a higher level of
legal interest in a property than a license.
Life cycle
The useable life span of a product, process, facility, tool, system,
technology, natural resource and the like. It is based on the presumption
that all things go through a continuous cycle beginning with creation, use
and disposal, and then ideally start all over again.
Life-cycle costing
Process of determining (in present-value terms) all costs incident to the
planning, design, construction, operation and maintenance, and
disposition of a structure over time.
Liquid assets
Cash or assets that can be immediately converted to cash (or are easily
convertible to cash).
Management
accounting
Relates to the provision of accounting information for an organization’s
internal users, designed to support the information needs of managers.
Unlike financial accounting, management accounting is not bound by any
specific accounting standards. Also referred to as managerial
accounting.
Net present value
(NPV)
The monetary value today that an investment project earns after yielding
the desired rate of return for each period during the life of the investment.
Operating budget
A short-term budget projecting all estimated income and expenses
during a given period (usually one year). Excludes capital expenditures
because they are long-term costs.
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Chapter 1: Finance and Business in the Facility Organization
Exhibit 1-1: Common Financial Terms for Facility Managers (concluded)
Term
Definition
Opportunity costs
Represent “lost” opportunities (measured in monetary units) that could
have accrued to the entity by pursuing an alternate course of action.
Payback period
Refers to the length of time it will take to recoup the initial investment
cost. In other words, how long it takes to earn back the funds you spent
on a project.
Period
Time interval covered by a financial statement; usually one year for
external statements but often less (month or quarter) for internal
statements.
Present value (PV)
This method is used to compare costs; all cash flows are converted to
their present value or the value of past and future dollars corresponding
to today’s value.
Profitability index
(PI)
The ratio of the present value of the cash inflows to the initial investment
cost.
Pro forma statement
A financial statement prepared as a projection of the future. Attempts to
present a reasonably accurate idea of a financial situation if present
trends continue or certain assumptions hold true.
Property loss
The loss in the book (balance sheet) capital value of an asset due to
changes in market conditions, requiring a write-down in the asset values
and thus a reduction in the value of the balancing equity value.
Property tax
A tax levied against owner, leasor or occupier of any property based on an
assessment of the value of the property, its public infrastructure
requirements, or some other determining factor.
Revenues
Cash or properties received in exchange for goods or services.
Statement of cash
flows
A financial statement used to show cash levels across the operating period
so as to ensure that predicted liabilities due to be paid at any given time do
not exceed the ability to pay.
Statement of
shareholders’ equity
A financial statement that starts with the balances from the end of the
prior period and shows changes due to net income (loss) and dividends
for the period or any new issuances or repurchases of stock.
Time value of
money principle
A dollar in hand is worth more than a dollar to be received in the future
because it can either be consumed immediately or put to work to earn a
return.
Trial balance
Total of all debits and credits; if debits do not equal credits, an error has
occurred (e.g., mistake in entry, omission, double posting).
Variable costs
Costs that change in total in proportion to changes in the related level of
total activity. For example, fuel costs depend on mileage driven.
Variable expenses
Expenses that fluctuate and may be influenced by factors such as
occupancy levels.
Working capital
The funds required to service the worst cash flow position plus any
contingency provision deemed necessary.
Zero-based
budgeting
A budget method in which the continued existence of items must be
justified both financially and operationally before they are included in the
new budget.
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Finance and Business
Topic 3: Fundamental Accounting Concepts
Accounting may be simplistically described as financial record keeping. It is a
framework that provides financial control over the actions and resources of an
organization. Through a variety of activities (collectively known as an
accounting information system), an organization maintains records of various
financial transactions. These activities take place on an annual cycle and
comprise what is commonly referred to as the accounting cycle.
The primary goals of an accounting information system are to:
•
Create accurate and timely tools to guide operating requirements—
financial controls that guide the actions and resources of an organization.
•
Ensure that financial data and economic transactions are entered correctly
into the records.
•
Ensure that all management financial documents and reports are accurate
and prepared in a timely manner.
•
Ensure that financial statements are relevant and reliable and fairly and
accurately represent the activities of the organization.
•
Support future business planning through the provision of accurate records
of past revenues and costs.
Collectively, these goals are important not only in ensuring efficiency and
stewardship over the organization’s resources but also in satisfying legal and
regulatory requirements.
Facility managers need not be accountants, but they should be proficient in
applying basic accounting concepts and principles. Fundamental accounting is the
foundation for many FM activities such as forecasting, budgeting and expense
review, which, in turn, influence the accuracy of organizational numbers.
Ultimately, sound accounting practices by facility managers influence how the
performance of the department is judged. To ignore accounting is like trying to
climb up a slippery slope. There’s potential for starts and stops and delays.
Financial inaccuracies or other problems resulting from poor accounting practices
are never pleasant. The content here is intended to help you avoid such headaches.
We begin our discussion with an overview of financial accounting and
management accounting. Subsequent information looks closer at accounting
standards. We close the accounting content with an overview of a few other
basic accounting concepts that can help a facility manager work effectively
with organizational decision makers who are focused on financial
considerations, purchasing and accounting departments, vendors and others.
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Chapter 1: Finance and Business in the Facility Organization
Financial
accounting and
management
accounting
Recall how these two terms were defined in the primer of financial terms:
•
Financial accounting: Relates to the preparation of financial statements
for the organization as a whole. May be used by owners and other internal
parties but primarily intended for external parties such as creditors,
investors, government agencies, unions and suppliers. Information is
developed according to specific accounting standards.
•
Management accounting: Relates to the provision of accounting
information for an organization’s internal users, designed to support the
information needs of managers. Unlike financial accounting, management
accounting is not bound by any specific accounting standards. Also
referred to as managerial accounting.
As these definitions point out, financial accounting prepares information
primarily for external use whereas management accounting includes the
design and use of information within organizations. A focus of financial
accounting is to provide information via financial statements. Management
accounting supports the information needs of organizational managers. In that
regard, some describe financial accounting as external accounting and
management accounting as internal accounting.
Exhibit 1-2 summarizes the basic differences between financial and
management accounting.
Exhibit 1-2: Financial and Management Accounting Differences
Financial Accounting
Management Accounting
Provides data for external users.
Provides data for internal users.
Provides objective and verifiable financial
information; emphasis on precision of
information.
Includes financial and nonfinancial
information; may also include subjective
information; accuracy is important but the
emphasis is on relevance and timeliness of
information.
Must follow externally imposed rules.
Not bound by any mandatory rules.
Reflects aggregate, summarized data for the
entire organization.
Reflects parts of an organization (measures
and reports internally about products and
services, departments, managers, employees
and customers) as well as the whole
organization.
Provides a historical orientation; records and
reports on events that have already occurred.
Records and reports on events that have
already happened but emphasizes providing
information about future events.
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Finance and Business
Organizational accounting systems should provide both financial and
management accounting information.
There are bound to be some variances in the actual accounting systems and
specific financial and management accounting practices across
organizations. Organizational specifics (e.g., size, sophistication, industry,
public, private and other characteristics) will dictate the accounts and
detailed records kept.
Some organizations have a single accounting system that supplies
information for both financial and managerial needs. Large organizations
may have two or more accounting systems for different purposes.
But whatever the practices and conventions, they should be consistently
implemented within an organization.
Further, a facility manager should understand what is usual and customary
and meet those expectations.
Facility
management
and
management
accounting
Facility management numbers are important in financial accounting.
Operations are reflected in financial statements through numbers such as
property, plant or equipment or other assets and expenditures that have long
lives. But the majority of day-to-day accounting in FM is grounded in
management accounting.
Management accounting provides a facility manager (as well as other internal
managers) information to facilitate the basic management activities of
planning, directing and motivating, controlling, and decision making shown
in Exhibit 1-3. Specific FM examples are included.
Exhibit 1-3: Application of Management Accounting Information
(continued on next page)
Management
Activity
Planning
Description
FM Examples
•
Identifying alternatives,
selecting a course of
action, and specifying
how the actions will be
achieved
•
•
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12
Reviewing current water
consumption reports and water bills
for a commercial building
Setting objectives and identifying
methods to increase profits by
improving water efficiency
Securing necessary organizational
approvals and funding
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Chapter 1: Finance and Business in the Facility Organization
Exhibit 1-3: Application of Management Accounting Information
(concluded)
Management
Activity
Directing
Description
Mobilizing and motivating
people to carry out plans
and execute operations
FM Examples
•
•
•
•
•
Controlling
Controlling operations to
ensure that plans are
carried out and
appropriately modified as
circumstances change
•
Monitoring water efficiency operations and
programs to ensure that they are being
carried out as intended
•
•
Monitoring program costs
Reviewing performance reports and
comparing actual performance and any
ongoing savings in water bills with old
expenditures, planned reductions and
expected savings
Soliciting feedback from FM staff,
customers and users about the water
efficiency initiatives
Taking corrective actions as warranted to
improve plan execution and/or control
costs
•
•
Decision making
Making a variety of
management decisions
throughout planning,
directing and controlling
activities
Assigning related tasks to FM staff
Retraining FM staff in procedures as
necessary
Installing aerators for sinks and showers
to provide immediate reductions
Initiating programs to collect rainwater and
runoff for irrigation systems
Educating customers, users and building
visitors about water resource
management efforts
•
•
•
•
Identifying alternatives and choosing
among competing objectives and methods
to carry out water efficiency plans
Reviewing related expenditures and
savings throughout the initiative
Making small and large decisions that
affect FM staff, customers, users and
building visitors
Answering questions, helping to solve
problems and arbitrating any disputes
As Exhibit 1-3 notes, planning, directing and controlling all involve decision
making. And, in practice, these management activities are more cyclical than
linear. For example, in daily operations, a facility manager’s management
activities are likely to flow from planning through directing and controlling
and back to planning again for a wide variety of tasks.
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Finance and Business
As depicted in Exhibit 1-4, decision making is an overarching activity
throughout.
Exhibit 1-4: Cycle of Management Activities
Planning
Directing
Formulating plans
Implementing plans
Text
Decision
Making
Controlling
Measuring performance
and comparing actual to
planned performance
The cycle of management activities shown in Exhibit 1-4 is akin to other FM
process and planning models (for example, the Plan, Do, Check, Act four-step
process).
The end result of a facility manager using management accounting information
in his or her planning, directing, controlling, and decision-making activities will
be evident in the many details that can make the difference between a pleasant,
efficient, cost-effective property and one that is irritating to customers, users and
building visitors and potentially struggling for financial soundness.
Accounting
standards
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Accounting standards may be generally defined as benchmarks prescribed for
the reporting of accounting data. There are different types of accounting
standards, and they can range from basic to extremely complex. Some
accounting standards apply specifically to financial accounting; others are
more applicable to management accounting. Organizations may have broad
guidelines as well as detailed procedures. Some standards that an organization
follows may be sponsor-driven. Industries may define best practices.
Individual nations also have national accounting standards and accounting
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Chapter 1: Finance and Business in the Facility Organization
practices. Next we look at two sets of accounting standards that a facility
manager should be aware of: the International Financial Reporting Standards
and the generally accepted accounting principles.
International
Financial Reporting
Standards (IFRS)
Globally, many countries require, or promote the use of, the International
Financial Reporting Standards (IFRS). The primer of terms at the beginning of
this chapter defines IFRS as a set of international accounting and reporting
guidelines and rules that organizations can follow when compiling financial
statements. These international accounting standards are established and
maintained by the International Accounting Standards Board (IASB), an
independent private-sector body formed from the accountancy bodies of
numerous countries.
The adoption of IFRS as a universal financial reporting language is gaining
momentum worldwide. Multinational organizations and more than 100
countries and political and economic unions follow IFRS; to name but a few,
the European Union, Hong Kong, Australia, Malaysia, Pakistan, several
Arabian Gulf states, Russia, South Africa, Singapore and Turkey. The use of
the standards allows organizations, investors, governments and others to
compare IFRS-supported financial statements with greater ease.
Generally accepted
accounting
principles (GAAP)
The accounting profession in the United States has attempted to develop a set
of standards that are generally accepted and universally practiced. The primer
of terms defined generally accepted accounting principles (GAAP) as rules,
procedures and conventions used to help govern an organization’s accounting
operations and the preparation of financial statements. In the United States,
GAAP is sanctioned by the Financial Accounting Standards Board (FASB), an
independent self-regulating body. All organizations operating in the United
States are expected to follow GAAP (and FASB standards) in accounting for
transactions and in representing their results in financial statements.
GAAP encompasses both broad guidelines and specific procedures. But a key
aspect of GAAP is an emphasis on “general.” GAAP accommodates variation
in applied accounting methods as long as the methods generally adhere to the
following basic principles:
•
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Relevance. Relevance means that the information presented in financial
statements (and other public statements) should be appropriate and should
assist a person evaluating the statements to make educated guesses
regarding the future financial state of the organization.
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Finance and Business
•
Reliability. Reliability is a measure of the neutrality of the sources of
information, the faith that the information represents what it purports to
represent, and the information’s independent verifiability. Reliability
implies that the organization is representing a clear picture of operations.
Basically, an organization must confirm that if an independent auditor
were to base his or her report on the same information he or she would
come up with the same results.
•
Comparability. Comparability means that statements reflect the use of
standards and techniques similar to those used in other organizations so
that users can differentiate real similarities and differences from those
caused by divergent accounting rules. By ensuring comparability, an
organization’s financial statements and other documentation can be
compared to that of similar enterprises within its industry to benchmark
how the organization is doing compared to its peers.
•
Consistency. Consistency means that all information should be gathered
and presented the same across all periods. The same standards are applied
over time so that financial statements from differing periods can be
compared. For example, an organization cannot change the way it
accounts for inventory from one period to another without noting it in the
financial statements and demonstrating that the new accounting methods
adopted are preferable to the prior methods.
GAAP is applicable only in the United States. However, the International
Standards Accounting Board is working toward convergence with GAAP.
A key point about accounting standards as they apply to financial
statements is that whether the financial statements are prepared for
operations in the United States, the European Union, Canada, Korea, India,
Brazil or most other countries around the globe, the statements are
expected to present fairly, clearly and completely the financial operations
of the enterprise. Without standards—whether IFRS or GAAP—each
organization could theoretically prepare financial statements according to
their own accounting standards and reporting practices, making it
problematic—if not impossible—to compare the financial statements of
different enterprises, even within the same industries. Suffice it to say that
numerous organizations and regulatory agencies take part in the financial
standards-setting process worldwide.
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Chapter 1: Finance and Business in the Facility Organization
Accounting standards guide the conduct to be followed by organizational
accountants. As they influence FM financial record keeping, facility managers
should also adhere to accounting standards.
Accounting
records
Organizational specifics generally influence the complexity and sophistication
of the accounting system. For example, a small, privately held FM
organization with one location and 30 employees will have fewer record
keeping requirements and less staff devoted to financial operations than a
large, multinational organization with global properties, complex transactions
and multiple role assignments. But, regardless of an organization’s unique
needs, any accounting system has standard records and practices. We next
look at three types of fundamental accounting records facility managers
should understand: the chart of accounts, ledgers and journals.
Chart of accounts
A chart of accounts is a numbered list of all standard items that an accounting
system tracks. It captures organizational revenues and expenses in a
systematic manner. Capturing all financial information through this
consolidated system:
•
•
Enables the organization to make sound financial decisions.
Provides critical data for the preparation of financial reports.
•
•
Allows for accurate financial comparisons.
Facilitates an organization’s ability to respond to requests for financial
data from regulatory agencies, lending institutions and others.
Coding can also be used to track costs across projects and matrix work units
(e.g., horizontally as well as vertically within business units).
Account categories
A chart of accounts typically covers five categories of financial information:
assets, liabilities, net assets (owner’s equity or capital), revenues and
expenses. These categories are listed in the order in which they customarily
appear in the financial statements.
•
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Assets. An asset is something that retains value for a period of time after
purchase such as a building or a piece of equipment. Assets are what an
organization owns. Assets may be physical; they may also be financial or
intangible resources. Examples of assets include cash on hand, accounts
receivable (uncollected monies), inventory (products and publications),
equipment (furniture, computers and other office equipment), real estate
(property and buildings) and investments.
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Finance and Business
Generally, assets are listed in descending order of liquidity. Cash is listed
first, followed by items that are easily converted to cash. Equipment and
real estate are usually listed last.
•
Liabilities. Liabilities are the debts a business incurs that are expected to
result in future negative cash flows to the firm (for example, salaries and
tax liabilities). Liabilities can also include an assessment of net risk items
(e.g., bad debts).
An organization’s liabilities are the financial obligations or debt that must
be paid with assets or services in the future. Liabilities represent claims on
the organization’s assets—cash or other assets that will be converted to
cash. In addition to salaries and taxes, other examples of liabilities are
loans, accounts payable and unearned or deferred revenues (advance
payments by an outside party for goods or services to be provided in the
future).
Liabilities are further classified as current and long-term. Current
liabilities are obligations due within the coming year. Long-term
liabilities are debts with maturity dates that are longer than a year.
Current liabilities are usually listed first, followed by long-term
liabilities.
•
Net assets. Simply put, net assets reflect an organization’s financial
worth. They are the balance that remains when liabilities are subtracted
from assets.
An equation often shown for net assets is:
Assets – Liabilities = Net assets
In the for-profit sector, net assets are considered profits. In not-for-profit
organizations, net assets are sometimes referred to as net equity or
reserves.
•
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Revenues. Revenues are cash or properties received in exchange for goods
or services. Revenues collectively describe an organization’s income
sources. In addition to income received from goods or services sold,
another example is income from investments.
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Expenses. Expenses are money outflow that represents goods and services
consumed in the course of business operations. Expenses are the costs of
assets used up and the liabilities incurred for the purpose of operating the
organization.
Chart of account structure and numbering conventions
Various factors influence what information should appear in a chart of
accounts. Primary considerations are:
•
How will the information be used?
•
•
What level of detail is required?
What is the capacity of the accounting system to track information?
•
What financial reports must be prepared?
Based on organizational requirements, a chart of accounts may be divided by
cost centers such as departments, projects, services and activities.
A common guideline when constructing a chart of accounts is to start simple
and revise it as the need for additional information increases. For example,
telecommunications expenses initially might be one category. Or, as required,
the chart of accounts could create separate telecommunications expense
categories for local access, long distance, Internet access, wireless and so on.
All financial information entered in the chart of accounts must be assigned an
account code. This numerical designation should correspond with the
organization’s accounting records so that the information can be tracked
through the financial reports, by department, by location, by project, by
operation and by building. Further, it is important that items in a chart of
accounts are grouped in a consistent manner.
An excerpt of a chart of accounts follows. It is hypothetical and not intended
to be comprehensive but rather to provide a simple and general illustration of
some common categories and numbering conventions a facility manager may
see in a chart of accounts.
In Exhibit 1-5, the following numbering conventions are used to assign
account numbers:
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•
1 for assets
•
2 for liabilities
•
3 for net assets
•
•
4 or 5 for revenues
7 or 8 for expenses
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Exhibit 1-5: Sample Chart of Accounts—Categories and Numbering Conventions
Assets
1000 Cash
1010 Checking account (name) #1
1015 Checking account (name) #2
1020 Savings account (name) #1
1030 Petty cash
1040 Temporary cash investments
1100 Accounts receivable
1120 Rental property leases
1300 Loans made to others
1400 Inventory—land
1500 Inventory—buildings
1600 Work in progress
1700 Other assets
1710 Prepaid expenses
1800 Fixed assets—general
1810 Business vehicles
1820 Tools and equipment
1830 Office furnishings and fixtures
1900 Depreciated assets—general
Liabilities
2000 Accounts payable
2010 Business taxes
2020 Open purchase orders
2030 Credit card (name) #1
2040 Credit card (name) #2
2100 Short-term loans
2101 Loan (name) #1
2102 Loan (name) #2
2200 Construction loans
2201 Loan (name) #1
2202 Loan (name) #2
2300 Other current liabilities
2400 Payroll liabilities
2500 Vendor liabilities
2600 Vehicle/equipment loans
2601 Loan (name) #1
2602 Loan (name) #2
2700 Mortgages owned
2701 (address) #1
2702 (address) #2
2703 (address) #3
Net Assets
3100 Construction revenue
3200 Professional services
3250 Property management
3500 Rental property income
Revenues
4100
4200
5100
Product revenues
Service revenues
Other revenues
Expenses
7000 Salaries and wages
7110 Management
7120 Other salaries and wages
7300 Payroll taxes
7320 Unemployment insurance and
taxes
7330 Workers’ compensation insurance
7340 Life and accidental death and
disability insurance
7500 Accounting fees
7510 Outsourced accounting fees
7520 Outsourced payroll fees
7530 Outsourced auditing fees
7540 Banking service fees
7600 Office supplies
7700 Telecommunications
7710 Local access
7720 Long distance
7730 Internet access
7740 Wireless
7750 E-mail service
7800 Postage and shipping
7900 Printing
8000 Janitorial services
8400 Corporate travel
8410 Airfare
8420 Lodging
8430 Taxi/limo
8440 Auto rental
8450 Meals
8600 Insurance
In setting up a chart of accounts, a range of numbers is assigned to each
category and unassigned numbers should be left open to accommodate future
growth and change. For large businesses, a wider range of numbers would be
required for each grouping.
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Chapter 1: Finance and Business in the Facility Organization
Again, keep in mind that Exhibit 1-5 is merely an excerpt. Organizations
have their own classification schemes and numbering conventions. In this
example, four digits are used in the number assignments. Some organizations
use three digits; others use five-digit account numbers to allow for plenty of
room to add accounts as needed. Typically, a chart of accounts will have a
key or legend of some sort that includes a brief description of the financial
data that should be included in each account.
There are numerous software programs with useful templates and fields that
may be used to construct a chart of accounts.
Ledgers
A ledger is a presentation of an account or accounts. Formally defined, a ledger is
an accounting book of final entry, recording journal transactions under separate
accounts.
Most organizations use computers for accounting (rather than manual recording).
Whether done by computer or manually, a ledger compiles accounting records.
A general ledger is a collection of all the organization’s financial information by
accounts—assets, liabilities, net assets (owner’s equity or capital), revenues and
expenses. The chart of accounts serves as a table of contents for the general
ledger.
Some organizations use subsidiary ledgers for additional detail related to a
specific general ledger account.
Journals
Journals, or books of original entry, systematically organize financial
information by transaction types (for example, receipts, disbursements,
payroll, accounts receivable and accounts payable). All accounting
transactions are chronologically recorded in a journal before being entered in
the general ledger.
Types of journals
The simplest journal type is the general journal, a chronological listing of
transactions and other events expressed in terms of debits and credits to
particular accounts. Some organization use special journals in addition to the
general journal. Special journals summarize transactions with common
characteristics such as (but not limited to) the following examples.
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•
Cash disbursement journal—provides a chronological record of all checks
that are written according to the categories used in the chart of accounts.
•
Cash receipts journal—gives a chronological record of all deposits that are
made according to the categories used in the chart of accounts.
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Finance and Business
•
Payroll journal—records all payroll-related transactions. (Some
organizations may opt to record payroll-related transactions in their cash
disbursement journal.)
•
•
Inventory purchases journal—records inventory purchases on credit.
Accounts payable journal and accounts receivable journal—tracks
income and expense accruals, respectively. These journals are useful in
grouping the income and expense accruals that would otherwise be too
numerous to record in the general journal.
Some financial accounting software packages will track all bills as accounts
payable and all revenue as accounts receivable. This type of software
eliminates the need for the cash disbursement and cash receipts journals.
An entry into a journal is called a journal entry or journalizing.
Sample journal entries
Each general journal entry has four parts:
•
•
The accounts and the amounts to be debited
The accounts and the amounts to be credited
•
•
A date
An explanation—usually made up of the creditor/debtor name, the type of
transaction (e.g., “goods supplied” or “monthly fee”), and the intended
journal title (as a cross-check).
Journal entries may or may not include monetary designations. When journal
entries show transactions within the same country, monetary designations are
often omitted. However, monetary designations specifying currency assume
particular importance in situations involving cross-border transactions and
multinational organizations. The euro (€) is the currency shown in Exhibit 1-6
below and in Exhibits 1-7 and 1-8 in the next section.
Exhibit 1-6 shows an example of a general journal with sample entries for the
following transactions.
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•
February 1: €20,000 water efficiency equipment purchased on account
from Aqua Monitoring Systems Company
•
February 2: €180 invoice received from Copy Max for brochures
promoting water conservation and explaining the facility management
water efficiency program
•
February 11: €2,400 credit for merchandise return to Aqua Monitoring
Systems Company
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Chapter 1: Finance and Business in the Facility Organization
Exhibit 1-6: General Journal with Sample Entries (No References Shown)
Date
20XX
February 1
February 2
February 11
Account Title and Explanation
Reference
Equipment
Accounts payable
(Purchased on water efficiency
equipment account from Aqua
Monitoring Systems Company)
Printing
Accounts payable
(Received invoice from Copy Max for
water efficiency brochures)
Accounts payable
Merchandise returns
(Returned equipment to Aqua
Monitoring Systems Company)
Amount
Debit
Credit
€20,000
€20,000
€180
€180
€2,400
€2,400
The first column of the general journal shows the date of the transaction. The
second column shows the account debited or credited (see columns four and
five), including a brief explanation. The third column shows a reference to the
specific account; this column is completed at the time the accounts are posted.
When journal entries are posted to the individual accounts in the general
ledger, a reference is made to the account number to indicate that the entries
were transferred.
Posting journal entries
The process used to transfer journal entries to the general ledger is known as
posting. Most organizations use the double-entry method, which is discussed
next.
Double-entry
accounting
As we have seen, an account is simply a record of transactions that fit within a
specific category. Double-entry (or dual-entry) accounting is a system in
which each transaction is recorded in at least two places: a debit to one
account and a credit to another account.
In the financial terminology primer earlier in this chapter, debit and credit
were defined as follows.
•
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Debit is an amount due to be paid from, or already paid from, an account.
Debit is the opposite of credit. In double-entry accounting, debits are
shown as the left-hand side of a journal entry or an account record, where
debts and expenses are recorded. Debit is commonly abbreviated as “Dr.”
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Finance and Business
•
Credit refers to positive cash entries in a bank account. A credit is an
amount due to be paid to, or already residing in, an account. It is the
opposite of debit. In double-entry accounting, credits are shown as the
right-hand side of a journal entry or account record, where payments to
the account are recorded. Credit is commonly abbreviated as “Cr.”
In Exhibit 1-7, we see a posting of journal entries for the water efficiency
equipment.
Exhibit 1-7: General Journal Postings in Ledger Accounts
Equipment
February 1
No. 1800
€20,000
The equipment account debit increases.
Accounts Payable
February 11
€2,400
No. 2000
February 1
€20,000
February 2
€180
Merchandise Returns
No. 2300
February 11
€2,400
The merchandise return account credit increases.
Printing
February 2
No. 7900
€180
The printing account debit increases.
Debit and credit do not automatically mean a decrease or increase to an
account; rather, they describe where entries are made in the recording process.
•
•
Debiting is making an entry on the left-hand side of an account.
Crediting is entering an amount on the right-hand side of an account.
This double-entry accounting format showing both the debit and credit sides
of the account is sometimes called a T-account because the left- and rightside format looks like the letter T.
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Chapter 1: Finance and Business in the Facility Organization
Double-entry posting ensures that a journal is always in balance. Every
transaction has two entries—a debit and a credit. That is because for any
transaction, money is moved from one account to another. For assets and
expenses, a debit increases the account and a credit decreases the account.
For liabilities and revenues, a debit decreases the account and a credit
increases the account. For example, the purchase of the water efficiency
equipment would initially be entered as a debit for equipment and a credit
for accounts payable. When the equipment is paid off, accounts payable
would be debited and the cash account would be credited. At any given
time, the total value of the debit accounts must equal the total value of the
credit accounts.
In the journal postings in Exhibit 1-7, the “No.” notations of 1800, 2000,
2300 and 7900 refer to the ledger accounts to which the respective items
are posted. Every organization selects its own numbering system for its
ledger accounts. In this example, the “No. 2000” is associated with
accounts payable. At the time of posting, these are the numbers that are
entered as references in the general journal.
Exhibit 1-8 is a completed version of Exhibit 1-6. It shows the reference
numbers recorded opposite the account titles in the journal, indicating the
ledger account number involved and that the posting has been completed
for the particular item.
Exhibit 1-8: General Journal with Sample Entries (References Shown)
Date
20XX
February 1
February 2
February 11
Account Title and Explanation
Reference
Amount
Debit
Credit
€20,000
€20,000
Equipment
Accounts payable
(Purchased on water efficiency
equipment account from Aqua
Monitoring Systems Company)
1800
2000
Printing
Accounts payable
(Received invoice from Copy Max for
water efficiency brochures)
7900
2000
€180
Accounts payable
Merchandise returns
(Returned equipment to Aqua
Monitoring Systems Company)
2000
2300
€2,400
€180
€2,400
Total debits = €22,580
Total credits = €22,580
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Finance and Business
Double-entry accounting is a widely accepted international accounting
practice, and it is used by most organizations throughout the world.
Businesses that have strictly cash transactions may use a single-entry
bookkeeping method instead, recording entries once. Single-entry
accounting is much like the way people record checks and deposits in a
checking account register.
In a manual accounting system, summary totals from all journals are entered
in the general ledger once a month. A year-to-date balance can then be
maintained for each account. In a computerized accounting system, account
data is typically entered only once. The software then automatically tracks the
account number wherever it appears and updates the general ledger. Most
software packages also include a general ledger that shows every transaction
included in the balance for each account.
Accounting
cycle
The accounting cycle refers to the accounting procedures organizations
typically use to record, analyze and summarize financial transactions and
events. The accounting cycle is repeated in each reporting period and
often referred to as a series of steps. Exhibit 1-9 on the next page shows
the steps in the accounting cycle. A brief explanation of each step follows
below.
Note that the first three steps (analyze, journalize and post transactions to
general ledger) are performed as transactions occur, throughout the
accounting period. Therefore, the discussion of these steps reinforces the
accounting concepts just presented. The remaining steps are performed at
the end of the accounting period.
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•
Analyze. The first step in the accounting cycle is to analyze a transaction
and its source documents (e.g., purchase order or invoice), quantify it in
monetary terms, identify the accounts that are affected, and then apply
double-entry accounting to recognize its effect on account balances—
whether those accounts are debited or credited.
•
Journalize. As most transactions affect two or more accounts (e.g., an
equipment purchase creates a debit for equipment and a credit for
accounts payable), they are not initially recorded in the general ledger but
in a journal. Journal entries should be supported by original source
documents.
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Chapter 1: Finance and Business in the Facility Organization
Exhibit 1-9: The Accounting Cycle
Analyze
Journalize
Post transactions to general ledger
Prepare unadjusted trial balance
Adjust entries
Prepare adjusted trial balance
Close accounts and prepare postclose trial balance
Prepare financial statements
Reverse journal entries
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•
Post transactions to general ledger. Posting records an item from a
journal in the general ledger, including summarizing and classifying the
item.
•
Prepare unadjusted trial balance. In double-entry accounting, each
transaction is recorded with equal debits and credits to an account. The
unadjusted trial balance displays a debit column and a credit column
listing the account balances for each account at a moment in time. The
debit and credit columns must balance. If the sums of the debit and credit
entries do not match, an error was made in one of the first three steps.
•
Adjust entries. In this step, accounts are adjusted for internal transactions,
like the use of prepaid rent or unearned revenue.
•
Prepare adjusted trial balance. The adjusted trial balance is the trial
balance after all adjusted entries have been made, reflecting the proper
balance of each account.
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•
Close accounts and prepare post-close trial balance. This step in the
accounting cycle closes accounts in preparation for the next accounting
period. Temporary or nominal accounts are closed, while permanent or
real accounts carry their balances into the next period.
Temporary or nominal accounts are reduced to zero so they are ready to
be used in the next period. As we will see in the subsequent discussion of
income statements, such accounts include revenue and expense accounts
by subcategory (e.g., sales or interest revenue accounts or expense
accounts). The accounts are closed to an income summary account.
Revenues would be debited and income summary credited; expenses
would be credited and income summary debited. Assuming that revenues
exceed expenses, net income or a credit balance would exist, and this
balance is transferred from income summary to retained earnings.
The post-close trial balance is prepared after closing to show that debits
and credits of the real accounts (assets, liabilities and shareholders’
equity) are equal.
•
Prepare financial statements. Financial statements are prepared from the
adjusted trial balance.
•
Reverse journal entries. Some adjusting entries made to prepare the
financial statements need to be reversed as of the beginning of the next
accounting cycle. An example might be an accrual or deferral recorded on
the last day of the accounting period. A reversing journal entry avoids
double-counting the amount when the transaction occurs in the next
period. Reversing entries are recorded on the first day of the new period.
All accounting systems use some variation of these steps to record and verify
transactions. When the steps in the accounting cycle are completed, the
sequence starts over again (in the next accounting period).
Overall, procedures in the accounting cycle help to ensure that financial
records are accurate and current and that they reflect appropriate accounting
standards (such as IFRS or GAAP). Although a facility manager does not have
responsibility for the full accounting cycle, a general awareness of the steps is
helpful.
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Chapter 1: Finance and Business in the Facility Organization
Accounting
principles for
financial
statements
Individuals responsible for preparing financial statements have decisions to
make about what, how and when to report activity. Facility managers are not
directly involved in these financial accounting activities. But they do need to
understand that they take place and that FM has a role in providing timely
information to allow close-of-period accounting activities; facility managers
should understand how their actions affect and are affected by the close of
period.
Some of the accounts shown in organizational financial statements do reflect
facility management activities. Organizational assets, for example, include
supplies, inventory, buildings, land and equipment. Liabilities encompass
items such as mortgages, salaries owed and taxes payable. Rents earned,
interest earned and revenues from repairs are part of revenues. Expenses
include utilities, rent, supplies, salaries, taxes, phones and so on. Given the
important financial contributions of FM, a facility manager should be aware of
some of the more basic accounting principles that guide deciding what, how
and when to review information, who approves the information, and who in
accounting records transactions.
Historical cost
Most assets and liabilities are reported on financial statements at the levels at
which they were acquired or incurred rather than at fair market value. Historical
cost is the amount paid to acquire an asset, or, for noncash exchanges, it is the
estimated value of the noncash asset or liability exchanged. Historical cost is the
most commonly used valuation method. Depreciation, amortization or other
allocations reduce the book value (the residual asset value shown in the balance
sheet) of the depreciated asset to the organization. The depreciation itself is
shown in the organization’s profit and loss (P&L) statement. Property, plant and
equipment and intangible assets are generally reported at historical cost less
accumulated depreciation or amortization, where appropriate.
Revenue
recognition
Accrual basis accounting is defined as revenues recorded when earned and
expenses recorded when incurred. The revenue recognition principle is a
cornerstone of accrual accounting. Revenue recognition helps to determine
the accounting period in which revenues and expenses are recognized.
According to the principle, revenues are recognized when they are realized
or realizable and when they are earned.
• “Recognized” means that revenue has been recorded as a journal entry.
•
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“Realized” means that assets such as goods or services have been
exchanged for cash or claims to cash (e.g., an invoice for an account
receivable).
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•
“Realizable” means that the assets can be readily converted to cash
without significant extra expense through sale in an active market at
prices that can be easily determined.
•
“Earned” means that the organization has done a substantial amount of
what it promised to do (provided goods or services). A prepaid service
contract, for example, is recorded as a liability until that service has
been substantially performed.
In other words, with the accrual method, income and expenses are recorded as
they occur, regardless of whether or not cash has actually changed hands.
Revenue is recorded when it is earned, regardless of when it is actually
collected. In addition, all expenses are recorded when they are recognized and
not when the cash is actually paid.
Deciding if these recognition conditions have been met can be complex. For
most goods, revenue is recognized at the point of sale because the actual sales
price can be verified. The period in which the sale is recorded is used in
accrual accounting as the point at which the revenue is recognized as earned.
For most revenue, the time of sale is the point at which all of the qualities
listed above are met. Some exceptions exist for recognition (e.g., long-term
construction projects). But these are the concern of financial accountants, not
facility managers, and therefore are beyond the scope of this discussion.
Full disclosure
Full disclosure and proper accounting complement each other. Financial
statements should include only items that fit within the element definitions and
that are measurable, reliable and relevant. If, for example, information is
aggregated at too high a level or is overly detailed, its usefulness can be reduced.
The full disclosure principle recognizes that statement preparers must make
compromises between levels of detail sufficient to help users with their
decisions while condensing that information enough to keep it understandable.
Supplementary information may be presented outside the main body of the
statements—for example, in footnotes to the financial statements.
You may encounter other accounting principles for financial statements. But
again, these accounting standards and conventions are primarily the direct
concern of the organization’s financial accountants and, for the most part,
beyond a facility manager’s responsibility. As warranted, you may find it
helpful to learn more about them.
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Chapter 1: Finance and Business in the Facility Organization
Progress Check Questions
Directions: Read each question and respond in the space provided. Answers and page references follow
the questions.
1. Providing financial information for internal users is known as
( ) a. financial accounting.
( ) b. accounting for decision making.
( ) c. accounting for transactions.
( ) d. management accounting.
Match the following accounting system components with their record-keeping function.
2.
Chart of accounts
a. Organizes financial information by accounts
3.
General ledger
b. Shows a numbered list of standard items that an
accounting system tracks
4.
Journal
c. Organizes financial information by transaction types
5. True or false? According to the rules of debit and credit, increases in assets are recorded on the debit
(left) side of the account.
( ) a. True
( ) b. False
6. The process that copies amounts from the journal to the ledger is
( ) a. recording transactions.
( ) b. journalizing.
( ) c. posting.
( ) d. preparing a trial balance.
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Finance and Business
Progress check answers
1.
2.
3.
4.
5.
6.
d (p. 11)
b (p. 17)
a (p. 21)
c (p. 21)
a (p. 25)
c (p. 27)
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Chapter 2: Financial Management of the Facility
Organization
After completing this chapter, students will be able to:
•
Develop, recommend and manage/oversee the facility budget.
•
Identify the basic financial statements an organization prepares and describe the elements
impacted by facility management operations.
•
Write business cases, supporting documentation and financial reports.
•
Apply cost concepts in facility management operations.
•
•
•
Use financial ratios and facility metrics to analyze and interpret financial documents.
Identify cost-containment opportunities.
Explain the use of chargebacks to allocate facility costs.
Topics in this chapter explore the essential concepts of finance and business
that facility managers need to know to be intelligent consumers of financial
information—how to develop and maintain budgets, judge the financial merits
of different investment opportunities, and determine which operations are
profit generators and which are not.
The information will not make you a financial expert or qualify you to become
a financial analyst, controller or CFO. But it will better prepare you to plan, to
use financial concepts, and to manage resources in making good FM business
decisions that add value to your organization.
Topic 1: Budgets and Budgeting Basics
A budget is a formal, numerical expression of how an organization expects to
operate for a defined period of time. It identifies the resources and
commitments needed to satisfy the identified goals over a period as well as
the sources of the funding to provide those resources. Stated another way,
budgets are financial plans for the future. In its simplest form, a budget
projects revenues and expenses. Budgeting is the process of gathering
information, establishing the financial projections and monitoring progress
toward them.
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Finance and Business
How skilled and knowledgeable are you in preparing and monitoring
facility management budgets? If you secretly think of it as a stressful,
time-consuming exercise that takes up valuable time you could be
devoting to other activities, you are not alone. Many managers (not just
facility managers) share the same thoughts about budgeting.
The good news is that FM budgeting doesn’t have to be that way. Yes,
budgeting typically requires lots of hours, and it can be intense. There’s no
magic wand that can change those aspects. But good budgets are worth the
time and effort. The following discussion is intended to provide budgeting
concepts that are easy to understand and implement, contribute to sound
budgets and help to reduce the time required.
We begin with an overview of the importance of budgeting and a look at
what budgets accomplish. Within any organization, there are many types
of budgets. Who is involved in preparing and monitoring the budgets also
varies across organizations. The content explains various approaches
organizations can use to develop budgets. It then provides details about
two types of budgets (operating and capital) that directly affect all facility
managers, regardless of organizational specifics. Additional budgeting
concepts that a facility manager may encounter, general budgeting
guidelines and high-level international budgeting considerations are
presented.
The importance
of budgeting
How do you prepare for an out-of-town business trip? Most likely you
pack a briefcase, your mobile phone and perhaps a laptop along with a
travel bag of clothes and personal articles. Basically, you think about
whatever you need for the trip and then try to plan accordingly. Of
course, you would take money or a credit card to cover anticipated
expenses. For most business travel, these are the essentials that help to
facilitate the trip.
Conceptually, budgeting is not that different. Through a budget, you try
to predict what will happen, estimate costs and plan for sufficient
resources. Budgets are actionable plans that help to ensure fiscal
responsibility which, in turn, contributes to the achievement of
organizational goals.
Budgets are important for management planning. In that respect, they are
similar to strategic plans and forecasting.
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Chapter 2: Financial Management of the Facility Organization
While they have additional commonalities, budgets have some key
distinctions.
•
Strategic plans. Strategic plans are generally characterized as long-term
organizational plans. They lay out an organization’s long-term goals and
objectives. Strategic planning is the process by which elements of the
organization (such as the FM department) meet with the leaders of the
organization to agree on the vision, mission, and major objectives of the
organization, and how those elements (the FM department) contribute to
the organization’s goals and objectives.
•
Forecasting. Forecasting is not a plan by itself but rather a technique for
projecting operating results over periods of time. Time periods vary;
forecasts may be for months, quarters, one year, multiple years,
accounting periods or other time frames. Forecasts may or may not be
stated in monetary terms. If a forecast is numerical in nature, it typically
estimates revenues, expenses and other items that affect cash flows.
Financial forecasts typically include pro forma statements or some form of
cash flow forecasting. (Pro forma statements are discussed in Topic 2 of
this chapter.)
Forecasts can and often do change. They are typically updated as new
information indicates a change in conditions.
•
Budgets. Budgets allocate the funds for specific activities during a
specified period of time to achieve those objectives. They represent a
management commitment to attain the budgeted objectives.
Budgeting serves dual roles of planning (looking ahead) and control
(looking backward, determining what actually happened and comparing it
with the previously planned outcomes).
Compared to strategic plans, budgets have a narrower focus. Strategic
planning encompasses numerous programs undertaken to implement
organizational strategies; it precedes budgeting and provides the framework
for budgeting. In that regard, resulting budgets portray a slice or segment of a
strategic plan.
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Finance and Business
Forecasting involves planning but lacks the high level of control and
accountability that budgets have. Variances in forecasts do not undergo the
same scrutiny as they do in budgets (where they are analyzed and
explained). Budgets imply that management accepts responsibility and
commits to meet the budgeted objectives (whereas the forecaster is not
directly responsible for forecasted outcomes).
Budgeting provides an organization with several fundamental benefits,
including (but not limited to) the following:
•
Improves communication and coordination. Budgets help to ensure
that all parts of an organization are working together to achieve
organizational strategies.
Example: An FM budget should be linked to the organization’s
goals and objectives and aligned to other business plans and
processes.
•
Forces management to plan. The detailed plans in a budget are
intended to help achieve specific goals and objectives. By their nature,
budgets encourage managers to foresee problems and think about how
to deal with uncertainty and the future.
Example: An FM budget should provide accurate and realistic cost
estimates. To that end, the budgets often make effective use of
historical data (previous costs), benchmarking data from other
organizations and industry-standard reference data.
•
Provides a basis for performance evaluation. A budget sets
benchmarks against which actual performance can be evaluated; it
provides a series of checks and balances on the actions of management
and staff responsible for the various aspects of the budget.
Example: An FM budget provides a financial plan against which
the facility manager can compare actual results with budgeted
results on an ongoing basis. Large differences between planned
and actual results can be corrected. Because the budget
represents a commitment by FM and assigns responsibilities to
individuals, it can be a part of the employee performance appraisal
process.
•
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Allows for fine-tuning the strategic plan. Strategic plans are stated
in fairly broad terms and based on the best information available.
Budgets assign responsibilities for expenditures to functional areas
and managers. The detailed planning that characterizes budgets uses
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Chapter 2: Financial Management of the Facility Organization
the latest information available. Budget preparation may surface
potential pitfalls in the strategic plan and provide information that
can be used to make informed decisions that that will improve
performance before unsatisfactory outcomes result.
Example: A strategic plan includes objectives for multiple real estate
acquisitions. The first draft of the FM budget projects that the repairs
and refurbishing requirements for one of those properties will be
excessive. This information allows organizational management to
reassess the risks associated with the investments and revise plans
before a commitment is made.
Budget
approaches
Approaches to budgeting differ across organizations, but all fall
somewhere on a continuum between being entirely authoritative and
entirely participative. Exhibit 2-1 on the following page provides an
overview of these budget approaches. Currency examples are in Canadian
dollars (C$).
The combined iterative budget approach is best for most organizations
because it provides balance between strategic and tactical inputs.
Ownership of budget and thorough review lead to tight budgets that get
followed.
Steps in a combined budgeting approach include the following:
1. Budget participants are identified, involving all levels of management
as well as key employees with expertise in a particular area.
2. Top management communicates the strategic direction to budget
participants.
3. Budget participants create the first draft of their budget.
4. Lower levels submit budgets to the next higher level for review in an
iterative process stressing communication in both directions.
5. Rigorous but fair budget approval sets the final budget.
Certainly, a facility manager will have to understand the budgeting norms
and conventions of the organization. Such knowledge is a critical success
factor to help ensure that:
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•
•
The financial models used to develop budgets are appropriate.
The format is appropriate and consistent with business requirements.
•
The process for developing the budget follows standard management
and financial practices of the entire organization.
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Exhibit 2-1: Comparison of Authoritative, Participative and Combined Budgeting
Budget
Approach
Authoritative
Description
Advantages and Disadvantages
Senior management sets everything
from strategic goals down to the
individual items of the budget for each
department and expects lower
managers and employees affected by
the budgets to fulfill these goals. Also
known as a top-down budget.
Advantages:
Budget goals reflect strategic
objectives.
•
Better control over decisions.
•
Disadvantages:
•
Dictates instead of communicates.
•
Senior management may be out of
touch with departmental operations
and set unrealistic or unattainable
goals.
•
Can result in employees feeling
resentful and/or unmotivated.
Example: Senior management gives FM a limit of C$200K for general landscape maintenance
activities for the upcoming year. The facility manager must develop the operating budget with C$200K
as the landscape maintenance expense target.
Participative
Managers at all levels and certain key
employees cooperate to set budgets
for their areas. Top management
usually retains final approval. Also
known as a bottom-up or self-imposed
budget.
Advantages:
•
Expertise leads to informed budget
decisions.
•
Can result in employees feeling
involved and empowered.
Disadvantages:
Strategic goals do not receive
priority in the budgetary process.
•
Easy or abdicated approval can lead
to loose budgets and budget
padding (where managers have
incentive to underestimate revenues
or overestimate costs).
•
Example: A facility manager develops a department operating budget with input from purchasing,
human resources and administration. Upon completion, the budget is sent to senior financial
management for review and approval.
Combined
The ideal process combines the
features of authoritative and
participative budgeting and falls
somewhere between these methods.
Also known as an iterative budget.
Characterized by two-way
communication:
• Senior management understands
participants’ difficulties/needs.
• Participants understand
management’s dilemmas.
Advantages:
Strategic goals are communicated
top-down and implemented bottomup.
•
Personal control leads to
acceptance, which leads to greater
personal commitment.
•
Disadvantages:
•
Control retained and expertise
gained at the cost of a slightly longer
process.
Example: Senior management provides FM (and all other department heads) with a clear
understanding of strategic goals. A facility manager works in her team to develop an operating budget
that incorporates FM tactical goals aligned to the larger strategic goals. Senior management reviews
the FM budget, and once any adjustments are negotiated, the budget is approved.
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Chapter 2: Financial Management of the Facility Organization
Setting budget
assumptions
Regardless of an organization’s unique requirements or budgeting
approach, the budget process typically involves developing a set of
assumptions. Most often, assumptions are formulated at start of
budgeting.
Assumptions are generally described as premises—statements that are
assumed to be true (without proof or demonstration) and from which a
conclusion can be drawn. Developing an FM budget requires making
reasonable assumptions about the future.
Formulating reasonable budget assumptions requires consideration of
questions such as (but not limited to):
•
What are expectations for revenues in the upcoming year?
•
What are projected operating expenses?
•
How many full-time equivalent (FTE) facility management employees
will be needed? How much will employees be compensated?
•
•
What are projected costs for health-care benefits?
How many contract personnel will be required? How much will the
outsourcing cost?
•
Are supplier prices expected to increase or decrease?
•
How much will rent, insurance and taxes be?
It’s inevitable that the list of questions will vary.
Developing budget assumptions is a mix of art and science; there’s no
crystal ball that can help predict the future. Historical data about past
performance, intuition and experience—even in changing times—can
collectively provide a starting point. Of course, due diligence is warranted.
Conducting research, reading trade journals and reviewing industry best
practices are all appropriate when formulating budget assumptions.
Discussions with colleagues and other organizational personnel are also
valuable activities:
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•
Senior management—for a clear view of strategic goals
•
Finance—for records of past performance and forecasts of future
trends
•
Human resources—for shifts in the labor market
•
•
Sales—for information about tenant prospects
Purchasing—for information about suppliers and price trends
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Finance and Business
It’s important to realize that the elements behind the questions and
assumptions are dynamic. Employment costs and conditions change, the
supply of and demand for facility management services varies, laws that
affect business and employment change, and a myriad of other factors can
shift up or down. To develop reasonable budget assumptions, facility
managers need to stay current with what is going on. In the end, the
assumptions are educated guesses about the future.
Once assumptions are in place, the budgeting process unfolds according to
organizational protocol, culminating in an agreed-upon pact between FM
and senior management. Reading about the elements of operating and
capital budgets next will provide a sense of additional steps that are
generally involved in their preparation.
Types of
budgets
Operating and capital budgets are two types of budgets that are extremely
important in FM. From a broad perspective, operating budgets are
considered short-term, as they typically project only one year at a time. By
comparison, a capital budget is long-term and may project two, five or
sometimes ten years into the future. Operating budgets and capital budgets
have several other distinguishing characteristics.
Operating budget
Formally defined, an operating budget is a short-term budget projecting all
estimated income and expenses during a given period (usually one year). It
excludes capital expenditures because they are long-term costs. Operating
budgets are also called operational budgets or operational expenditures.
Operating budgets provide an important management planning and control
mechanism. At a minimum, development of the budget should take into
consideration:
•
Management’s objectives for the site and facility.
•
Trend data (e.g., surveys, demographic research and benchmark
reports).
•
•
Probable changes in economic factors—anticipated changes in external
factors such as higher utility costs, labor costs/availability, material
costs/availability, regulations and new codes.
Detailed information on the site and facility’s age, physical condition
and finances.
Internal customer needs for ongoing services and upcoming projects.
•
Organizational initiatives.
•
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Chapter 2: Financial Management of the Facility Organization
True to its name, an operating budget consists of funds that are used to support
daily operations. Customarily, an operating budget estimates revenue (income)
and expense items on a monthly basis and includes projections for a one-year
period. Specific items contained in an operating budget may vary, but typical
categories are shown in Exhibit 2-2.
Exhibit 2-2: Customary Operating Budget Revenue and Expense Categories
Revenues (if any)
Chargebacks (if any)
Expenses—categories such as (but not limited to):
• General and administrative
• Office
• Operations and maintenance
• Noncapital projects
• Design and engineering
• Taxes
• Insurance
• Marketing
• Leasing
• Depreciation (all capital depreciation)
The operating projections should take into account seasonal variations in
expenses and income (e.g., utility costs or snow removal) as well as expenses
that are paid on something other than a monthly schedule (e.g., real estate
taxes or insurance).
An ongoing challenge in FM is to be proactive regarding assets and avoid
getting mired in reactive initiatives of fixing things as they break. Good due
diligence in preparing an operating budget enhances asset management and
helps to mitigate perpetual reactive maintenance.
Developing an annual work plan (as a precursor to the operating budget) can
result in a helpful tool to plan and organize expense information about
projects, operations, maintenance and other costs and expenditures for the
projected period. The annual work plan (AWP) covers short-term needs, is
very specific and based on solid projections.
Exhibit 2-3 shows an example of customary information found in an annual
work plan. Note that the list of cost categories reflects the expense categories
shown above in Exhibit 2-2.
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Finance and Business
Exhibit 2-3: Common Cost Categories in Annual Facility Management Work Plan
General and administrative
Operations and maintenance, continued
Salaries
Employer’s taxes
Employment insurances
Pension payments
Health-care insurances
Other benefits
Maintenance
Preventive
Scheduled
Deferred
Repair
Custodial
Cleaning contract
Consumables
Pest control
Moving/porter services
Office
Purchase
Rental
Clothing and uniforms
Car fleet
Fuel and oil
Maintenance and repairs
Office automation
Telecommunications
Landlines
Mobile phone charges
Switch maintenance
Printing
Copier leases/renewals
Mail
Postage
Equipment
Couriers
Noncapital projects
Minor construction
Renovation
Repair
Design and engineering
Computer-aided design (CAD) photography and
renderings
Taxes
Insurance
Building insurance
Liability insurance
Marketing
Operations and maintenance
Leasing
Utilities
Natural gas
Electricity
Steam
Water/sewage
Fuel oil
Environmental costs
Waste management
Operations
Landscaping and grounds maintenance
Health and safety operations
Life and safety
Emergency and disaster planning
Security
Guards
Systems
Fire precautions
Detection and alarms
Extinguishers
Snow removal
Employee amenities
Vending areas
Cafeteria/food service
ATM
Day care
Depreciation (all capital depreciation)
A software spreadsheet can be used to translate the categories into an actual
work plan. Exhibit 2-4 is a work plan excerpt showing the general and
administrative costs from Exhibit 2-3.
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Chapter 2: Financial Management of the Facility Organization
Exhibit 2-4: Annual Facility Management Work Plan
Sample Excerpt
Cost Categories
Amount
Comments
General and administrative
Salaries
Employer’s taxes
Employment insurances
Pension payments
Health-care insurances
Other benefits
Keep in mind, this work plan excerpt is just an example of possible categories. It is
not intended to be a ready-made template. Categories and how they are populated is
a function of what is appropriate for an organization. Of course, there are myriad
possibilities that could exist due to the types and complexities of facilities. The line
items shown here are included simply as likely categories of general and
administrative costs but not meant to be all-encompassing or complete.
In this sample, there are no entries in the fields. The “Amount” headers should
specify the currency being used. Whatever remarks might be helpful to clarify the
costs or expenses can be included in the “Comments” column. For example,
regarding “Personnel,” if the facility manager is planning to hire one new FTE
maintenance person, the comment might be: “Includes one new hire FTE
maintenance.”
Next, we see how this annual work plan excerpt could be translated into an
operating budget. Exhibit 2-5 on the next page shows a sample excerpt of a
hypothetical operating budget for general and administrative costs for the
calendar month of April. Actual expenses are shown in comparison to budget;
variances are also included.
A well-planned operating budget:
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•
Helps to optimize FM department performance. Careful and
meticulous monitoring of expenses against budget allocations allows
appropriate adjustments to be made.
•
Greatly enhances a facility manager’s ability to recognize patterns
and trends. It facilitates a manager’s ability to take appropriate
preventive action to avert potential problems or implement corrective
action if problems or unplanned needs do arise.
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Finance and Business
Exhibit 2-5: Facility Management Operating Budget, April 20XX
Sample Excerpt
Expense
This Month
(Month 8)
Expense
This
Month
Last Year
Change
Year on
Year
Current
Year-End
Forecast
Forecast
Outturn
Against
Budget
–20,833.33
22,315.00
18,475.22
3,839.78
270,833.33
–20,833.33
16,666.67
–2,083.33
2,231.50
1,847.52
383.98
27,083.33
–2,083.33
60,937.50
54,166.67
–6,770.83
7,252.38
6,004.45
1,247.93
88,020.83
–6,770.83
10,000.00
7,500.00
6,666.67
–833.33
892.60
739.01
153.59
10,833.33
–833.33
Health-care insurances
62,500.00
46,875.00
41,666.67
–5,208.33
5,578.75
4,618.81
959.95
67,708.33
–5,208.33
Other benefits
25,000.00
8,762.25
16,666.67
7,904.42
250.00
1,000.00
–750.00
17,095.58
7,904.42
Total
453,750.00
330,324.75
302,500.00
–27,824.75
38,520.23
32,685.00
5,835.22
481,574.75
–27,824.75
Fiscal Year
Budget
Amount
Expended
Year-toDate
Budget
Year-toDate
Variance
Salaries
250,000.00
187,500.00
166,666.67
Employer’s taxes
25,000.00
18,750.00
Employment insurances
81,250.00
Pension payments
Cost Categories
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Chapter 2: Financial Management of the Facility Organization
Capital budget
A capital budget shows financial impacts resulting from major, long-term,
non-routine expenditures for items like property, plant and equipment.
Two related terms are capital asset and capital expenditures:
•
Capital asset—a depreciable item whose cost is significant to the
company and whose expected life is longer than one accounting period
and often much longer.
•
Capital expenditures—acquisitions of new or expanded long-term plant
assets.
A capital budget is a direct, high-dollar response to the organization’s business
objectives. Capital budgeting requires an organization to reserve substantial
funds and resources for use on large investments, oftentimes to realize benefits
far into the future. Because of the magnitude of capital expenditures, a capital
budget is a multiyear presentation.
The organization’s finance department customarily sets organizational rules
for capital program development, and finance personnel (e.g., CFO,
controller, analysts) are involved in capital budget approval and monitoring.
A facility manager has a major role in gaining approval for capital projects
and in capital program development. But the facility manager (or any other
operational department manager) does not set policies for capital budgeting
and execution. Suffice it say, no capital project should be started without
appropriate approvals by the management levels authorized by organizational
financial policy.
Organizations may set capital thresholds (cutoff levels) that establish the
sphere of influence that finance and operational managers each have for
capital projects. For example, finance may delegate more authority and
responsibility to a facility manager for capital requirements below $50K.
That finance department then takes ownership for any expenditure above
$50K. Facility managers (and all other department managers) must
understand organizational rules, policies and procedures for capital budgeting
set by finance management, and they must unconditionally observe the
protocol.
Capital projects are evaluated internally. The FM department and other
departments submit capital requirements for approval. Finance makes go/nogo decisions through a process that assesses, prioritizes, programs and budgets
initiatives before releasing them back to the submitting department for
execution. Ideally, submissions for capital requirements show long-term
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Finance and Business
economic and operational benefit to the organization. Of course, there can be
some situations where capital project justification is driven by another
reason—compliance with a new mandatory regulatory requirement, for
example.
Gaining approval for capital project can be challenging. A facility manager
increases chances for approval by rigorous due diligence. Answering the
questions listed in Exhibit 2-6 increases the probability for approval.
Exhibit 2-6: Due Diligence Considerations for Capital Projects

Does the project support
organizational business objectives and
reflect the priority of those objectives?

What are the boundaries for the
project (e.g., what the project will do
and what it will not do)?

Is the funding needed to complete an
ongoing project?

Does this project involve maintenance
or replacement of worn-out
equipment?

Will this project yield a high expected
return on investment?

Will this project yield an average return
on investment?

Will this project modernize work
processes and result in cost savings?

Is this project needed to ensure the
organization’s financial integrity?

Is this project necessary to comply with
legal/regulatory requirements?

What are the financial risks associated
with this project?
By its nature, capital budgeting is complex. Capital expenditures often have a
different tax treatment from operational expenditures and are sometimes more
or less attractive to the CFO, depending on that tax treatment. However,
decisions on whether an expenditure can be treated as capital versus operating
are often beyond the control of the facility manager.
The upcoming discussion of business cases (Topic 3) further discusses the
justifications related to capital investments. As you will see, capital
investment decisions are crucial to an organization’s welfare as they involve
large expenditures that have a long-term impact.
Additional
budgeting
concepts
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Several important operating and capital budgeting principles have been
presented. The following overview of some additional budgeting concepts can
help facility managers to better coordinate efforts with upper management and
promote their departments in terms that finance- and business-oriented senior
management will understand.
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Estimating revenue
and expense
projections
A budget must account for revenue and expense projections.
Revenue projections
Most facility managers do not have any revenue projections—unless they have
retail space they are leasing on a regular basis; are leasing property owned by
their company, such as a building, or space to a third party; are subleasing
property, a building or space to a third party where the facility has a lease with
a landlord; or the facility manager will realize monies from the sale of a
facility. There are some FM departments that have a chargeback requirement
to their internal customers where the facility manager would realize revenue
from the work provided to internal customers.
If there are revenue projections, it is wise to remember that unpredictable
events can and will affect revenues. However, revenues can be projected with
some degree of accuracy, based on experience. The key in projecting revenues
is to make adjustments as soon as there is sufficient information to anticipate
future plans or changes.
Expense projections
Expense projections should consider all the costs required to achieve the
organization’s objectives—capital expenses (for example, equipment) and
general administrative expenses.
As with revenue projections, experience can help determine some of the
expenses. But upcoming changes and unknowns must then be factored in, such
as (but not limited to):
• Increased personnel costs and associated expenses (e.g., compensation and
benefits, training, additional office space and supplies and any additional
supervision).
• Rising administrative costs (e.g., increases in rent and insurance
premiums).
•
Seasonal variations (e.g., temporary increases or decreases in labor
requirements, periodic maintenance, utility costs, snow removal and so
forth).
Ultimately, revenue and expense projections must be compared, even though
there is no rule that says they must always balance. Deficits and surpluses or
breakevens may occur. Certainly, large deficits are undesirable. Typically,
when revenues and expenses are not at desired levels, FM activities are
reevaluated and, in some situations, readjusted.
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Finance and Business
Fixed/variable
budgeting
Fixed/variable budgeting separates costs according to how they relate to other
areas of an organization’s business.
Fixed costs
Fixed costs are costs that remain unchanged in total for a given time period,
despite wide changes in the related level of total activity, for example, a
licensing fee or taxes.
The organization is committed to fixed costs for the whole of the accounting
period, and (in general) such costs cannot be reduced or deferred without
incurring some significant additional risk, business impact or cost of change.
In addition to remaining stable, fixed costs tend to be recurring. Additional
examples are rent held constant by a lease, annual liability insurance
premiums and depreciation. Short of a major change (such as the renegotiation
of a lease), an organization’s actual and budgeted fixed costs should be
identical month after month.
Although fixed costs remain stable and do not change up or down for the time
period, they can and often do change between budget cycles. Taxes, for
example, can go up or down but are not activity-driven.
Variable costs
Variable costs are at the other end of the spectrum. Variable costs change in
total in proportion to changes in the related level of total activity. For example,
fuel costs depend on mileage driven. Variable costs are cost elements that can
be changed in the short term with few constraints. (Albeit often there is still
some business impact.)
As the name implies, variable costs are not stable—they vary directly with
changes to activity in a budget (such as assets and expenses). If a budget
activity increases, so will variable costs (and vice versa). A couple of other
examples of variable costs are the costs of mail services or printing—expenses
that vary based on usage.
Budget periods
Organizations must prepare budgets for a set time period. A budget is
typically established for the one-year period that corresponds to the fiscal
year of the organization (although the organization’s fiscal year may not be
the same as the government’s tax year).
Annual budgets are often broken down into quarterly and monthly time
periods, allowing managers regular opportunities to compare actual data with
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Chapter 2: Financial Management of the Facility Organization
budgeted data. This process can highlight any problems and allows managers
to remedy the problems more quickly.
An increasingly popular budgeting method is continuous budgeting (also
called a rolling budget), which is a 12-month budget system that rolls
forward one month (or quarter) as the current month (or quarter) is
completed. A continuous budget has a month, quarter or year basis. As each
period ends, the upcoming period’s budget is revised and another period is
added to the end of the budget.
Supporters of continuous budgeting maintain that this type of budget will be
more relevant than a budget prepared once a year. The continuous budget can
reflect current events and necessities in its estimates. Continuous budgets
have the advantage of breaking down a large process into manageable steps.
It is thought that because managers always have a full period of budgeted
data, they tend to view decisions in a longer-term perspective than with a
one-year budget (which will cover a shorter and shorter period of time as the
year progresses). Potential disadvantages of continuous budgets include the
need to have managers use part of each month working on the next month’s
budget.
Budget methods
There are several different budgeting methods an organization may use.
Budget methods a facility manager may encounter may include any one of the
following.
Incremental budgeting
Incremental budgeting is a budget method that extrapolates from historical
data. Next year’s budget is constructed by starting with the current year’s
budget as a baseline and then adjusting each line item for expected changes.
In incremental budgeting, a manager starts with last year’s budget and adds to
it (or subtracts from it) according to anticipated needs. Of the various
budgeting methods, incremental budgets generally are easier to complete and
involve less work. An advantage of the method is that history, experience and
future expectations are used to develop the budget. The main drawback to
incremental budgeting is that such budgets tend to only increase in size over
the years. Managers may simply use the figures from the past budget period
and increase them by a set percentage rather than devoting appropriate time to
research the realities of the current and future environment. A sense of
entitlement may also arise with the use of an incremental budget.
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Finance and Business
Zero-based budgeting
Zero-based budgeting is a budget method in which the continued existence of
items must be justified both financially and operationally before they are
included in the new budget.
.
Most budgeting methods incorporate some review of historical data. Zerobased budgeting incorporates a unique perspective regarding historical
records. Zero-based budgets help to avoid situations in which ineffective
activities continue to exist simply because they were in the prior budget.
While the traditional incremental budget focuses on changes to the past
budget, the zero-based budget focuses on a critical review of every assumption
and cost justification for all proposed expenditures.
If an organization uses zero-based budgeting, facility management (and
other departments) would be required to rank all of its activities from most
to least important and project costs for each activity.
Example: Statutory compliance with standards for accessible design
that apply to new construction and alterations might be highly ranked
as essential for business to continue , a necessity for business
growth, and an important organizational commitment to improve
services.
Senior management reviews these lists and cuts items that lack justification
or are less critical. In the process, questions are asked, such as, “Should the
activity be performed and if it isn’t, what will happen?” or “Are there
substitute methods of providing this function such as outsourcing?” Senior
managers may also use benchmark figures and cost-benefit analysis to help
decide what to cut. Only those items approved appear on the budget. Once
the justification is made, the budget must be based on the most accurate
information available—hopefully, historic.
The primary strength of the zero-based budget is that it forces review of all
elements of a business. A facility manager would have to perform an in-depth
analysis of each line item—considering objectives, exploring alternatives and
justifying requests.
Because it is more analytic than incremental budgeting, zero-based budgeting
can improve budgeting accuracy. But it also presents some distinct challenges,
such as:
•
•
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A significant amount of budget preparation time.
Added paperwork.
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•
The potential for unwanted competition for resources, morale problems
and so forth, as senior management eliminates programs.
•
Potential for inaccurate estimates (if prior budgets are not considered and
past expenses and lessons learned from prior years are ignored).
Activity-based budgeting
True to its name, an activity-based budget (ABB) focuses on activities. ABB
includes the use of activity-based costs to make a clear connection between
resource consumption and output. This allows managers to better understand
how resource demands are affected by changes in activity.
Implementing ABB in developing a facility management operating budget
would require three basic steps:
•
•
Identifying activities for the department
Estimating the demand for each activity’s output
•
Assessing the cost of resources required to deliver the activity output
Assuming that two or more activities share spaces or buildings, ABB must
naturally be complemented by some type of chargeback system to the activity.
(Chargebacks are discussed in Topic 7.)
The ABB approach emphasizes value-added activities and expresses
budgeting units in terms of activity costs. By identifying value-added versus
non-value-added activities, ABB provides opportunities for cost reduction and
elimination of wasteful activities.
ABB proponents maintain that traditional incremental budgeting focuses on
departments or products and services and obscures the relationship between
costs and outputs by oversimplifying the measurements and grouping them
into broad categories. Because traditional budgets rely on past (historical)
budgets, there is more potential to continue funding items that would be cut if
their cost-effectiveness (or lack of) were known. ABB proponents further
think that the activity-based budgeting approach coordinates and synchronizes
activities of the entire organization to better serve customers.
General
budgeting
guidance
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Many factors characterize an FM budget, but no single factor can lead to a
successful operating or capital budget. FM is a major consumer of
organizational resources. As such, the reality is that FM budgets are subject
to closer scrutiny than those of most other departments. Facility managers
do not need to be budget experts, but the high-level visibility of their
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budgets necessitates that they be able to knowledgeably contribute to the
budget process, answer resource questions with FM and business
knowledge using the financial language/words that management
understands, and demonstrate the department’s efficient and effective use
of resources.
Finance and business personnel who review and approve FM budgets are
often unfamiliar with department practices and principles. Given that, the
budget process provides a facility manager with the opportunity to educate
those individuals about what FM does to accomplish the following:
•
Support the organization’s core business. When presenting the
current budget, a facility manager can discuss how it supports business
and operational objectives by showing, where possible, how FM costs
are in response to organizational requirements.
•
Control costs. Budget discussions with finance and business personnel
provide the chance to review FM cost savings, control and avoidance
strategies, and accomplishments.
•
Outline anticipated cost increases and/or decreases for the budget
period. A facility manager should identify the cause for the changes
and the strategies the FM department is employing to counteract any
negative effects. As feasible, any requests for funds should be in sync
with objectives set by senior management.
•
Quantify the impact of any capital requirements on the operating
budget. How capital project requirements influence the operating
budget line items for increased or decreased space, increased expenses
and depreciation can be presented.
The overall goal of the budget process is to produce accurate and detailed
financial projections and provide for fiscal accountability—a
straightforward goal but not an easy one. As we have read throughout the
budgeting content presented here, organizations will vary in how they
gather information and implement, monitor and adjust activities. But a
proactive FM budget process facilitates the preparation of both operating
and capital budgets. Exhibit 2-7 offers some general guidelines
appropriate for facility management across all types of organizations.
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Chapter 2: Financial Management of the Facility Organization
Exhibit 2-7: Guidelines for Effective Facility Management Budgeting
•
Know the organization’s strategic plan, core
business and operational objectives. Make
budget decisions that align FM to them.
Demonstrate that alignment to external
reviewers and stakeholders.
•
Design the FM budget process to
be consistent and easy to
understand. Clarify everyone’s roles
in the budget process.
•
Understand the organization’s budgeting
process—the guidelines you need to follow,
the timing of the process, and how the
organization will use the budgets.
•
If time permits, draft a preliminary
budget that estimates revenues and
expenses. If they are not within
senior management parameters,
look for ways to make adjustments.
•
Understand all line items in the budgets FM
contributes to. If you don’t know what
something means or how the number is
derived, ask questions to find out.
•
Once a budget is implemented,
regularly monitor expenses against
budget levels to track progress
toward budget goals.
•
Foster buy-in from decision makers.
Understand the concerns of the people
making decisions about the FM budget. Be
sure to address those concerns in the
department budgets.
•
If budget problems arise, be
prepared to correct them through
formal plans of action and to offset
negative budget variances.
•
•
Establish rapport with finance staff involved
in the budgeting process. Regularly
communicate and coordinate FM
requirements. Ask questions about points
you don’t understand. As appropriate, seek
advice about the assumptions being made
in the FM budgeting.
Have ongoing discussions with
those involved in FM budgeting.
The better the communications and
planning, the increased chance of
handling and responding to
unplanned contingencies.
•
Have several contingency projects
and activities identified should
spending levels be lower than
anticipated.
•
If other FM personnel are to participate in
the budget process, make sure that
everyone involved understands elementary
accounting principles.
Budget
monitoring
Monitoring expenses against budget levels is a core management activity for a
facility manager. “Periodic review” is a term often used interchangeably with
budget monitoring.
The frequency—weekly, monthly, quarterly, midyear or annual—is determined
by the detail required, organizational practices and personal preference.
Regardless of timing, each review provides a facility manager with important
data. Periodically monitoring the budget by reviewing reports and accounting
records helps to determine if allocated funds have been spent as specified. If
deviations appear between the approved budget and actual spending, variations
can be analyzed and, if warranted, appropriate adjustments made.
Weekly analysis
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Weekly analysis facilitates tracking of large or seasonal expenditures on a
timely basis. Most accounting systems routinely update financial information on
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a monthly basis; there may be an additional reporting lag before the information
is available for a facility manager’s review. Weekly checks can help to ensure
that there are no surprises when monthly budget reports become available.
Monthly analysis
Monthly analysis provides expenditures for that month and helps to assess shortterm spending patterns, timing of billing and payments, and like activities.
Monthly combined
with year-over-year
and year-to-date
analysis
This combination facilitates comparisons of current monthly and year-to-date
expenses with both the authorized budget and previous spending. The
combination helps to identify trends and variances.
Monthly comparisons of actual expenditures may be made with budgeted
expenditures for that month. Variances between actual and anticipated
expenditures can be noted. Actual monthly expenditures can be compared to the
same month last year, and budgeted amounts at year-end can be compared. Lease
costs at the end of a fiscal year, for example, could be compared to budget. Or
lease costs could be compared from month to month or the previous year.
Quarterly analysis
Quarterly analysis typically coincides with the organization’s fiscal calendar.
Many organizations monitor their targets on a quarterly basis and report to the
stock market and/or shareholders on that performance, so it is key from a
“whole organization” perspective and from a target/results basis.
• Variances identified by quarterly cost reviews can be used to fine-tune
budgets and reallocate funds as necessary.
• As quarterly analysis at the end of the second or third quarter is usually
tied to organizational profit and loss statements (discussed in subsequent
content on financial statements), a facility manager can use the analysis
results to ensure that the department’s budgeting and spending approach is
consistent with the organization as a whole.
Midyear analysis
Actual expenditures for the first six months can be compared with budget and
projections for the second six months. This is also the point at which some
organizations start to plan budgets for the next fiscal year.
Annual analysis
Year-end budget reports can provide further insights about how efficient the
department is and where improvements may be needed. Valuable comparisons
can be made, such as:
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•
Percentage of maintenance and repair versus new work.
•
Trends in maintenance and repair versus new work.
•
Unit costs compared to benchmarks (such as the IFMA benchmarks for
facility costs).
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Data analysis and statistical analysis software has greatly increased the
amount of data and information that budget analysis can compile.
Spreadsheets, databases and financial analysis software can produce accurate,
up-to-date information for review. In addition, many organizations incorporate
enterprise resource planning (ERP) programs into their budgeting process.
ERP programs have the ability to consolidate all of an organization’s
operating information into a single computer system. For example, a facility
manager and finance personnel could use ERP data to estimate and then track
the effects that an FM budget alteration has on other parts of an organization.
The accounting systems that organizations and FM use to monitor budgets
may vary. Regardless of how it is done, there is a clear message for a facility
manager: If you do not regularly monitor expenses against budget levels, it is
possible (even highly probable) that you won’t properly understand FM
budget status and there is a greater likelihood for wrong decisions based on
misunderstanding. Remember that for some organizations, capital
expenditures can be a direct cost to a business unit and a wrong decision can
result in a direct loss to that business unit versus profit for the year or longer.
Budget
closeout
Budget closeout coincides with the end of the fiscal year. As with many
aspects of budgeting, budget closeout can be simple or complex. Some
organizations may have formal authorization requests to close; others may
have a more informal closeout process, signaled when all administrative
actions have been completed and expenses have been posted to accounts.
Simple or complex, the process typically requires coordination between the
facility manager and the finance department.
Legal and financial requirements and even simple tasks may differ across
organizations. For example, in most government sectors, there is a rigorous
closeout of purchase orders. With few exceptions, the government closes out
its books at the end of every fiscal year since the authority to obligate those
funds normally expires at the end of that year. Expenses are simply accounted
for based on the obligation incurred during the fiscal year in which the funds
were appropriated. Customarily, this is followed by a financial audit. FM must
follow the rules prescribed by the organization and its environment.
In the private sector, accruals are a part of the year-end closeout process. An
accrual refers to either accrued revenues (which are earned revenues yet to be
received as cash or recorded) or accrued expenses (which are incurred but
unpaid expenses yet to be recorded).
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There are two ways to account for receiving cash or paying expenses.
•
Cash basis (or cash basis accounting) accounts for cash when it is
received or spent. Items promised to be paid or received, such as accounts
payable and receivable, are ignored.
Example: When a work order has been issued and the work has been
carried out but not yet invoiced, the work order value may be used to
calculate the accrual.
Cash basis accounting is not allowed under IFRS or GAAP.
•
Accrual basis (or accrual basis accounting) records the revenue or
expense when it can be reliably measured.
Example: Utilities accruals may be based on meter readings and selfcalculation of the sum due, as utility invoices are often too late in being
issued by the provider for year-end purposes.
Accrual basis accounting is the accepted norm for most organizations.
In FM, accruals are funds that a facility manager estimates to be expended by
a certain date because of obligations made before that date. At fiscal year-end,
a facility manager estimates what he or she can obligate, although those items
may not be expensed until the first quarter of the next fiscal year. For
example, a bill is coming due and a facility manager needs to accrue against
that amount. There are issues associated with “over” or “under” accruing.
Budget closeout ultimately reveals how well a facility manager has managed
the budget. Whether it is one percent or less, within five percent, or some
other percent, the number is an indicator of performance—good or bad.
In The Facility Manager’s Guide to Finance and Budgeting, authors David
Cotts and Edmond P. Rondeau describe good budget management as a learned
skill and they use the analogy of the budget as a map. If you recall the earlier
content comparing budgeting to preparing for an out-of-town business trip, it
makes further sense. Good budgets are like maps; they allow a facility
manager to know at all times where he or she is in order to reach a destination.
Multinational
budgeting
considerations
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Multinational organizations have additional considerations in budgeting.
Operating and capital budgeting theory does not change, but the process is
more complicated. Furthermore, there are many additional complexities in
global investment analysis.
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Even though a facility manager cannot directly influence global budgeting
practices, it is wise to have a general awareness of the major issues and
challenges such as (but not limited to) those listed in Exhibit 2-8. These same
issues and challenges prevail when evaluating global investments.
Exhibit 2-8: Impact of Select Global Factors on Budgeting
Global Factor
Potential Budget Implications
Legal and regulatory requirements
Country-specific factors must be carefully researched,
documented and understood. Government policies and
regulations can affect acquisitions and purchases, taxation
and other budget items.
Currency
Unpredictable events can sometimes result in rapid changes
in rates of inflation and monetary exchange rates.
Collective bargaining, employee
representation and government
mandates
Employees in most parts of the world are protected from
actions that impact their wages and employment conditions.
The implications for minimum wages, severance packages
and pensions must be understood.
Culture
Cultural differences necessitate involving local contacts to
understand usual and customary practices.
Risk management
There are many potential issues that can pose high levels of
risk to the safety and well-being of employees and other
organizational assets.
State or crossborder
benchmarking
and budgeting
There is general international acceptance that standards are a proven business
facilitator and standardization increases consumer confidence, lowers costs
and otherwise supports the growth of economies.
The European Committee for Standardization (CEN) is such a business
facilitator in Europe. Through its services, CEN provides a platform for the
development of European Standards and other technical specifications that
become the national standards in each of its member countries. CEN along
with its American counterpart, ANSI (the American National Standards
Institute), are both member organizations of ISO (the International
Organization for Standardization).
CEN has developed several European Standards for real estate and facility
management. These standards are of key importance to many of the European
Union member countries who have traditionally worked to their own
standards. In a globalized world, CEN standards strive to promote conformity,
provide a transparent basis for management, and support the communication
of information. All of these outcomes have the potential to reduce the
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challenges of real estate and facility management across states and borders and
help organizations make better decisions.
Specific to measuring, analyzing and comparing performance data important
to real estate and facility managers, objective and consistent benchmarking
across borders poses challenges. CEN’s benchmarking standard attempts to
facilitate meaningful comparison between services in different geographical
locations and especially in different jurisdictions or countries.
CEN’s benchmarking standard identifies many factors that can impact finance
or business in state or cross-border benchmarking such as (but not limited to):
•
National rules and regulations.
•
Currency exchange rates.
•
•
Taxation and value-added tax.
Accounting rules.
•
•
Rental basis and service charges.
Labor costs.
•
Level of outsourcing.
•
•
•
Subletting.
Spare capacity (temporarily/short-term vacant space).
Effect of internal recharging.
The impact of these factors (and others) cannot be ignored but must be
understood when deciding whether to use benchmarking or which factors to
benchmark.
In general, cross-border benchmarking should be used with extreme care and
should include careful analysis of all relevant factors. It is likely to be a valid
exercise when the objective of the benchmarking is to establish at least one of
the following comparisons:
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•
Real operating costs within an organization so as to make an informed
decision on relocation
•
The cost/benefit/risk of potential investment in a new operation in a new
territory
•
Resource usage or effectiveness within existing operations in two or more
different territories to assess best practice within the organization
•
Resource usage or costs per output unit to assess the impact of best
practices on outputs between organizations in the same or similar industry
but in different locations
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Chapter 2: Financial Management of the Facility Organization
Topic 2: Financial Statements
Financial statements portray the current financial health and recent financial
history of an organization. They answer basic questions about the organization,
such as (but not limited to):
•
•
What does it own?
What does it owe?
•
•
What are its sources of revenue?
How is money spent?
•
How much profit is made or loss incurred?
•
What is the state of the organization’s financial health?
An organization prepares financial statements from accounting records once it is
confident that all accounting data is accurate. In turn, all data presented in a
financial statement should be:
•
•
Clear—appropriate for the intended audience.
Accurate—free of errors.
•
Complete—including any additional information the intended audience
might need to understand the statement (for example, reporting variance
against the actual budget and comparative data from the previous year or
including text-based notes).
Consistent—fulfilling any applicable accounting standards or requirements.
•
•
Timely—prepared and distributed so well-thought-out action can correct any
problems.
Provisions of the Sarbanes-Oxley Act of 2002 (often shortened to SOX) have
important implications for FM. This legislation was enacted in the United States
in response to high-profile corporate financial scandals. The intent of SOX is to
protect shareholders and the general public from accounting errors and
fraudulent practices in the enterprise. Key provisions of SOX:
• Define the responsibility of boards and senior management to provide
accurate and complete financial reports and address conflicts of interest by
auditors and stock analysts.
• Extend whistleblower protection—legal protection for employees
reporting fraudulent practices (including U.S. workers overseas).
•
Apply to all companies listed in the United States and their auditors, both
foreign and domestic.
Since SOX applies to organizations trading in or with the United States (no
matter where they are based), it is also applicable to facility managers
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internationally. Any significant changes from FM capital or expense
projections must be brought to the attention of finance to ensure that the
organizational financial statements accurately reflect operations.
Financial
statement
categories
Organizations may prepare two sets of financial statements—one for internal
purposes and a second set for external disclosure. Publically traded companies
have an additional requirement for their external financial statements—they
are required to produce external audited financial statements.
Internal financial
statements
Internal financial statements are produced on a regular basis (usually monthly)
and made available to senior management, staff management and others with
operating or oversight responsibilities. Internal statements serve as essential
reporting mechanisms and management tools. They may present information
about the organization as a whole, or they may report on data for each department
or units within departments.
Periodic review of this type of data provides a management control mechanism
and alerts an organization to any necessary remedial actions. The method of
disclosing information in internal statements and the degree of detail provided is
often adapted for the audience’s requirements and level of financial knowledge.
Many organizations internally audit their financials. Through a systematic
methodology, statements and supporting documentation are reviewed and
analyzed. The specific scope of internal audits varies, but they customarily
consider items such as compliance with the organization’s policies and
procedures, the efficacy of operations, the reliability of financial reporting,
potential fraud, safeguarding assets, and compliance with laws and regulations.
Such internal organizational audits are different from financial statement audits
required for compliance with accounting standards (discussed next).
External financial
statements
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Publically traded companies are required by law to produce external financial
statements that are prepared in accordance with accounting standards—IFRS or
GAAP and FASB. The terminology in external financial statements is precisely
defined by the applicable accounting standards. Full disclosure (mandated by
regulatory bodies such as the Securities and Exchange Commission in the United
States) requires that external financial statements be made available to regulatory
bodies, banks, lending institutions, the public and other interested parties. Even
though companies that are not publically traded do not have a similar mandatory
requirement, they still typically produce external financial statements for their
private owners, banks and lenders.
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Audited financial
statements
Audited financial statements are prepared and certified by an auditor. The
credentials of the auditor may vary. In the United States, an independent
certified public accountant (CPA) is the auditor; in the United Kingdom, a
chartered accountant serves as the auditor.
During the audit process, the organization is responsible for providing source
documents for its financial statements to the auditor. Source documentation
includes a wide range of financial documents, such as accounts payable and
accounts receivable information, expense reports and budgets. The audit
includes a rigorous review of the organizations’ financials as well as the
additional documents; the auditor examines, evaluates and cross-references
them. The outcome is a professionally prepared set of audited financial
statements that the organization can then present to interested parties. In the
United States, for example, the auditor certifies that the financial statements
meet the requirements of the GAAP.
Audited financial statements include a document that is referred to as an
opinion. It is the responsibility of the auditor to provide either an unqualified
opinion or a qualified opinion.
An unqualified opinion:
•
•
•
States that the financial statements are presented fairly.
Provides the highest level of assurance an auditor can supply regarding the
accuracy of the financial statements.
Indicates that the auditor is satisfied with the financial statements as a
whole.
A qualified opinion:
•
Suggests that there is a material problem with one or more aspects of the
financial statements.
•
Flags an issue that the auditor has reservations about (such as a minor
departure from IFRS, GAAP, or the Sarbanes-Oxley Act.)
In extreme cases, the auditor may express no opinion on financial statements.
Such a disclaimer of opinion results from incomplete records, unauditable
records, litigation, lack of auditor independence and so forth. When an auditor
declines to issue an opinion, it is an indication that the financial statements are
unreliable and unpredictable. It also indicates that the organization needs to
examine and retool its internal accounting procedures so it can operate
according to customary and proper accounting standards.
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Increasingly, not-for-profits undergo similar independent financial statement
audits, examining the accuracy and completeness of information presented in
their financial statements. These audits may be voluntary or they may be
legally required (for example, as a result of tax exemption regulations, terms
of the organization’s bylaws and funding requirements).
Next we take a closer look at the types of financial statements a facility
manager may encounter. Very basic hypothetic examples are included to
augment the discussion of each statement. The currency shown in all the
financial statement examples is U.S. dollars (USD).
A couple of general points to keep in mind: When reviewing a financial
statement (budgets and other financial documents, too), usually a single
underline designates a subtotal and a double underline is used to show a grand
total. The numbers enclosed in parentheses indicate negatives (losses).
Types of
financial
statements
In accounting, the core set of financial statements includes the:
•
•
•
Income statement.
Statement of shareholders’ equity.
Balance sheet.
•
Statement of cash flows.
Collectively, these four external financial statements capture transactions that
reflect the operations and activities of an entity. All transactions are supported
by appropriate source documents.
Exhibit 2-9 on the next page provides the general order and process used to
generate the statements and includes brief notes about each one. First, net
income is determined, including shareholders’ equity (on the income
statement and the statement of shareholders’ equity); then assets and liabilities
are determined and presented on the balance sheet. The statement of cash
flows is used to reconcile the other statements.
Of the four financial statements, the three essential ones that a facility
manager should have a fundamental awareness of are the income statement,
the balance sheet and the statement of cash flows. Shareholders’ equity is a
financial statement that starts with the balances from the end of the prior
period and shows changes due to net income (loss) and dividends for the
period or any new issuances or repurchases of stock. This is not a statement
that directly impacts FM. Therefore, we focus our attention on the remaining
three statements.
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Chapter 2: Financial Management of the Facility Organization
Exhibit 2-9: External Financial Statements
Income Statement
• Record of revenues and expenses for
current period
• Revenues – Expenses = Net income (or
net loss)
Statement of Cash Flows
Shareholders’ Equity
• Shows sources and uses of cash
• Three sections: operating, investing,
financing
• Cash flow from profit = Other
sources of cash – Uses of cash =
Change in cash
• Net change in shareholders’ equity from
operations over specified period of time
• Shown as a footnote to income statement
• Assets – Liabilities = Shareholders’ equity
Balance Sheet
• Snapshot of performance at one point in
time
• Assets = Liabilities + Shareholders’ equity
As you review the sample financial statements, keep in mind two points:
•
In most organizations, financial statements are prepared by a stand-alone
financial accounting division or department.
•
Much of the content of financial statements comes from departments or
divisions outside the FM arena.
It is important, however, that a facility manager have a working knowledge of
organizational financial statements. A facility manager must be able to track
and report supporting information that financial managers need to prepare the
statements.
Income statement
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The income statement is an accounting document that represents the
company’s revenue and expense transactions for the reporting period. Also
called the profit and loss (P&L) statement or the earnings statement, it shows
the profitability of an organization for a specific period. In other words, the
income statement indicates cumulative business results within a defined time
frame. However, it does not reflect the organization’s financial solvency. An
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income statement is comparable to the statement of activity (SOA) prepared
by not-for-profit businesses.
Exhibit 2-10 shows a simple version of an income statement (an adapted
excerpt), reporting revenues and expenses and the results of operations. A total
is compiled for each category, and the difference between the two totals is
then reported as the change in net income. Often referred to as the bottom line,
the difference between revenues and expenses (including taxes) indicates net
profits or net losses for the period. In not-for-profit organizations, the change
in net income is referred to as the organization’s change in unrestricted assets.
In a full organizational income statement (unlike the adapted excerpt shown
here), the categories of revenues and expenses reported would be more
extensive and would vary, depending on the organization.
Exhibit 2-10: Sample Adapted Income Statement
XYZ For-Profit Organization
USD in Millions
Current Year
Prior Year
$8,380
$7,757
Cost of operating expenses
4,982
4,594
Cost of goods sold
2,300
2,109
Interest expense
173
172
Depreciation and amortization
39
24
Income before income taxes
886
858
Income tax expenses
269
275
Net income
$617
$583
Revenues
Expenses:
Legend for key terms in adapted income statement:
•
•
•
•
•
•
•
Statement date shown—A specific period of time—in this case, annual figures; at year-end, the result of
operations is added to or deducted from net income reported on the balance sheet.
Revenues—Also called income; reported as gross (not net).
Expenses—All expenditures that are not capitalized; refers to current period debts.
Cost of operating expenses—Administrative costs such as FTE salaries and benefits, rent and other costs not
directly related to the cost of delivering a product or service.
Cost of goods sold—Actual cost to the organization for items sold.
Depreciation and amortization—Counted as an expense on the income statement even though it does not
involve out-of-pocket payments.
Net income—For-profit terminology for profit or loss.
The sample income statement excerpt presents collective information,
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Chapter 2: Financial Management of the Facility Organization
capturing data for different departments, programs and other cost centers on
one statement. However, there may also be separate income statements
prepared for FM operations or other departments, programs and cost centers.
In this adapted income statement, FM would principally impact the operating
expenses.
In addition to serving as a budgeting tool, the income statement helps
management to understand the financial condition of the organization. For
example, comparing results from one annual period to a previous year will
show what items affect the bottom line.
The next rendition of the adapted income statement, in Exhibit 2-11, shows
the dollar and percentage changes through a comparative horizontal analysis.
Exhibit 2-11: Sample Adapted Income Statement
Comparative Horizontal Analysis
XYZ For-Profit Organization
USD in Millions
Increase (Decrease)
Current Year
Prior Year
$8,380
$7,757
$623
8.0%
Cost of operating expenses
4,982
4,594
388
8.5
Cost of goods sold
2,300
2,109
191
9.1
Interest expense
173
172
1
0.6
Depreciation and amortization
39
24
15
62.5
886
858
28
3.3
Revenues
Amount
Percentage
Expenses:
Income before income taxes
Income tax expenses
269
275
(6)
(2.2)
Net income
$617
$583
$34
5.8
A simple horizontal analysis that studies the percentage changes in these
comparative statements reveals the following.
The dollar change was $623, computed as follows:
$8,380 – $7,757 = $623
Revenues in the current year increased by 8 percent, computed as follows:
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Percentage change =
Dollar amount of change
Base-year amount
Percentage change =
US $623
= 0.080 = 8%
US $7,757
While revenue increased by 8 percent in the current year, the bottom line grew by
only 5.8 percent. This may be attributed to the fact that expenses grew faster than
revenues (the cost of operating expenses by 8.5 percent and the cost of goods sold
by 9.1 percent).
Depreciation and amortization had the largest percentage increase (62.5 percent),
but this should not be a cause for concern because the dollar amount is low.
Many decisions in an organization hinge on the trend of revenues, income,
expenses and so on. In addition to the simple horizontal analysis shown here,
finance will perform a variety of additional trend analyses that are critical in
management planning.
Our sample adapted income statement shows comparative figures on the same
page (e.g., current year to prior year). There are different variations of income
statements. For example, a two-column format may be prepared showing current
month totals and a second column with year-to-date figures. Or income
statements may show only a singular period. Generally, analysis is greatly aided
in a multiperiod format, allowing the reader to spot trends and turnarounds.
Balance sheet
A balance sheet is a “snap shot” of a firm’s financial position at a specific point
in time. It reports on an organization’s assets, liabilities and net assets at a
specified date. The statement illustrates an organization’s solvency and cash
position; it does not reflect profitability. The balance sheet is comparable to the
statement of financial position (SOFP) prepared by not-for-profit businesses.
A balance sheet is usually divided into two sections, with assets on top and
liabilities and shareholders’ equity (owners’ equity or net assets) listed below.
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•
Assets are resources obtained, owned or controlled by an organization as a
result of past transactions or events that will probably result in future
economic benefits to the organization. Assets are generally divided into
categories and shown in the order of their liquidity—arranged from most
to least liquid. Typical categories include current assets; plant, property
and equipment (PPE); long-term assets; and other assets.
•
Liabilities are what the organization owes to others. They are listed in
order of the time frame in which they are due, usually as current and long-
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term. Current liabilities, or accounts payable, are expected to be settled
within the normal operating cycle or one year of the balance sheet date
and include the portion of long-term debt expected to be paid in this
period. Long-term liabilities (e.g., mortgages, bonds) are any liabilities not
qualifying as current and other (those liabilities that are not material
individually).
•
Equity is the ownership interest in an organization’s assets after deducting
all of its liabilities (the difference between the assets and the liabilities, or
net worth).
As implied by its name, in the balance sheet assets must always equal
liabilities plus equity. You will see in Exhibit 2-12 that total assets equal total
liabilities and shareholders’ equity.
The balance sheet also indicates:
•
The amount the organization has invested in assets and where the money
is invested.
•
The amount of the monetary investments in assets that comes from
creditors (liabilities) and shareholders (equity).
Analysis of a balance sheet indicates how efficiently an organization is
utilizing its assets and managing its liabilities. A balance sheet is prepared by
accountants, but it has important implications for managers relative to working
capital and financial leverage.
•
Working capital is the amount of money tied up in short-term
investments. Too little working capital can indicate that the organization
may be unable to pay bills or take advantage of profitable opportunities;
too much working capital reduces profitability because it must be financed
in some way, usually through loans.
•
Financial leverage is the use of borrowed money in acquiring an asset. A
high percentage of balance sheet debt relative to the capital invested by
owners indicates that the organization is highly leveraged. Interest paid on
loans may be deductible but can be negated if the asset doesn’t retain
value (e.g., drops in value or fails to produce anticipated revenues).
To provide a context for decision making, a current balance sheet should be
compared to previous ones. A comparative balance sheet shows a second set
of figures for another reporting period. As with other multiyear presentations,
a comparative statement allows some interpretation of how the organization
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has changed over time.
A simple version of a balance sheet (an adapted excerpt) is shown in Exhibit
2-12. A legend of key terms follows the statement.
Exhibit 2-12: Sample Adapted Balance Sheet
XYZ For-Profit Organization
December 31, 20XX and 20XX
USD in Millions
Current Year
Prior Year
Assets
Current assets:
$192
$130
Short-term investments
Cash and cash equivalents
15
27
Accounts receivable, net
169
168
Inventory
67
63
Prepaid expenses and other
363
342
Total current assets
Plant, property and equipment, net
Intangible assets
Other assets
Total assets
806
730
3,280
3,037
878
849
656
784
$5,620
$5,400
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable and other current
$1,213
$1,166
Income tax payable
238
208
Short-term debt
10
146
1,461
1,520
2,056
2,299
983
987
4,500
4,806
916
1,046
Retained earnings (accumulated deficit)
414
(203)
Accumulated other comprehensive (loss)
(210)
(249)
Total shareholders’ equity
1,120
594
Total liabilities and shareholders’ equity
$5,620
$5,400
Total current liabilities
Long-term liabilities
Other liabilities
Total liabilities
Shareholders’ equity:
Common stock
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Legend for key terms in adapted balance sheet:
•
Statement date shown—The specific date the statement was prepared—the snap shot taken at midnight
on December 31, 20XX.
•
Current assets—Cash and cash equivalents and assets held for sale or expected to be realized in the
current operating cycle or within one year of the balance sheet date. Cash, prepaid items, accounts
receivable, certificates of deposit and inventory are examples.
•
Accounts receivable—Monies owed to the organization by customers, members and so forth.
•
Inventory—Items owned by the organization and held for eventual sale.
•
Prepaid expenses—Expenditures made in a current period that the organization will benefit from in a future
period.
•
Plant, property and equipment—Includes cost, accumulated depreciation and resulting book value of
land, buildings and furniture. All assets are recorded at original cost, regardless of whether they have
appreciated or depreciated in value.
•
Other assets—Assets not classified in the other accounts.
•
Total assets—The subtotal of all four asset accounts—the aggregate value of all assets held by the
organization. This total is used in computing financial ratios.
•
Current liabilities—Amounts owed by the organization and due within 12 months of the statement date.
•
Accounts payable—Amounts owed to creditors and vendors and the current-year portion of long-term
debt.
•
Long-term liabilities—Monies owed by the organization not due to be paid in the current year.
•
Other liabilities—Any liability not classified as current or long-term debt.
•
Total liabilities—Total amounts owed and due within 12 months of the statement date.
•
Shareholders’ equity—The net assets portion of the statement; reflects an organization’s total assets
minus its total liabilities.
In this adapted balance sheet, FM would principally impact the plant, property
and equipment asset.
Every accounting transaction affects an organization’s balance sheet. In
particular, capital projects can have significant implications. What
constitutes capital costs are determined by tax law and organizational
policy, both of which are complex and can vary widely across nations and
organizations.
The next rendition of the adapted balance sheet, in Exhibit 2-13 on the next
page, shows the dollar and percentage changes.
Horizontal analysis reveals:
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•
Total assets grew by 4.1 percent.
•
•
Total liabilities fell by 6.4 percent.
Retained earnings turned from a deficit to a positive balance (indicating
growth of operations in the current year).
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Exhibit 2-13: Sample Adapted Balance Sheet
`
XYZ For-Profit Organization
December 31, 20XX and 20XX
USD in Millions
Current
Year
Prior
Year
Increase
(Decrease)
Amount
Percentage
Assets
Current assets:
$192
$130
$62
47.7%
Short-term investments
Cash and cash equivalents
15
27
(12)
(44.4)
Accounts receivable, net
169
168
1
0.6
Inventory
67
63
4
6.3
Prepaid expenses and other
363
342
21
6.1
Total current assets
806
730
76
10.4
8.0
3,280
3,037
243
Intangible assets
Plant, property and equipment, net
878
849
29
3.4
Other assets
656
784
(128)
(16.3)
$5,620
$5,400
$220
4.1
$47
4.0%
Total assets
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable and other current
$1,213
$1,166
Income tax payable
238
208
30
14.4
Short-term debt
10
146
(136)
(93.2)
Total current liabilities
Long-term liabilities
Other liabilities
1,461
1,520
(59)
(3.9)
2,056
2,299
(243)
(10.6)
983
987
(4)
(0.4)
4,500
4,806
(306)
(6.4)
916
1,046
(130)
(12.4)
Retained earnings (accumulated deficit)
414
(203)
617
303.9
Accumulated other comprehensive (loss)
(210)
(249)
39
15.7
Total liabilities
Shareholders’ equity:
Common stock
Total shareholders’ equity
1,120
594
526
88.6
Total liabilities and shareholders’ equity
$5,620
$5,400
$220
4.1
Statement of cash
flows
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A statement of cash flows is used to show cash levels across the operating
period so as to ensure that predicted liabilities due to be paid at any given
time do not exceed the ability to pay. The statement provides relevant
information about cash receipts and cash disbursements—where the
organization’s cash came from and how it was used—during the time
interval specified in its heading. The specific time frame may vary (e.g., a
quarter), and multiperiod or multiyear presentations may be prepared.
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As we see in the simple cash flow statement in Exhibit 2-14, uses of cash
are recorded as negative figures and sources of cash are shown as positive
figures. A legend of key terms follows the sample.
Note that this sample provides the traditional (financial accounting) view
of cash flow—a year-end annual statement—a “snap shot” of the year-end.
Nevertheless, a facility manager should be generally aware of the
statement and the implications. Later in this chapter, in Exhibit 2-17, the
FM perspective of cash requirements at each period end over the year is
shown.
Exhibit 2-14: Sample Statement of Cash Flows
ABC For-Profit Organization
Year Ended 20XX
USD in Millions
Operating activities
Net income
Adjustments for noncash items
Depreciation
Net increase in current assets other than cash
Net increase in current liabilities
Net cash flow from operating activities
Investing activities
Sale of plant, property and equipment
Net cash flow from investing activities
$35,000
$14,000
(24,000)
8,000
(2,000)
33,000
$91,000
91,000
Financing activities
Borrowing
Payment of long-term debt
Purchase of treasury stock
Payment of dividends to stockholders
Net cash used for financing activities
Net increase (decrease) in cash
$22,000
(90,000)
(9,000)
(23,000)
(100,000)
$24,000
Legend for key terms in adapted cash flow statement:
•
Operating activities—Primarily results from day-to-day revenue and expense activities depicted on the
income statement; converts the items reported on the income statement from the accrual basis of
accounting to cash.
•
Investing activities—Reports the purchase and sale of long-term investments and property, plant and
equipment as well as certain transactions involving securities or other non-operating assets.
•
Financing activities—Results from activities involving cash transactions by and for owners; reports on the
contribution and redemption of equity capital (e.g., the issuance and repurchase of the company’s own
bonds and stock and the payment of dividends) and creditor loan repayments.
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Some of the analysis findings from this statement of cash flows reveal:
•
Operations provides less cash than net income; this may be harmless or it
may signal difficulty collecting receivables or selling inventory.
•
The sale of plant, property and equipment is the major source of cash; due
to the amount, it is probably a one-time situation or a sell-off of
unproductive assets. However, sale of plant assets should not persist or the
organization could go out of business.
There was more payment of long-term debt than new borrowing—a
positive indicator.
•
Cash flow statements routinely include a section of supplemental information,
reporting the exchange of significant items that did not involve cash and the
amount of income taxes and interest paid.
Cash flow statements are prepared by rearranging items on the balance sheet
and income statement. Much like a bank statement for a checking account, a
cash flow statement shows where the organization’s money went and how
much is left for the given period. Further, the statement portrays how an
organization is able to turn accounts receivable into cash. It provides a
reasonable indication of solvency and the ability to pay bills as they come due.
Statements of cash flow are important in understanding investment and credit
decisions. To many investors and creditors, the beginning and ending cash
balances on the statement are the primary barometer of an organization’s
financial well-being.
In large organizations, changes in cash flow do not typically impact day-to-day FM
operations. But cash flow projections may be important considerations during the
annual budget process. If cash is limited, budget spending should be appropriately
conservative. Conversely, good cash levels may present opportunities for new
purchases or investments. Cash flow for small organizations typically has great
significance both for day-to-day operations and the longer-term outlook.
Notes to financial
statements
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Notes are an important part of financial statements because they help to portray
an organization’s finances beyond the actual numbers. Notes to financial
statements for a publically traded organization generally start with highlights of
significant accounting policies and proceed to describe matters of importance
such as (but not limited to):
•
•
Major acquisitions.
Changes in operations.
•
Pension requirements.
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•
Any pending litigation.
•
Any special contracts or major agreements.
Not-for-profits may have different supplemental notes about contributions
receivable, investments, joint fundraising costs and so forth.
Auditors review notes and footnotes as part of the annual audit process. Other
interested parties should also carefully review notes and footnotes for the
relevant information they contain.
Accurate assessment of an organization’s financial health requires a thorough
analysis of all financials plus any supplementary notes. Such analysis is a
complex undertaking. Certainly, detailed analysis of financial statements is not
an expectation for a facility manager. But it is prudent for a facility manager to
understand some of the managerial issues implicit in the income statement, the
balance sheet and the statement of cash flows. As we will see in the discussion
of ratios in Topic 5, data for standard financial ratios is derived from an
organization’s financial statements.
Depreciation
Depreciation is a noncash charge against assets, such as cost of property, plant
and equipment over the asset’s useful life. It is an expense associated with
spreading (allocating) the cost of a physical asset over its useful life.
For most assets, depreciation is a way of showing reduced value as a result of
wear and tear, age or obsolescence. With the exception of land, most assets lose
their value over time (in other words, they depreciate) and must be replaced once
the end of their useful life is reached. Land rarely declines in value; this is why
land is not depreciated. In the case of buildings, they may depreciate or they can
appreciate in value. What depreciates is the investment in the fabric, fittings,
fixtures, plant and equipment in the building. But in any case, revaluation is very
often undertaken to offset tax liabilities and “mop up” excess profits.
To a certain extent, the concept of depreciation may be counterintuitive. For
example, a portfolio may include a priceless historical building that was long ago
depreciated to zero on the financial books but may still be a very valuable
property.
In FM, depreciation is customarily associated with tangible assets such as
buildings and equipment. However, the concept is also applicable to natural
resources and intangible assets. (When accounting for natural resource assets, the
assets are expensed through depletion and depletion expense is the portion of the
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natural resource’s cost that is used up in a particular period. For intangible
assets—those with no physical form—cost is most often systematically expensed
through amortization.)
In the United States, GAAP allows organizations to set their own guidelines for
defining certain expenses and assigning them to assets to be depreciated. There is
also no prescribed time frame for depreciation, leaving that decision up to the
organization, but requiring the organization to do it the same way every time. For
example, a new building may be depreciated over 40 or 50 years, while certain
other improvements may have a shorter life span. The bottom line for a facility
manager is to learn and know the rules of the organization and ensure that the FM
organization adheres to those rules in every way.
In accordance with standard accounting practices, the cost of a fixed asset
initially recorded in financials is not just the cost of acquiring the asset. In
addition to purchase price, the amount recorded includes all additional expense
necessary to get the asset ready for intended use. For example, the figure for a
new piece of maintenance equipment should include all additional expenses for
delivery and installation. In some countries, costs incurred for employee training
would also be included.
Depreciation reduces the balance sheet value of the asset over time. To
depreciate an asset, it is necessary to start with the original cost and then
determine the asset’s depreciable base. The depreciable base is the asset’s
original cost less its salvage value. Salvage value (sometimes called residual
value or scrap value) is the estimated value of an asset if it is sold at the end of
its depreciation period or service life. Salvage value can be zero. The
difference between the cost and the salvage value is the depreciable cost.
The example below shows the depreciable cost for maintenance equipment.
Depreciable Cost for Maintenance Equipment
Purchase price for equipment
Freight delivery charges
Installation
Employee training
Total cost
Less salvage value
Depreciable cost
$200,000
$2,500
$6,500
$1,000
$210,000
$60,000
$150,000
(Example in USD)
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Why depreciate
assets?
Generally speaking, there are two reasons to depreciate an asset—for
accounting purposes and for tax purposes.
From the accounting perspective, expenses incurred in producing
revenue should match the revenue they helped to earn for that period.
This embodies the following two accounting principles.
•
Revenue recognition. According to the revenue recognition
principle, revenue should be recognized at the time the transaction
is completed, for example, recording revenue in an account when
the customer is billed. For simple cash transactions, the revenue is
recorded when the sale is completed and the cash received.
However, for capital expenditures, the application of this principle
is not always as simple. Consider any large project that takes a
number of years to complete. An organization cannot wait until the
project is entirely completed before it bills. Instead, it bills
periodically—for the amount of work completed—and receives
payments as the work progresses. Revenue is taken into the
accounts on this periodic basis.
Application of the revenue recognition principle helps to ensure
that revenue is taken into the accounts properly and the earnings
statements of the organization are accurate.
•
Matching. An extension of revenue recognition, the matching principle
implies that each expense item related to revenue earned must be recorded
in the same accounting period as the revenue it helped to earn. If this is not
done, the financial statements will not measure the results of operations
fairly.
Thinking about the maintenance equipment and applying the revenue
recognition and matching principles, if 20 percent of the useful life of the
equipment is used up in the first year of operation, the asset should be
depreciated by that amount.
The second reason for depreciation is for tax purposes. Some nations tax the
depreciated value of an asset using a flat rate. Based on other taxation rules,
organizations may be allowed to depreciate assets according to accelerated
schedules—rates faster than their useful life—or methods that write off assets
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over a predetermined amount of years that has nothing to do with the asset’s
useful life.
Depreciation
methods
Different depreciation methods exist. Common methods include the
following.
•
Straight-line depreciation method. The simplest form of depreciation
is the straight-line depreciation method. Straight-line depreciation
assumes that the asset has the same usefulness and repair expense in
each year. While this may be unrealistic, the method is popular because
it is straightforward.
The straight-line method determines the amount to depreciate per year
by simple division.
Straight-line depreciation per period =
Depreciable base
Estimated service life
In our example, estimating five years of service life, the maintenance
equipment would be depreciated as $150,000/5 = $30,000 per year. In
Year 0, the asset would be worth $200,000; in Year 1, it would be
worth $200,000 – $30,000 = $170,000; and in Year 5 it would be
worth US $60,000, its salvage value.
Depreciating the maintenance equipment attempts to allocate the
acquisition cost of the equipment over five years (what was
established as its useful life).
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•
Activity method. Unlike the straight-line method, the activity
method is not based on the passage of time but on a measure of
productivity relative to the total expected productivity for the
asset.
•
Accelerated depreciation. Accelerated depreciation methods
have a steadily decreasing charge so that assets are depreciated
quickly in early years, which can better match the usage patterns
of many assets. Items that have increasing maintenance costs will
have more balanced total costs if accelerated depreciation is
applied. Accelerated methods include the sum-of-the-years’digits method and the declining balance method.
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•
Modified Accelerated Cost Recovery System. In the United States, the
Internal Revenue Service allows a Modified Accelerated Cost Recovery
System (MACRS) for tax filings that employs straight-line and
accelerated depreciation methods. MACRS includes an asset classification
system that groups similar types of assets together and shows the number
of years of depreciation for each type of asset. Besides real estate, two
common asset classes are the five-year asset class (including automobiles
and light-duty trucks) and the seven-year class (including most machinery
and equipment). An FM light-duty truck would be depreciated for five
years, and a copier would be depreciated for seven years—both according
to depreciation rates set for each class.
Facility managers do not have discretion in choosing between depreciation
methods; rather, they follow organizational protocol. Accountants generally
choose the method that fits the usage pattern and service life of the asset most
closely. Taxation also influences depreciation methods in different ways.
Depreciation is an important concept to be aware of because facility managers
often manage assets that necessitate depreciation. In some organizations, FM
may be required to pay back all depreciation charges through centralized
accounting. In other scenarios, FM may receive an annual depreciation charge
equal to the sum of all annual depreciated costs for all depreciable assets
managed by the department. This expense item (which can be significant)
shows up on the FM budget throughout the depreciable life of the asset. A
facility manager would have to budget for the amount because it reduces the
amount of operating funds available for other work.
Capitalization
versus
expense
Whether an asset should be capitalized or expensed is defined by tax law and
organizational policy. Typical considerations in making the determination are:
•
The useful life of the asset (e.g., less than or longer than one year).
•
The cost of the item (e.g., whether it exceeds the organizational
capitalization cutoff point).
This capitalization cutoff point is a designated limit (or floor) for capital
requests under which an item is expensed in the period purchased and over
which it will be capitalized and depreciated for the length of its useful life.
If an item is capitalized, it is recorded among the fixed assets of the
organization and depreciated according to the organizational depreciation
policy.
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Returning to the maintenance equipment purchase, let’s say that the
organization had a policy of capitalizing goods and services in excess of
$20K. Since the equipment cost $200K, it was capitalized and depreciated
over the five-year period established as its useful life.
A facility manager may also have to consider organizational policies and
practices when performing certain high-cost maintenance or repair
activities.
Example: A building may have a 50-year life for financial purposes.
That building may have a roof with a 20-year life. Replacement of
the roof may be very costly. Some organizations may characterize
that major repair as a capital activity; others may expense the
activity.
This is yet another demonstration of the importance of a facility manager
knowing an organization’s rules.
Lease or
purchase
considerations
for capital
assets
Whether an organization is public or private, the CFO, finance director or
senior finance management will have established specific financial
considerations and recommendations for acquiring capital assets. These
financial considerations related to lease or purchase often vary depending
upon the asset (e.g., equipment, land, buildings and vehicles).
Examples: Management might decide to pay off and buy a
maintenance vehicle at the end of a three-year lease term. But for other
lease assets, management may have concerns over ongoing operating
expenses and the investment in (or financial commitment for) those
assets.
Lease or purchase considerations for capital assets should involve life-cycle
cost analysis. Generally speaking, the influencing factors between lease and
purchase decisions are tax implications, the organization’s cash position and
the cost of alternative decisions.
A facility manager needs to balance a customer’s real estate and related work
and space requirements and the organization’s financial, legal and strategic
requirements. On one hand, there is the need to increase or create value for
customers with a focus on the physical location and customer needs for space,
furnishing, equipment, amenities and so forth. But of paramount consideration
is the aggregate amount of capital dollars available for investment and how
capital investments align with organizational decisions related to staffing,
contracting and investing. There’s an overarching need for balance.
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Chapter 2: Financial Management of the Facility Organization
There are myriad financial, legal and tax issues that enter into lease versus
purchase decisions. The outcomes influence the organization’s financial
statements, FM budgets, cash position and many other factors. We will
examine this complex issue further in subsequent content on business cases
and financial analysis.
Pro forma
statements
In the realm of finance, the term “pro forma” generally describes financial
statements (income statement, balance sheet, and cash flow statement) that
have one or more assumptions or hypothetical conditions built into the data.
Stated another way, pro forma financial statements are forecasts of goals for a
future period. They predict how the income statement, the balance sheet and
the cash flow statement will look in the future if expected events occur.
Pro forma statements are the end result of the budgeting process. An
individual pro forma statement is a budgeted financial statement based on
forecasted data—historical documents adjusted for events as if they had
occurred. Pro formas portray financial conditions for the end of the specified
budget period if events happen according to plan.
Exhibit 2-15 provides basic descriptions of each type of pro forma statement.
Exhibit 2-15: Pro Forma Financial Statements
Statement
Description
Pro forma income
statement
Summarizes various component projections of revenues and
expenses for the budget period. It indicates the expected net
income for the period. Also called a budgeted income
statement.
Pro forma balance
sheet
Used to project how assets will be managed in the future.
Starting with the beginning balance sheet, the figures are
adjusted for expected events during the coming fiscal year. The
adjusted balances comprise the pro forma balance sheet of the
end of the fiscal year. Also called a budgeted balance sheet.
Pro forma cash flow
statement
Provides an idea of what average cash flow may look like during
a given period. Classifies cash receipts and disbursements
depending on whether they are from operating, investing or
financing activities (as does the regular statement of cash
flows). Also called a budgeted cash flow statement.
Pro forma statements are used routinely in preparing “what-if” scenarios,
formulating business plans, estimating cash requirements or submitting
financing proposals. Most pro formas are prepared for one year.
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Forecasting cash
flows
The importance of forecasting cash flows cannot be overstated. Running out of
cash is not a desirable position for any organization. Even a profitable organization
can end up in bankruptcy if it runs out of cash at the wrong time (e.g., when loans
and other large payments are due).
Cash flows are influenced by the collection of accounts receivable and the payment
of accounts payable. Speeding up the collection of receivables and postponing the
payment of payables can have a positive short-term effect on cash flows.
Cash flow effects can be projected by estimating ending balances in the
receivables and payables accounts and calculating the changes in those balances
from the beginning of the year. The following relationship illustrates this concept:
•
When accounts receivable decrease, MORE of them have been converted into
CASH that is available for use.
•
When accounts payable increase, FEWER of them have been paid and MORE
cash is available for use.
•
When accounts receivable increase, FEWER of them have been converted
into CASH that is available for use.
When accounts payable decrease, MORE of them have been paid and LESS
cash is available for use.
•
Exhibit 2-16 provides a sample cash flow forecast showing the monthly
effects over a six-month period.
Exhibit 2-16: Sample Cash Flow Forecast
XYZ For-Profit Organization
Six-Month Period
Month 1
Month 2
Month 3
Cash bal B/F
500.00
470.50
477.00
Revenue
Month of receipt of payment due
500.00
600.00
Working capital
Salaries
Employer’s tax payments
Other staff costs
Expenses
Operating costs
Capital expenditure
VAT/sales tax
Total outgoings
200.00
50.00
1.50
3.00
200.00
0.00
75.00
529.50
Surplus (deficit) for month
Capital available (required)
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Month 5
Month 6
–72.50
–21.50
–21.00
600.00
600.00
600.00
750.00
200.00
50.00
1.50
2.00
250.00
0.00
90.00
593.50
250.00
55.00
2.00
2.50
250.00
500.00
90.00
1,149.50
250.00
55.00
2.00
2.00
150.00
0.00
90.00
549.00
250.00
55.00
2.50
2.00
200.00
0.00
90.00
599.50
250.00
55.00
2.00
2.00
250.00
0.00
112.50
671.50
–29.50
6.50
–549.50
51.00
0.50
78.50
470.50
477.00
–72.50
–21.50
–21.00
57.50
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Chapter 2: Financial Management of the Facility Organization
Why are pro forma statements important? Organizational financial
statements measure performance. Pro formas predict how financial
statements will look in the future. Collectively, these budgeted pro forma
financial statements are instrumental in the allocation of resources.
If senior financial management has serious concerns about the pro formas
resulting from the FM budgeting process or cash flow forecasting, a
facility manager may have to revisit the budget process and re-create the
pro forma statements. This reiterative process may continue until senior
management finds them acceptable or is convinced there are no better
alternative plans.
“Smoothing”
facility
management
investments
Planning is critical in FM. But the reality is that FM decisions exist in a
resource-constrained environment. Forecasting and other financial
analysis techniques can provide voluminous information. But many times
decision making comes down to what can or should be afforded and when.
Financial statements, pro formas and other cash flow forecasting helps to
quantify FM investments. Yet organizational management tends to bristle
at sudden spikes in FM budgets.
Critical and noncritical projects are generally obvious. For example, major
building renovations might be mandated to comply with the passage of new
occupational safety and health regulations. But in FM, there’s often a struggle
for funding and resources for many mainstream middle-ground items.
Example: A major piece of equipment needs a costly repair. The reality
is that it needs to be replaced, but adequate funding for the
replacement is not available. The facility manager did not have a sound
plan for repairing and replacing assets that have exceeded their useful
life span.
A simple way to avoid this problem is to develop a five-year plan to keep
track of assets. A computer spreadsheet can facilitate the task.
•
Assets—both capital and operations and maintenance (O&M)—that are
of considerable expense and are therefore likely to be viewed as a
budgeted project can be listed in the leftmost column.
•
The remaining useful life of each asset can be listed in the second
column.
Column three identifies the year the asset was installed.
•
•
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The next series of columns represents the next five years (column one
being the current year). Each year is divided into two categories—
capital expenditures and O&M expenditures.
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•
As assets reach the end of their useful life, the cost of the replacement
is identified in the appropriate column.
•
At the far right, a column can be added for comments.
Since this plan is revised on an annual basis, each year the RUL will
decrease by one year.
The spreadsheet format easily and quickly communicates assets and their
costs and the date of scheduled replacement. It can provide a logical way to
augment financial planning and decision making.
Summary
guidelines for
effective and
efficient
financial
operations
Simply stated, facility managers must have efficient and effective financial
systems and procedures in place. Reflecting back on the content just
presented, we conclude with the general guidelines in Exhibit 2-17 that
facility managers should keep in mind. Organizations may vary in how
information is gathered, implemented, monitored, adjusted and the like, but
the guidelines that follow are appropriate in all environments: public, notfor profit, government, nongovernmental organization (NGO), partnerships
or sole proprietorships.
Exhibit 2-17: Guidelines for Effective and Efficient FM Financial Operations
•
Understand the organization’s mission and
how the FM budget and financial decisions
move the organization toward that mission.
•
Keep accurate financial records.
•
Compile accurate historical data for
evaluating trends and forecasting.
•
Establish rapport with organizational
finance personnel and external customers.
•
Prepare accurate and timely operational
and capital budgets.
•
Clearly define roles in the FM budgeting
process (top-down versus bottom-up and
the approval process).
•
Monitor budgets and take appropriate
actions/adjustments required to
correct/offset negative budget variances.
•
Understand fundamental accounting
practices and organization-specific
practices.
•
Know how to discern the managerial
implications of external and internal
financial statements.
•
Maintain clear, well-understood and
documented financial handling processes.
Thus far, we have examined some of the primary documents in finance
(accounting records, budgets, financial statements and pro formas) as well as
several important accounting principles. What you have read will not make
you an accountant, but it should facilitate a fundamental understanding of
concepts that are critical to FM success. As we will see, there is more to learn
about finance and how to make better decisions in FM.
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Chapter 2: Financial Management of the Facility Organization
Topic 3: Business Cases, Supporting Documentation and
Financial Reports
Selling facility
management in
business terms
Let’s join a facility manager who has responsibility for the overall operations
and financial oversight of a large commercial property.
Results of the current year-end client satisfaction survey substantiate
ongoing problems with the building cafeteria. Low tenant ratings of the
café have been a consistent trend in the past three annual surveys,
progressing from “somewhat dissatisfied” to “extremely dissatisfied.”
Further, in the current survey, the tenants’ open-ended comments note
numerous issues with the café.
During a meeting with the organization’s regional manager to review
the survey results, both individuals mutually agree that it is time to
renovate the 10,000-square-foot café. (It’s been on hold for a long
time.) The discussion also touches on the upcoming capital budgeting
process. The facility manager’s action item: Put together a request for
capital funds to renovate the café.
The facility manager recalls that in its most recent strategic plan, the
organization committed to various sustainability goals. Facility
management’s alignment to the strategic plan includes adopting
sustainable design standards for all new construction and significant
renovations. The facility manager is extremely aware that this will be of
prime importance in the proposal to senior management.
The facility manager contemplates developing a narrative describing
how the café renovation will include a variety of green design
strategies such as the use of sustainable materials, improving the
interior air quality, making energy-efficiency enhancements, and
providing greater access to daylight and views. He momentarily
wonders if that will suffice.
Probably not. A discussion of green design strategies will be
important. But it would be a mistake to not prepare a business case
with additional supporting documentation and financial reports to
justify the capital funding that will be required for the café
renovation.
This story is fictional, but the issues expressed here are often the reality for
facility managers. The moral of this story: Facility managers need to be
conversant with business terms that upper management and colleagues
understand. They also need to sell facility management projects and
initiatives. A business case is a marriage of the two.
As the name implies, a business case explains how a specific project or
initiative will add value to an organization. It captures the reasoning for a
project or initiative and how fulfilling specified needs is aligned with the
organization’s strategic plan and/or can support specific organizational
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Finance and Business
strategies and objectives. As most organizations are ever-mindful of the
bottom line, a business case should also define how much money will be
involved in the project or initiative and how much the organization will
make (or save) through the change. It should demonstrate an understanding
of the organization’s concerns for profits, reduced costs and similar
financial concerns. Additional considerations for winning funds for FM
may include positioning how the project or initiative may improve the lives
and welfare of people or fulfill compliance with legal and mandatory
requirements.
Business cases are customarily required whenever significant resources
such as money and personnel time and effort are to be consumed. In
different settings, business cases can range from comprehensive and highly
structured to informal and brief. While “business case” is commonly
accepted nomenclature, the document is employed across all types of
organizations—not just for-profit businesses. In some environments, other
terminology may be used.
Typically, a business case is presented as a structured written document,
but sometimes a case may be made through a short verbal argument or
presentation. Some situations require a written document in combination
with a presentation.
Whatever the format or level of sophistication, a business case should be
compelling and should adequately capture the quantifiable and
unquantifiable (qualitative) characteristics of a proposed undertaking.
Components of
a written
business case
Similar to a good news story, a well-crafted written business case tells
readers about the what, when, where, how and why of the proposed
initiative. All relevant narrative and financial data should be linked
together into a cohesive presentation to justify resource and capital
expenditures.
As with so many other documents that a facility manager prepares, a
business case should follow the preferred or approved organizational
format and include the expected elements. Thus, these materials cannot
provide a prescriptive list of items that a business case must include.
However, in Exhibit 2-18 we see a list of components often found in many
written business cases. (We will look at some of these elements in more
detail in a subsequent business case excerpt.)
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Chapter 2: Financial Management of the Facility Organization
Exhibit 2-18: Common Components of a Business Case
Component
What It Provides
Executive summary
A high-level overview of the proposed initiative,
including why it is necessary and key
recommendations.
Current status
A description of the current situation, the
requirement for the proposed initiative and
recommendation, and how the effort will fulfill
organizational objectives.
Assumptions
Recognition of what major assumptions are behind
the proposed initiative.
Business analysis
Financial analysis results: Initial cost estimates
(funding required and related expenses), projected
cash flows and financial payback.
Nonfinancial results: Qualitative aspects of the
proposed initiative (e.g., improved customer
satisfaction, increased retention of tenants,
improved reputation for the organization).
Rationale for change: A discussion of how the
solution addresses issues or opportunities.
• Potential benefits, such as improved customer
satisfaction or reduced maintenance costs.
• Compliance with mandatory regulatory
requirements, such as standards for accessible
design or legislation related to health and safety
at work.
Risk analysis
An overview of:
• What will happen if the effort is not undertaken
(also referred to as the do-nothing scenario);
where the organization would be without the
project.
• Risks involved in the proposed initiative.
• Alternative options as well as a ranking of those
options demonstrating the optimum solution.
Recommendation
Content describing the recommended solution(s).
Goals and timeline
Estimates about money, people and time that will be
needed to deliver the solution and realize the
benefits.
For now, let’s momentarily return to the business case needed for the café.
The facility manager realizes it is likely that the proposed initiative will be
challenged. At best, it will be questioned with a skeptical eye because the café
renovation will require the organization to make out-of-the-ordinary
investments at the front end. The business case will have to pass muster with
finance.
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With further consideration, the facility manager opts to provide a holistic
picture of the proposed sustainability renovation—not just a narrative and
not just financial data—and decides to include:
• Background information that establishes the need for the renovation
(e.g., results of the annual customer satisfaction surveys and
organizational commitment to sustainability).
•
Points about how the proposed sustainable initiative will not only be
doing the right thing but will assist the organization to perform better
in the marketplace.
•
High-level information about the sustainable design standards and
why they make economic sense.
•
A firm, clear recommendation describing the renovation and
explaining its value and how the café and the services it provides are a
continuing need.
•
Detailed financial analysis quantifying how much the green initiative
will cost, the comparative costs for other alternatives, the payback,
and the potential for more tangible revenue and reduced operating
expenses.
•
A discussion of expected qualitative benefits (e.g., more
environmentally beneficial, improved customer satisfaction, improved
reputation for the organization).
Risks and trade-offs of alternative options.
•
•
Estimates of the resources required and timelines as well as plans for
how the renovation will be monitored in real time and adjusted if
necessary changes are warranted.
There are various ways this facility manager can capture and convey this
information in a business case. Proposed capital investments in facility
management (both in this hypothetical scenario and in real life) have to
compete for capital funding. Finance and other senior management will
review the case and prioritize the project against the many other initiatives
that may require capital investment. Several concepts and techniques that
are useful in developing a solid business case are examined next.
Quantifying the
costs and
benefits
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Financial information and performance information are important
components in a business case. To compile such information involves:
•
Researching the problem or opportunity.
•
Identifying the alternative solutions available.
•
Quantifying the benefits and costs of each solution.
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The level of due diligence required to quantify costs and benefits and
secure the necessary funding will vary depending on the specific business
case need. The concepts and techniques that follow may not apply in
every scenario, but a facility manager should understand their potential
utility.
Concept of best
value
In business, value is generally described as an amount of goods, services
or money considered a fair and suitable equivalent for something else.
Value is often equated to satisfaction with the cost of a good or service for
the given quality received.
In Total Facilities Management, authors Brian Atkin and Adrian Brooks
discuss best value. They note that best value extends the conventional
wisdom pairing value and money and instead implies a need to continually
strive for something superior at the lowest practicable cost.
Authors Atkin and Brooks make succinct points underpinning best value
decisions:
•
Value is about the relationship of cost or price and quality or
performance.
•
Ideally, cost and quality should both be considerations in FM
decisions.
•
Cost should take sole priority only when financial constraints are
severe and dictate so.
An organization may think it is achieving best value when it pays less for
goods and services. Costs are typically easier to measure and by their nature
more readily quantified. But to equate value with a mere reduction in cost can
be shortsighted. According to Atkin and Brooks, value for money
encompasses the quality of a service and the economy, efficiency and
effectiveness with which it is delivered.
Life-cycle costing
Life-cycle costing (LCC) is the process of determining (in present-value
terms) all costs incident to the planning, design, construction, operation and
maintenance, and disposition of a structure over time. LCC involves the
analysis of the costs of a system or a component over its entire life span. The
term “whole-life costing” is synonymous with life-cycle costing.
Because life-cycle costing considers all of the costs incurred during the service
life of an asset, it facilitates making economically sound decisions. Compiling
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all costs related to creation and operation for facility system components
(costs related to planning, design, construction, operations, maintenance and
disposal) provides a basis to compare the relative merits of competing project
implementation alternatives. The economic consequences of mutually
exclusive project alternatives (where the acceptance of one capital budgeting
project precludes the acceptance of others) can be evaluated over a period of
time.
In practice, there are different methodologies for LCC. It is beyond the scope
of our discussion here to present any specific methodology, but the basic
considerations inherent in most approaches are:
• Identifying alternatives.
•
•
Estimating costs.
Computing life-cycle costs for each alternative.
•
Making cash flows time-equivalent by converting them to present
values.
•
•
Totaling all costs.
Conducting appropriate risk and uncertainty assessments.
There are different ways to test assumptions made and “what-if” scenarios for
high-cost items (such as what happens if maintenance costs are 15 percent
more or less than planned). Sensitivity analysis, scenario analysis and other
ways of assessing and mitigating investment risks will be covered later in this
topic.
In conjunction with a life-cycle cost analysis, supplementary measures of
economic evaluation (such as net present value, internal rate of return and
payback methods) are often calculated. LCC is consistent with these other
common valuation measures if they use the same parameters and length of
study period. (We explain these additional capital investment analysis
techniques in just a bit.)
LCC is an analytical process. The concepts underlying LCC are fairly
straightforward, but their application can present some challenges—most
frequently related to uncertainty as to when and how LCC should be
employed and what assumptions should be made during the analysis. There
are many variables that are key to the assumptions made in the process.
As a facility manager, if you have control for the go/no-go decision for a
capital project, LCC is a useful decision-making tool. But even if you do not
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Chapter 2: Financial Management of the Facility Organization
have sole authority for the decision, LCC is valuable for ranking
(prioritizing) projects when making recommendations to a CFO, finance
director or other finance personnel.
A facility manager’s recommendation may take into account the
organization’s strategic plans and other environmental factors. The lowest
LCC may not be the best recommendation based on market economics and
the long-term outlook. For example, ownership of a real property asset may
have the lowest life-cycle cost, but leasing may be a better financial decision
for other reasons.
Benchmarking
Benchmarking describes the continuous, systematic process of measuring
products, services, costs, quality and practices against the best levels of
performance. Many people think of benchmarking as capturing best-in-class
information, but the practice has a much wider application. Quite often, best
levels are comparisons to external benchmarks of industry leaders. However,
they may also be based on internal benchmarking information or measures
from other organizations (outside an industry) that have similar processes.
Measuring effectiveness of activities may be enhanced through benchmarking
with peers.
Initially benchmarking was used primarily by manufacturing companies to
improve products. Benchmarking practices are now commonly used in service
industries as well and applied to customer service and other types of staff
departments. Benchmarking studies can have different focus (e.g., operational
or strategic), and they can take many formats (e.g., best practice, functional,
process, competitive). Best levels may be financial or nonfinancial measures.
Benchmarking is yet another tool a facility manager can use when
quantifying costs and benefits. Consider but a few applications for FM:
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•
To provide a rational method for setting goals, taking the emotion out of
any arguments
•
To help to ensure that planning and decisions are based on best practices
and on objective external comparisons and facts
•
To establish a baseline for self-improvement, or to establish how peer
organizations/similar buildings/similar functions are performing so as to
establish if there is scope for improvement, what that might cost and
what benefit would accrue
•
To provide an unbiased assessment of what needs to change or what
course the FM department or the organization should pursue in an
investment
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Capital investments
and time value of
money
Capital is a limited organizational resource. Organizations often have great
difficulty recovering money tied up in bad capital investments. Given these
two simple facts, all FM capital projects or initiatives must be carefully
evaluated.
To understand how to analyze capital investments first requires an
understanding of what constitutes a capital expenditure (versus an operational
expense) and an appreciation of the concept of the time value of money.
Capital expenditures and operational expenses
Earlier content provided information about operating and capital budgeting.
Let’s begin with a recap of a few salient points to establish the basic
distinctions between operational expenses and capital expenditures.
Operational expenses (also called operating expenses or current expenditures)
are short-term in nature; they are considered current investments that can be
written off in the same year that the expenses occur. Wages, salaries and many
administrative expenses are all examples of operating expenses. The operating
budget provides a plan for the operating expenses and revenues associated
with activities for the current time period.
Capital expenditures (or capital investments) are long-term. A capital
investment results in a current cash outlay with the expectation of future
benefits. The value of the initial cash outlay is gradually reduced (amortized)
over a period of years according to tax regulations. Examples of capital
investments include major expenditures for new or replacement equipment,
construction and renovations. A capital budget provides a plan of proposed
outlays for acquiring long-term assets and includes the means for financing the
acquisition.
An organization’s stability and future success often depend on its capital
investments as they require a significant commitment of funds in the present
with the expectation of future returns through additional cash inflows or
reduced cash outflows.
Time value of money
The time value of money principle states that a dollar in hand is worth more
than a dollar to be received in the future because it can either be consumed
immediately or put to work to earn a return.
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Stated another way, the time value of money recognizes that:
•
A dollar (or any other monetary unit) is worth more today than a dollar
received tomorrow because that dollar can be invested today to earn a
return.
•
A dollar tomorrow is worth less than a dollar today because of the interest
foregone.
If finance grants FM funds for a capital project, the organization loses the
potential to invest that money in an interest-bearing account.
To further explain the time value of money, let’s consider the café renovation
again. The facility manager estimates the project to be a $3 million
investment. As shown below, if finance could invest it and secure a 10 percent
annual interest rate (rather than granting FM that money), $3,000,000 would
be worth almost $3,630,000 in two years because of the cumulative interest
earned.
Period
1
2
Beginning Value
$3,000,000
$3,300,000
Interest Earned
+ $300,000
+ $330,000
Ending Value
$3,300,000
$3,630,000
This simple example demonstrates that money has value over time. It also sets
the stage for a discussion of two additional capital investment concepts:
present value and future value.
Present value (PV) is the method used to compare costs; all cash flows are
converted to their present value or the value of past and future dollars
corresponding to today’s value. PV is the amount that a given future amount is
worth today at a specific rate of interest. In our example, the $3,000,000 is the
present value.
Future value (FV) is the amount that a given amount, invested today at a given
rate of return or interest rate, will be worth at some designated future time.
The $3,630,000 is the future value.
There’s a simple formula used in finance to calculate the time value of money.
Present value x Future value interest factor = Future value
$3,000,000 x 1.2100 = $3,630,000
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Note that the future value amount arrived at in this calculation is the same as
the future value shown earlier. Where did the 1.2100 future value interest
factor come from? Finance has interest factor tables. In fact, open any
financial textbook and you’ll find a set in the text to explain the time value of
money and investments. For years, it was necessary to locate the appropriate
interest multiplier in a table (in this case, for 10 percent over two years, the
factor is 1.2100) and then do the calculation. But take heart: Business
calculators and electronic spreadsheets now have the interest factors and
formulas preprogrammed. If you know the variables, the time values are easy
to determine.
Understanding future value is fairly intuitive—you invest money and you
collect interest. If the investment is secure, you can reasonably expect the
future value to increase.
Understanding present value is bit more involved but not overly complex.
Present value is the monetary value today of a future payment that is
discounted at some appropriate interest rate. The present value of $3,630,000
is $3,000,000. In finance jargon, the 10 percent interest rate is called the
discount rate. As with future value, there are present value interest tables for
calculating the present value of money received in the future.
The formula used in finance to calculate the present value is:
Future value x Present value interest factor = Present value
$3,630,000 x 0.826 = $2,998,380
The present value interest factor for 10 percent over two years is 0.826. The
reason for $2,998,380 (not $3,000,000) is because of rounding of the present
value interest factors in the table. Again, facility managers do not have to do
manual calculations like this. Financial calculators and spreadsheets can
perform the calculations. We have shown it here for explanatory purposes.
Two final points about future value and present value:
•
•
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The operation of evaluating a present value into the future value is called
capitalization. In our example, it shows how much $3,000,000 today will
be worth in two years.
The reverse operation—evaluating the present value of a future amount of
money—is called discounting. This explains how much $3,000,000
received in two years—at some interest rate—is worth today.
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In many organizations, finance is responsible for time value calculations.
Facility managers may have little (if any) responsibility related to calculating
the numbers. The basic point here is that you should understand the terms and
the concepts because it is part of the language of senior management.
There are, of course, different sources of money for capital investments.
Money for an FM capital project may be internal; capital investments may
also be funded externally through numerous ways (e.g., bank loans, private
loans, venture capital, public offerings of shares of company stock to investors
and so forth). Depending on the source of the funding, a facility manager may
have different responsibilities.
Capital investment
analysis
There are four key questions that finance typically considers when
evaluating potential capital investments.
•
•
Are the projects independent or mutually exclusive?
Do the projects have the same or different size, cash flow pattern and
life?
•
•
Are the projects subject to capital rationing?
Do the projects have the same risk?
Let’s consider some of the terms and concepts behind these questions.
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•
Independent or mutually exclusive. Acceptance or rejection of an
independent project has no impact on the acceptance or rejection of
other projects under consideration. In the previous discussion of lifecycle costing, mutually exclusive projects were described as situations
where the acceptance of one capital budgeting project precludes the
acceptance of others.
•
Size, cash flow pattern and life. Size is self-explanatory. Cash flow
is net cash before financing, including acquisitions. Stated another
way, cash flow is the income from all sources less expenses,
indicating how much cash is available at a given time. It refers to the
actual flow of cash into cash receipts and savings and out of cash
payments of an organization during a given period of time. Estimating
capital project cash flows is critical because erroneous assumptions or
inaccurate or unreliable data can corrupt the entire capital budget.
“Life” in this context generally refers to the duration of the project or
the stages of a project over time (from initiation to completion).
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•
Capital rationing. Capital rationing is the allocation of investment funds
among multiple projects when senior management places an upper limit
on the size of the capital investments or the organization lacks sufficient
money.
•
Risk. Risk is the possibility that the actual benefits provided by the
investment will deviate from the investor’s initial expectations; the chance
of loss.
There are various capital budgeting techniques to evaluate and select
independent and mutually exclusive projects and make decisions under capital
rationing. Next we look at some of the more commonly used techniques and
the meaning of their results. (We will deal with risk in a separate discussion.)
Such analyses can become quite involved. Here we merely provide an
overview of a few techniques a facility manager is likely to encounter—net
present value (NPV), internal rate of return (IRR) and payback period.
Typically, a facility manager works with finance professionals on capital
investment analysis. Thus, no formulas or calculations are shown in the
discussions.
Net present value, internal rate of return and the payback method can be
classified as discounting methods and nondiscounting methods. The use of
discounting methods has increased over the years; however, some
organizations still use the nondiscounting methods, and many organizations
use both types.
Discounting methods recognize the time value of money. The net present
value method and the internal rate of return are two approaches to making
capital budgeting decisions using discounted cash flows. The same basic
assumption underlies both the NPV and IRR methods: risk, or uncertainty, is
not a major problem. They evaluate a capital investment by comparing the
equivalent present values of all future net cash flows for the initial investment.
Discounting methods also acknowledge that those projects promising earlier
returns are preferable to projects promising later returns.
Exhibit 2-19 summarizes key characteristics of net present value, internal rate
of return and the payback method. The intent of the information is to help
facility managers understand enough of the principles to know what
information finance needs from them. A discussion comparing the three
methods follows the exhibit.
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Exhibit 2-19: Comparison of Capital Investment Analysis Techniques
Net present value (NPV)
A discounting method that determines the monetary value today that an investment project earns after yielding the
desired rate of return for each period during the life of the investment.
Description
•
•
•
Advantages and Disadvantages
Compares the present value of an investment
project’s cash inflows (benefits) to the present value
of the investment’s cash outflows (costs).
Yields a monetary value.
Reference point for NPV for accepting or rejecting
projects is zero.
• For independent projects if the NPV is zero or
greater, an investment project is acceptable.
• For mutually exclusive projects, the investment
with the highest positive NPV should be accepted.
Advantages:
•
Recognizes the time value of money.
•
May be used to evaluate investments with uniform
net cash flows and uneven cash flows.
•
Provides theoretically correct accept/reject
decisions.
Disadvantages:
•
Does not provide any indication of relative
profitability.
•
Present value monetary value can be difficult to
understand.
Internal rate of return (IRR)
A discounting method that determines the rate of return promised by an investment project over its useful life. It is
sometimes simply called the yield on a project.
Definition/Description
•
•
•
•
Advantages and Disadvantages
Estimates the discount rate that makes the present
value of net cash inflows equal to the initial
investment—a discount rate that will make the NPV
of an investment zero.
Yields a percentage showing the return on each
dollar invested.
Comparing the estimated internal rate of return for a
capital investment to a predetermined criterion.
The criterion rate (hurdle rate) serves as a cutoff
point. Projects below this cutoff rate are rejected,
unless they are mandatory projects.
• For independent projects, accept if IRR is equal or
greater than the criterion rate; reject if IRR is less.
• For mutually exclusive projects, the investment
with the highest positive IRR that exceeds the
criterion rate should be accepted.
Advantages:
•
Recognizes the time value of money.
•
The percentage rate of return facilitates
comparisons with the organization’s minimal
acceptable rate of return or hurdle rate.
•
May be used to evaluate investments with uniform
net cash flows and uneven cash flows.
Disadvantages:
•
Requires a process of trial and error.
•
Delivers only a percentage rate of an investment’s
potential earnings, not the magnitude or duration of
cash flows.
Payback
A nondiscounting method that determines the time required for an organization to recover its original investment—the
speed of recovering the initial investment.
Definition/Description
•
Advantages and Disadvantages
Advantages:
•
Easy to understand.
•
Provides an indicator of liquidity and risk.
Based on a target payback period (PP)—the
maximum cutoff considered to be an acceptable
length of time for a project to recover its original
investment.
• Projects with a PP shorter than the target are
accepted; those with PPs longer than the target
are rejected.
• For independent projects, accept if the PP is less
than or equal to the maximum payback period;
otherwise, reject.
• For mutually exclusive projects, accept the
shortest PP that is less than or equal to the
maximum payback period.
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Disadvantages:
•
Ignores time value of money.
•
Based primarily on experience and judgment; no
firm guidelines for setting the maximum payback
period.
•
Does not measure profitability, only speed of
recovering original investment.
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Both the NPV and IRR methods have gained widespread acceptance as decisionmaking tools. In comparing the two methods, it is important to keep in mind that:
•
The NPV method is often simpler to use because the IRR method requires a
process of trial and error. However, computer spreadsheets can be used to
automate the IRR method.
•
The NPV method makes a more realistic assumption about the rate of return
that can be earned on cash flows from a project. If the NPV and IRR methods
disagree about the worthiness of a project, it might be wiser to use the data
from the NPV method.
A major difference is that the end result of NPV is a monetary value whereas
the final computation for IRR is a percentage. Therein is an advantage for
NPV, as the NPV values of individual projects can be added to estimate the
effect of accepting some possible combination of projects. Because IRR yields
a percentage, multiple projects cannot be added or averaged to evaluate any
combination of capital investment projects. However, some people have
difficulty understanding the NPV measure of present value monetary return
(as compared to IRR’s percentage return).
Another advantage of the NPV method is its usefulness in evaluating a project in
which the required rate of return varies over the life of the project. The total
present value of the cash inflows can be determined and compared with the total
initial investment to evaluate the attractiveness of a project. Again, it is not
possible using the IRR method to infer if the project is unattractive. Different
required returns for each year means that there is no single rate of return or a
single IRR value.
Both methods have some reliability cautions:
• NPV is only as reliable as the discount rate that is selected. An unrealistic
discount rate can result in an erroneous decision to accept/reject a project.
•
A capital investment project should not be accepted solely on the basis of
a high IRR value. A high IRR result must be looked at further to assess if
an opportunity to invest cash flows at such a high IRR is realistic.
But among all the various methods to analyze capital investments, the discounted
cash flow methods are theoretically some of the most reliable. The NPV and IRR
methods will typically yield similar results as long as there are no differences in:
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•
The project size (the amount of the initial investment).
•
The net cash flow pattern.
•
The life of the project.
•
The cost of capital over the life of the project.
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Compared to the NPV and IRR discounting methods, the nondiscounting
payback method ignores the time value of money; this is a critical deficiency.
The payback method can lead a manager to choose investments that do not
maximize profits.
However, the payback method is useful as a screening measure and can help
identify investment proposals that managers should consider further. If a
proposal doesn’t provide a payback within some specified period, the potential
project can be rejected without additional consideration.
Because discounting and nondiscounting techniques have distinct strengths
and weaknesses, organizations should and often do use multiple criteria for
evaluating investment projects. Collectively, multiple methods mitigate the
potential for estimation errors and/or incorrect decisions that are not in the
best interests of the organization.
Minimizing risk
in capital
investments
By definition, risk implies uncertainty and instability. Fundamentally, there
are no risk-free capital investments. Consider just a few reasons why this is an
accurate statement:
• Future cash inflows can vary unexpectedly throughout the life of a project.
•
The rate of return used in calculations may not be accurate for the life of
the project.
•
•
The cost of financing may increase during the life of a project.
New mandatory regulatory factors can require additional investments at
any given point in time.
•
The life of the related product or service could be significantly shorter or
longer than anticipated.
Inflationary or recessionary economic conditions may impact the value of
cash flows.
•
•
Domestic or global political events may impact project cash flows or the
viability of the project as a whole.
There are different ways to minimize the risk in capital investments.
Sensitivity analysis and scenario analysis are two useful approaches that you
should be aware of in FM.
Sensitivity analysis
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Sensitivity analysis measures the change in one variable as a result of a change
in another variable. It helps determine which variables have the greatest
impact on a capital project’s outcome.
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As it pertains to capital investments, sensitivity analysis is a “what-if”
technique evaluating how NPV, IRR and other indicators of the profitability of
a project change if the discount rate, labor or materials costs, sales or some
other factor varies from one case to another. The purpose is to assess how
sensitive the NPV, the IRR, or another specified profitability measure is to a
change. Spreadsheet programs facilitate the “what-if” analysis.
Sensitivity analysis can be used to answer questions such as (but not limited to):
•
What happens to NPV if cash flows increase or decrease for each year of the
project?
•
Will NPV remain positive throughout a project if there is no cash inflow in
the second year of a three-year project?
•
What will happen to NPV if the discount rate increases or decreases?
•
What would happen to NPV if a major redesign, requiring additional capital
investments, becomes necessary at some point during the project in order to
address competitive new products?
What would be the impact on NPV if the project is extended, with decreasing
cash flows and increased maintenance costs in the extended years?
•
The principal merits of sensitivity analysis are its ability to pinpoint forecasting
errors and the fact that computer spreadsheet programs eliminate many tedious
manual calculations. However, sensitivity analysis does not account for the
probability of any of the outcomes or the impact of simultaneous changes in
variables and it does not provide a decision rule for accepting/rejecting projects.
Scenario analysis
Scenario analysis examines what happens to profitability estimates such as
NPV if a certain set of events (called a scenario) arises. Probability estimates
are examined against different sets of assumptions or conditions.
Scenario analysis is a variation of sensitivity analysis. But where sensitivity
analysis measures the change in one variable as a result of a change in another,
scenario analysis measures the impact of simultaneous changes and reflects a
range of outcomes as reflected by a probability distribution.
An infinite number of assumptions or conditions exist, but scenario analysis
often includes the following three.
•
Optimistic—the outcomes of some variables are better than the most
likely variables.
Example: Operating revenues and the salvage value of an asset
could be greater than the most likely values.
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•
Pessimistic—the outcomes of some variables are worse than the most
likely variables.
Example: The initial cash outlay and the tax rate could be greater
than expected; the useful life could be less than expected.
•
Most likely—the most likely scenario results from the range of possible
optimistic and pessimistic values for each variable.
Pros and cons exist for scenario analysis. A distinct benefit is that the
“what-if” analysis considers other possible outcomes beyond the most
likely case. A pessimistic scenario can, for example, help avoid surprises
and a tendency for forecasting optimism. Severe consequences of a worst
case scenario might lead to rejecting a project. But there are also
weaknesses in scenario analysis, a principal one being that it is typically
limited to a few discrete outcomes. Realistically, many other possibilities
exist because subjective judgments are involved in what forms optimistic
and pessimistic scenarios may take. While sensitivity analysis has uses, it is
by no means routine and is usually led by a specialist accountant.
Business case
sample
Excerpts of a sample business case are shown on the following pages. This
example compares the choice between two different investment options.
The presentation highlights a comparison of the long-term financial
implications for a purchase decision.
As you review this business case sample, keep in mind that this scenario is
hypothetical and only business case excerpts are shown. This is not a
complete case example. The spirit of this information is to describe some of
the likely components of a business case. Content presented here would
vary with the organization’s needs and expectations.
As noted back in Exhibit 2-18, “Common Components of a Business
Case,” other information would logically be included in such a business
case.
Remember that most organizations or agencies have a required format for
their business cases and specify the type of financial analysis required. It is
incumbent on a facility manager to ensure facility management business
cases follow organizational protocols. Here we simply provide some of the
most significant business case information necessary for this scenario.
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Executive Summary
In the organizational strategic plan, the mandate is: “Strive to become more competitive and effective and
provide the best workplace possible for employees.” Facilities are a vital component in this strategy.
In terms of the critical comfort needs of the people and the things in a building, a high-performance
heating, ventilating and air conditioning (HVAC) system makes a building a more desirable work
environment. To continue to provide air conditioning and sustain a competitive and pleasant workplace, a
chiller must be replaced. The current chiller is beyond its useful life.
This proposal for capital funding is based on the analysis of two mutually exclusive investment choices.
The recommendation is a new 300-ton chiller. The new chiller will play a significant role in creating the
right comfort environment. Not only will a new chiller provide the right temperature, humidity and
ventilation; it will also help reduce the building cost of operation, provide energy efficiency, and minimize
environmental impact.
Current Status
Keeping the HVAC system running at maximum efficiency is one of the best ways to minimize service
calls, eliminate surprises and control total cost of operation. The reliability of the current chiller is
declining, and repairs are both expensive and problematic.
This proposal for capital funding analyzes two mutually exclusive investment choices:
• Option 1: 300-ton chiller
• Option 2: Six 50-ton package units
Based on a life-cycle costing analysis that considers all of the costs incurred during the service life of an
asset, the economically sound choice between the two alternatives is option 1, the 300-ton chiller.
Assumptions
The following assumptions support the choice of the 300-ton chiller:
• There are no physical constraints to installing the recommended 300-ton chiller.
• There is adequate space to accommodate the chiller.
• The 300-ton chiller model is one of the latest and most reliable products on the market and will
enhance the reliability of the building HVAC system.
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Chapter 2: Financial Management of the Facility Organization
Business Analysis
The financial analysis shown here outlines the initial cost estimates for the two options under
consideration.
Option 1: 300-ton chiller
The first table that follows represents a running total of expenses for option 1 (the 300-ton chiller).
The last column (PV$) identifies the present value in dollars. That number is derived using an annually
decreasing factor (PV factor) based on a discount rate of ten percent. The PV factor is a discount factor
that establishes future costs in today’s dollars.
It is also important to note that both the maintenance and utility costs are subject to an annual 4 percent
increase (FV factor in column 3). The annual adjustment is included in this analysis and is totaled in
column 6.
Note that in year ten, an expense of $170,000 is identified. This expense is for a major overhaul of the
chiller system based on the manufacturer recommendations.
Option 1 (300-Ton Chiller): Present Values (PV) of Annual Cash Flows
Year
Initial Cost
FV
Factor
Maintenance
0
$ (295,000)
1.0000
$
Utilities
Total M&U
Total Cost
PV Factor
PV$
(1,725)
$ (20,000)
$ (21,725)
$ (316,725)
1.0000
$ (316,725)
1
1.0400
(1,794)
(20,800)
(22,594)
(22,594)
0.9091
(20,540)
2
1.0816
(1,866)
(21,632)
(23,498)
(23,498)
0.8264
(19,419)
3
1.1249
(1,940)
(22,498)
(24,438)
(24,438)
0.7513
(18,361)
4
1.1699
(2,018)
(23,398)
(25,416)
(25,416)
0.6830
(17,359)
5
1.2167
(2,099)
(24,334)
(26,433)
(26,433)
0.6209
(16,412)
6
1.2653
(2,183)
(25,306)
(27,489)
(27,489)
0.5645
(15,517)
7
1.3159
(2,270)
(26,318)
(28,588)
(28,588)
0.5132
(14,671)
8
1.3686
(2,361)
(27,372)
(29,733)
(29,733)
0.4665
(13,870)
9
1.4233
(2,455)
(28,466)
(30,921)
(30,921)
0.4241
(13,114)
1.4802
(2,553)
(29,604)
(32,157)
(202,157)
0.3855
(77,932)
11
1.5395
(2,656)
(30,790)
(33,446)
(33,446)
0.3505
(11,723)
12
1.6010
(2,762)
(32,020)
(34,782)
(34,782)
0.3186
(11,081)
13
1.6664
(2,874)
(33,327)
(36,201)
(36,201)
0.2910
(10,533)
14
1.7317
(2,987)
(34,634)
(37,621)
(37,621)
0.2633
(9,906)
15
1.8024
(3,109)
(36,047)
(39,156)
(39,156)
0.2405
(9,415)
16
1.8730
(3,231)
(37,460)
(40,691)
(40,691)
0.2176
(8,854)
17
1.9494
(3,363)
(38,988)
(42,351)
(42,351)
0.1988
(8,417)
18
2.0258
(3,495)
(40,516)
(44,011)
(44,011)
0.1799
(7,917)
19
2.1085
(3,637)
(42,169)
(45,806)
(45,806)
0.1643
(7,524)
20
2.1911
(3,780)
(43,822)
(47,602)
(47,602)
0.1486
10
(170,000)
(7,074)
$ (636,364)
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Finance and Business
Option 2: Six 50-ton package units
In this second table, we identify the life-cycle cost of option 2 (six 50-ton package units). In year ten, an
expense of $392,253 is identified. This expense is for replacement of the six package mount units. The
present-day price of this replacement is $265,000, but we are escalating this cost 4 percent per annum to
accurately reflect the rising cost of inflation, parts and labor; hence, the larger cost of $392,253.
Option 2 (Package Units): Present Values (PV) of Annual Cash Flows
Year
Initial Cost
FV
Factor
Maintenance
0
$ (265,000)
1.0000
$
Utilities
Total M&U
Total Cost
PV Factor
PV$
(1,600)
$ (18,750)
$ (20,350)
$ (285,350)
1.0000
$ (285,350)
1
1.0400
(1,664)
(19,500)
(21,164)
(21,164)
0.9091
(19,240)
2
1.0816
(1,731)
(20,280)
(22,011)
(22,011)
0.8264
(18,190)
3
1.1249
(1,800)
(21,092)
(22,892)
(22,892)
0.7513
(17,199)
4
1.1699
(1,872)
(21,936)
(23,807)
(23,807)
0.6830
(16,260)
5
1.2167
(1,947)
(22,813)
(24,760)
(24,760)
0.6209
(15,373)
6
1.2653
(2,024)
(23,724)
(25,749)
(25,749)
0.5645
(14,535)
7
1.3159
(2,105)
(24,673)
(26,779)
(26,779)
0.5132
(13,743)
8
1.3686
(2,190)
(25,661)
(27,851)
(27,851)
0.4665
(12,992)
9
1.4233
(2,277)
(26,687)
(28,964)
(28,964)
0.4241
(12,284)
1.4802
(2,368)
(27,754)
(30,122)
(422,375)
0.3855
(162,826)
11
1.5395
(2,463)
(28,866)
(31,329)
(31,329)
0.3505
(10,981)
12
1.6010
(2,562)
(30,019)
(32,580)
(32,580)
0.3186
(10,380)
13
1.6664
(2,666)
(31,244)
(33,910)
(33,910)
0.2910
(9,866)
14
1.7317
(2,771)
(32,469)
(35,240)
(35,240)
0.2633
(9,279)
15
1.8024
(2,884)
(33,794)
(36,678)
(36,678)
0.2405
(8,819)
16
1.8730
(2,997)
(35,119)
(38,116)
(38,116)
0.2176
(8,294)
17
1.9494
(3,119)
(36,551)
(39,670)
(39,670)
0.1988
(7,884)
18
2.0258
(3,241)
(37,984)
(41,225)
(41,225)
0.1799
(7,416)
19
2.1085
(3,374)
(39,533)
(42,907)
(42,907)
0.1643
(7,047)
20
2.1911
(3,506)
(41,083)
(44,589)
(44,589)
0.1486
(6,626)
10
(392,253)
$ (674,585)
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Chapter 2: Financial Management of the Facility Organization
Recommendation
The recommendation is the purchase of option 1, a new 300-ton chiller.
As shown in the following table, when initially comparing two options in a total cost analysis, the
projections for the initial capital costs and annual maintenance costs and utility costs for option 1 (300-ton
chiller) are higher than for option 2 (six 50-ton package units).
Annual Net Cash Flow (Disbursements)
Option 1
300-Ton Chiller
Option 2
Six 50-Ton Package Units
Initial capital cost
$295,000
$265,000
Maintenance costs*
$1,725
$1,600
Annual utility costs*
$20,000
$18,750
Useful life span
20 years
10 years
* Subject to 4% escalation per year
While the inclination may be to select option 2, the package units, because it is initially less expensive,
this is not the best choice. A decision based solely on the initial purchase price is a short-term tactical
one.
Note that the service life of the option 2 package units is 10 years, compared to the 20-year useful life
span for the option 1 300-ton chiller.
Based on life-cycle costing that considers all of the costs incurred during the service life of an asset, the
economically sound choice between the two alternatives is the option 1 300-ton chiller. The decision to
purchase the 300-ton chiller is based on a long-range strategic evaluation.
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Finance and Business
Topic 4: Fundamental Cost Concepts
All organizations incur costs. However, the term “cost” may imply different
things and have distinct applications from one organization to another and
sometimes even within the same organization. That is because management
classifies costs according to how they are used. For example, preparing
financial statements requires the use of historical cost data; budget preparation
and decision making typically involve predictions about future costs.
What does the term cost mean to you? Is it the price paid for an asset? A
cash outflow? Something that affects department profitability? Speaking in
general business terms, costs are a measurement of the resources necessary
to achieve a specific objective—to produce a product or a service. Costs are
usually monetary measures.
The importance of costs to an organization cannot be overstated. In forprofit organizations, for example, profits are the result of total revenue
minus costs. Even in not-for-profit organizations, costs are at the heart of the
organization’s vitality and survival. Revenues come in and cost expenses go
out. As in any other business, there must be more money in cash reserves at
the end of the day than was spent. Should expenses consistently exceed
reserves and revenues, the organization fails.
In The Facility Manager’s Guide to Finance and Budgeting, authors David
Cotts and Edmond P. Rondeau define costs as “the price paid for
acquisition, maintenance, production, or use of materials or services.” The
text makes several critical points about costs as they pertain to facility
management. Among the comments are:
•
•
•
Facility managers manage a huge cost center within an organization.
Costs are the most highly scrutinized aspect of FM performance.
Facility managers must understand their costs of doing business.
In this topic we examine some of the principal cost terms and cost
accounting concepts encountered in FM. Understanding basic cost
terminology and concepts facilitates communications with other managers
and organizational finance personnel. It also facilitates effective and
efficient management, accurate cost accounting, proper financial analyses,
and sound recommendations to senior management.
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Chapter 2: Financial Management of the Facility Organization
Cost terms and
classifications
Quite often, it is necessary to predict how a particular cost will behave. Cost
behavior doesn’t refer to good or bad behavior but rather how a specific cost
will behave in response to changes in business activity levels. Costs may stay
the same or may change proportionately (rise or fall) in response to a change
in activity.
In FM, understanding cost behavior is helpful in a variety of situations such as
creating a budget, preparing a forecast, or determining which of two
alternatives should be selected.
Consider, for example, a facility manager who expects to undertake a
xeriscaping (waterwise) landscaping project next year. The facility manager
will need to know how that will affect the FM operating budget. The facility
manager anticipates that the amount of expenditures for premises support in
the budget will change in the following manner:
• There will be an expense for a landscape designer to draw up plans and
consult as needed during the project.
•
•
Planting materials will increase, but the grounds won’t expand.
Once completed, requirements for water, fertilizer, maintenance and pest
control should decrease.
•
No additional new FM staff will be required to do the project; existing
full-time equivalent (FTE) staff will execute the plan.
In order to develop an accurate budget for next year, the facility manager
needs to understand the behavior of all the different costs affected. To help
make distinctions about which costs will change and by how much, costs are
often categorized as variable, fixed, mixed or total.
Variable costs
Recall from the primer of financial terms that variable costs are costs that
change in total in proportion to changes in the related level of total activity.
For example, fuel costs depend on mileage driven. Stated another way, a
variable cost routinely increases and decreases proportionately with changes in
activity level.
Example: The cost of the xeriscaping project materials will vary in
direct proportion to selection of drought-resistant grasses, low water
native or adaptive plants, and the use of rocks and accent boulders.
These are variable costs.
Utilities, waste disposal, costs of materials and supplies, travel expenses and
billing costs are customary examples of variable costs in FM.
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Finance and Business
Fixed costs
Fixed costs remain unchanged in total for a given time period, despite wide
changes in the related level of total activity.
Example: The facility manager’s salary will not change while
overseeing the xeriscaping project nor will the salary of the FTE
grounds staff who do the landscaping.
In FM, rent, depreciation, insurance, property taxes, licensing fees,
supervisory salaries and administrative salaries are all examples of fixed
costs.
There are some additional points to understand about fixed costs. Fixed
costs remain constant in total unless they are influenced by some outside
force (such as a price change). Also, to say a cost is fixed means that it is
fixed within some relevant range.
Relevant range is the range of activity within which the assumptions about
fixed costs (and variable costs) are valid. Relevant range is typically
expressed as specific cost drivers for a specific duration of time.
Cost drivers are those activities that have a direct and causal relationship to
the incurring of overhead costs. A cost driver (also called allocation base)
can be any factor that has a cause-and-effect relationship on costs. A
change in a cost driver will result in a change in the total cost of a related
cost object.
A cost object is anything for which cost data is accumulated. A cost object is
used to determine how much a particular thing or activity costs. In FM, items
or activities such as customers, projects and services are considered as cost
objects.
The following example puts all these concepts together to illustrate fixed costs
and relevant range.
Example: The assumption that the rent for an FM copier is USD $200
per month is valid within the relevant range of 0 to 20,000 copies per
month. But a significant increase in the demand for copy services that
skyrockets the monthly copy count would mean renting an additional
copier. The fixed cost of monthly rent for reprographics will increase
because of the second copier.
Most fixed costs do not have cost drivers. However, fixed overhead is
allocated to cost pools using an allocation base.
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Chapter 2: Financial Management of the Facility Organization
A cost pool is an aggregation or grouping of cost objects, defined any way
that is meaningful to management for assigning accountability.
Example: Cost objects such as a trenching machine used for
modifying the landscape irrigation system during the xeriscaping
project and the labor for a maintenance employee may be included
in the maintenance department cost pool, which is itself a cost
object for FM.
Mixed costs
Mixed costs (also called semivariable costs) are costs that vary with changes
in volume or activity, but not by a direct proportion. Many mixed costs are a
combination of fixed and variable costs. They change in response to a change
in volume and activity but by less than a proportionate (equally
corresponding) amount.
The time horizon is important for determining cost behavior, because costs
can change from fixed to variable depending on whether the decision takes
place over the short run or the long run. All three cost patterns (fixed, variable
and mixed) are found in most organizations.
Total costs
As the name implies, total costs are all the fixed and variable costs for a cost
object.
Assigning
costs to cost
objects
Assigning costs to a cost object is pertinent in many FM applications
including pricing, profitability studies, control of spending, and chargebacks
(discussed later in this chapter). When assigning costs to cost objects, costs are
classified as direct or indirect.
Direct costs
Direct costs are costs that can be specifically traced to an item or activity
(for example, repairing a hole in the roof). They can be easily and
accurately traced to a cost object (usually direct labor and direct
materials).
Example: To reduce water usage outdoors, the standard automatic
timer that turns on irrigation controller systems at set intervals is
replaced with a “smart” controller that uses weather data and site
information (such as plant type and sprinkler controller system
output) to adjust watering times and frequency. The maintenance
labor and material costs directly related to that activity are direct
costs.
Indirect costs
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Indirect costs are costs that are spread over a period of time, regardless of
specific activities (for example, yearly insurance premiums).
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Finance and Business
Indirect costs are related to a cost object but cannot be easily and accurately
traced to a cost object (such as overhead). In other words, indirect costs are
related to an item or activity but not directly and solely associated with that
item or activity. In addition to annual insurance premiums, other examples
of indirect costs in FM include some maintenance costs, utility costs for a
building, or salaries.
Indirect costs are allocated (assigned to a cost object) through reasonable
estimation.
Example: A FTE corporate concierge will have multiple and varied
responsibilities for building occupants and visitors. To say that a
concierge’s salary should be assigned to any one service provided
(e.g., document delivery, catering, event planning) is not reasonable. It
is a cost incurred supporting a variety of activities. The concierge’s
salary would be allocated.
How senior management perceives FM is often measured in terms of costeffectiveness. Facility managers must be relentless in evaluating past cost
performance and continually look for ways to reduce necessary costs and
eliminate unnecessary expenditures. Building on all of the fundamental
cost concepts and terms just presented, we next look at cost measurement
systems and how they support cost control efforts.
Cost
measurement
systems
The purpose of measuring costs is to manage them. A good cost
measurement system (or cost allocation system) allows a facility manager
to understand how resources consumed in creating and delivering products
and services to customers contribute to FM costs and what factors cause
them to change. In addition, a well-designed cost system provides a facility
manager with information to estimate the cost of adding new products and
services or additional features to existing ones. Simply put, a cost
measurement system helps a facility manager track and quantify costs and
provide customers with high-quality products or services, at reasonable
costs, in a timely fashion.
There are different cost measurement systems that organizations can
implement. They are often broadly categorized as traditional and
contemporary. Contemporary is generally synonymous with activitybased.
Before explaining characteristics of traditional and activity-based cost
measurement systems, some related baseline terminology needs to be
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Chapter 2: Financial Management of the Facility Organization
clarified. (These terms will be used throughout the discussion of the
various cost systems.)
•
Cost accumulation. Cost accumulation collects and organizes cost
information in some organized way through an accounting system.
Whenever a cost is incurred, such as a purchase of equipment or
supplies or performance of a service, that cost is accumulated over
the accounting period.
•
Cost assignment. Cost assignment precedes an activity or takes
place without measurement of the activity, as it makes assumptions
about the proportion of costs that are assumed to relate to an
activity. It is normally done where either:
•
•
The costs are too small to be worth accurate allocation.
•
There is reliable historical data on which the assignment can be
based.
The data collection would be too expensive or difficult relative
to the cost.
•
Cost allocation. Cost allocation determines the proportional share
of a total cost that belongs to a particular cost object based on data
about the proportions of the total resource cost consumed by the
cost object.
•
Cost tracing. Cost tracing assigns direct costs to a particular cost
object.
•
Unit costs. Unit costs relate resources consumed to outputs or
outcomes provided by those resources in the form of a ratio.
There are different schools of thought about the use and merits of
traditional versus activity-based cost measurement systems. For the most
part, organizations use different cost systems because they produce
different outputs. Most facility managers do not have a choice in the
matter, so the point of our discussion here is to provide an overview of how
traditional and activity-based systems differ and then explain the basics of
how each cost measurement system converts data into information of
interest to management.
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Finance and Business
Traditional and activity-based costing both start with the same basic cost
elements. But as shown in Exhibit 2-20, traditional and activity-based cost
measurement systems are built on conceptually different foundations.
Exhibit 2-20: Comparison of Traditional and Activity-Based Cost Measurement Systems
Traditional Costing
Basic cost
elements
Include salaries and wages, utilities,
depreciation, materials and supplies,
and taxes.
Include salaries and wages, utilities,
depreciation, materials and supplies, and
taxes.
Cost object
selection and
procedures for
tracking cost
flows
Use responsibility centers (e.g.,
departments or functional areas) as
the key cost object in tracking flows.
•
Use activities and operations* as
intermediate cost objects in tracing
costs to final cost objects.
•
Assign costs to final cost objects
based on cost drivers.
Cost allocation
rules
•
Use a single base for allocating
indirect (common) costs.
•
•
Limit what is included, primarily to
materials (and direct support
costs).
Include all traceable activities (e.g.,
marketing, customer support,
business support) and nontraceable
indirect activities.
•
Focus attention on who does the
work.
Focus attention on the process of the
work.
•
Provide comprehensive information by
functions, resources, activities and
cost drivers.
•
*
Activity-Based Costing
An activity is generally described as a series of related tasks performed by a person; an operation is a series of
tasks performed by a machine. Sometimes the distinction is not totally definitive.
Now let’s have a closer look at how traditional, department-focused cost
measurement systems differ from contemporary, activity-/operation-focused
systems.
Traditional cost
measurement
systems
Traditional cost measurement systems reflect the influence of mass
production and focus on inventory measurement. As noted in Exhibit 2-20,
they use responsibility centers for cost tracking and a single base for
allocating costs to products and services. A responsibility center groups
units and sub-units, departments and divisions based on the functions they
perform.
Two popular forms of traditional cost measurement systems are job order
costing and process costing. In practice, many organizations use hybrids of
the two but to explain their differences, we will look at each one in a pure
form.
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Chapter 2: Financial Management of the Facility Organization
Job order costing
Job order costing is direct labor, direct material and overhead costs associated
with a job or batch that meets the specific demands of a designated customer.
Also called job costing, this system accumulates resource costs from multiple
sources that are brought together to deliver a product or service. Job order
costing is used in situations where many different products are produced or
services delivered each period and each unique job uses a different amount of
resources.
Job costing systems assign costs (e.g., the direct materials, direct labor and
overhead) that go into the product or service to a specific job (a distinct unit,
batch, or lot of a product or service). Overhead costs are typically applied at a
predetermined percentage rate. Each job is given a unique identification code or
number, and a job cost sheet is used to record and accumulate job order costs.
A job order costing system assigns costs to individual jobs using the following
steps.
•
Identify the job by a unique code or other date-specific reference method.
•
•
•
Trace the direct costs for the job.
Identify indirect cost pools associated with the job (overhead).
Choose the cost allocation base (cost drivers) to be used in allocating
indirect costs to the job.
Calculate the rate per unit of each cost allocation base.
•
•
Assign cost to the cost object by adding all direct and indirect costs (based
on a combination of machine and labor hours).
The benefits of job order costing systems include the following:
•
•
They provide detailed results of a specific job or operation.
They are flexible enough to be used by a wide variety of organizations.
•
They can have strategic value for an organization because they give a
detailed breakdown of all the different types of costs.
•
They can help pinpoint sources of cost overruns across different jobs.
Process costing
Process costing involves costs not associated with specifically identifiable
units of production or customer identifiable jobs; [it is] usually used where
there are no distinct jobs associated with processes. A process costing
system accumulates product or service costs by process or department and
then assigns them to a large number of nearly identical products by dividing
the total costs by the total number of units produced.
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Finance and Business
Process costing is appropriate for highly automated, repetitive processes
where the cost of one unit is identical to the cost of another. It lends itself
well to situations where a continuous flow of nearly identical products is
produced or where there are no distinct jobs associated with a service
rendered.
Costs of direct materials, direct labor and overhead are traced to individual
departments or processes. Costs are accumulated for each step in the
process, and a record of units worked on is also maintained. At the end of
the accounting period, the total cost is allocated to units processed in that
given time period. This is accomplished by simply dividing the total cost of
production in that time period by the units produced, resulting in a cost per
unit.
Job order costing and process costing systems share a number of
similarities.
•
Both systems assign material, labor and predetermined overhead costs to
products produced and services provided as a mechanism for computing
unit product or service costs.
•
Both systems use the same basic accounts, such as overhead, materials,
work-in-process and finished goods.
•
The flow of costs through the accounts is basically the same in both
systems.
However, despite the similarities, the differences between the systems are
significant, as shown in Exhibit 2-21.
Exhibit 2-21: Key Differences Between Job Order Costing and Process Costing
Job Order Costing
•
•
•
•
Used with a wide variety of distinct
products or services.
Total job costs consist of actual direct
materials, actual direct labor and
overhead applied using a predetermined
rate or rates.
Costs accumulate by the individual job or
order and are tracked separately.
Unit cost is computed by dividing total job
costs by units produced or served at the
end of the job.
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Process Costing
•
•
•
•
•
112
Used with similar or identical products
and a steady stream of units.
Costs are assigned uniformly to all units
passing through a department during a
specific period.
Costs accumulate by process or
department.
The flow of costs is simplified because
costs are traced to fewer processing
departments.
Unit cost is computed by dividing total
process costs of the period by the units
produced or served at end of the period.
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Activity-based
costing
Activity-based costing (ABC) is most often used to track and control
overhead costs; it accumulates costs of activities that consume
resources.
ABC is a method of assigning costs to customers, services and products
based on an activity’s consumption of resources. It emphasizes the
management of activities and operations rather than the department or
functional area that performs the work.
Instead of using a single cost driver (such as direct labor hours) to
calculate an estimated, overall, predetermined overhead rate, ABC uses
many separate cost drivers (called activity bases) to derive actual
overhead costs that are then applied to products or services. Instead of
applying a flat overhead percentage across the board, ABC identifies
and quantifies specific overhead costs. For that reason, managers
typically find it helpful in trying to understand and contain overhead
costs. The level of detail provided with ABC costing can also facilitate
more accurate benchmarking and/or chargeback systems.
(Benchmarking was discussed earlier in this chapter in Topic 3;
chargebacks are addressed in Topic 7.
The basis for ABC is that activities use resources but produce products or
services. The resource cost is calculated using a cost driver; the amount of
an activity consumed in a period is multiplied by the cost of the activity.
The calculated costs are assigned to the product or service.
ABC systems are often used in organizations that have multiple products
and services and/or products and services that use varying amounts of
resources, which include not only materials and other direct costs but also
indirect costs such as customer service, quality control and supervision.
When each product or service consumes each of these costs at different
rates, a broad brush or uniform cost for all items tends to make some
products and services appear more profitable and others less profitable than
they really are.
Understanding ABC is easier when the steps for designing an activitybased cost measurement system are explained. Key steps are shown in
Exhibit 2-22.
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Exhibit 2-22: Implementing ABC in Facility Management
Step 1: Extract from a selection of cost driver activities all costs that represent the gross
overhead component of each of those activities; set them aside.
Step 2: Identify separate and unique overhead activities associated with each full cost driver’s
gross overhead component, and create a cost pool for each of those overhead
activities. From here on, each cost pool will be used to accumulate activity base costs
from many different and often widely varying cost drivers (hence the name activitybased costing). Cost pools might include overhead activities such as building
maintenance, heating the building, service equipment repairs, etc.
Step 3: Determine how overhead costs can best be measured by determining an activity base
unit for each overhead activity base (square feet, per person, per hour, etc.).
Step 4: Determine the exact amount or proportion of activity base units consumed by each
cost driver activity.
Step 5: Consolidate identical activity base units under their appropriate cost pools.
Step 6: For each associated cost pool, sum the activity base units to arrive at a gross activity
base for that cost pool.
Step 7: Calculate an overall cost per unit for each overhead activity by dividing the total cost
pool for that overhead activity by its gross activity base.
Step 8: Allocate future overhead activity costs to non-overhead activities based on usage
using proration of the cost pool or, better still, by applying the unit costs derived in step
7.
Step 9: Periodically repeat the process (especially steps 4 through 7) to ensure the validity of
the applied overhead activity costs.
Let’s consider some examples of ABC allocation and apportionment in FM.
•
Allocation. Two basic conditions must exist before a facility manager can
allocate costs: (1) the cost center must have caused the overhead to be
incurred and (2) the exact amount of overhead must be known.
Examples:
• Power consumption in a stand-alone data center
• Courier delivery costs (such as FedEx or a similar courier) that can
be tracked directly
• Rebranding a reception area (usually the marketing or public affairs
department)
• Hospitality catering
• Overtime costs for FM staff to keep a building open and provide
services (for example, during a corporate acquisition)
• Staff canteen subsidy—when FM has usage figures by department
(for example, from payment cards) and can allocate by proportion
of users or money spent by each department
• Internal moves requested by a department—where FM can allocate
whole cost and any related “knock-on” costs
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•
Apportionment. Where the overheads cannot be specifically identifiable to
the specific cost unit center, a suitable basis must be found to charge the
various cost units with a fair share of the overhead. There is no right way of
doing this, but it should be agreed and published in advance so departments
can budget for it.
Examples:
• Power consumption in a shared office (and rent, property taxes, water)
apportioned by floor area occupied or by head count
• FM office salaries, apportioned by departmental head count
• Staff canteen subsidy, apportioned by departmental head count when
there is no data on departmental usage
• Internal moves dictated by corporate need, apportioned by departmental
head count or by numbers of heads/desks actually moved
Computer databases have made tracking individual costs using ABC more
feasible. Organizations that adopt ABC will be able to use it not only in
accounting for costs but also for decision making. They can cost products and
services, analyze processes, assess management performance and assess
profitability better than firms that use a volume-based (traditional) costing system.
Additionally, the information derived from ABC can be used to eliminate nonvalue-adding activities. Some activities and resources necessary to create and
deliver a product or service are also valued by customers. However, there are other
activities and resources that customers are indifferent to. Such non-valued-added
activities are not absolute necessities. If an activity or resource can be eliminated
without increasing the cost and/or without decreasing the desirability of the
product or service to customers, potential cost savings are possible.
ABC has many advantages. But there also are some limitations. Exhibit 2-23
lists general advantages and disadvantages of activity-based cost systems.
Exhibit 2-23: Advantages and Disadvantages of Activity-Based Costing
Advantages
•
•
•
•
•
Disadvantages
More accurate costing of products/services;
reduces distortions caused by traditional cost
allocation methods.
Utilizes unit cost rather than just total cost.
Better understanding of overhead; measures
activity-driving costs.
Makes waste/non-value-added visible; allows
management to better understand how overall
cost/value are affected if changes are made.
Facilitates benchmarking.
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•
•
•
Not all overhead costs can be related to a
particular cost driver; some may need to
be arbitrarily allocated.
Cost of buying, implementing and
maintaining activity-based system; requires
numerous development and maintenance
hours, even with software and databases.
Generates vast amounts of information;
the volume of information can mislead
managers into concentrating on the wrong
data.
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Finance and Business
Using costs in
decision
making
Costs are an important part of many business decisions in FM. Consider but
a few:
•
What sorts of property, plant and equipment should the organization
hold?
•
Should the organization modernize or sell an old property?
•
•
Should the organization upgrade mechanical systems at a property?
Should services be reduced to save cost, or could they be improved with
little or no cost impact?
•
Should a service be done in-house or outsourced?
When making FM decisions such as these, it’s important to understand the
following cost concepts.
Differential costs
The differential cost concept implies that costs and revenues differ depending
on the conditions. Incremental costs and relevant costs are other names for
differential costs.
Differential costs are relevant to a decision maker because they are costs that
differ between two or more possible uses of funds.
Example: A facility manager is considering the purchase of a
replacement machine. The replacement machine will have
depreciation of $100,000 per year, while the current machine has
depreciation of $65,000. The differential cost would be $35,000 of
depreciation per year.
Differential costs are used to evaluate and choose between alternative
courses of action. When assessing differential costs, a facility manager
should ignore those costs that are the same for all of the alternatives under
consideration; only changing costs are considered relevant to the decisionmaking process.
Opportunity costs
Opportunity costs represent “lost” opportunities (measured in monetary
units) that could have accrued to the entity by pursuing an alternate course
of action. Opportunity costs are the potential benefits sacrificed when
choosing one alternative over one or more other possibilities.
Example: When investing time and funds in a major renovation
project, the maintenance employees cannot work on anything else,
and even if there are no other viable projects, the funds could have
been invested to earn a return.
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Chapter 2: Financial Management of the Facility Organization
IFMA’s Finance Competency Course—Finance for Facility Managers offers
another example of opportunity costs related to investments.
Example: Instead of implementing plan A, which could have netted us
$X, we chose to go with plan B, which will probably cost us $Y. Our cost
of passing up alternative A in favor of alternative B will mathematically
cost us X minus Y dollars. Perhaps we expect alternative B to result in
greater returns than alternative A in the long run. Regardless of the
reasoning or the eventual outcome, opportunity costs are an important
factor to consider in business decision making, especially when
resources are constrained (limited). The yield on the best alternative is
known as its opportunity cost. The alternative that offers the best
investment opportunity is preferred. If another investment is chosen
over that one, the opportunity to invest in the first alternative is given up.
Sunk costs
Sunk costs are money that has already been spent on decisions that cannot be
changed. A sunk cost should be ignored in a decision-making process because
the cost was incurred in the past and cannot be changed. The money is history
and therefore irrelevant to decisions made about any future business activities.
Example: Three years ago, the organization made a significant capital
investment in a wastewater system. Due to new environmental
regulations, the system has been rendered obsolete. Looking back, the
decision may have been unwise, but no amount of regret can change or
undo the decision. The money paid is gone and cannot be applied as a
differential cost in the purchase of a new system or any other future
investment decision.
Sometimes facility managers erroneously include sunk costs in investment
analysis in order to justify continued expenditures in a particular area.
On occasion in real estate, sunk costs warrant some consideration.
Example: Following the purchase of a property and money spent to
engineer the site, the property cannot be used. The property acquisition
costs, attorney fees and engineering costs become sunk costs. If
management directs that the property be disposed of, these sunk costs
would be included to understand the total investment made in the
property and help to set a sales price. Ideally, it would be best to sell the
property for what was paid for it, plus the sunk costs.
Summarizing these cost concepts as they relate to investment decisions in FM:
•
•
•
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Differential costs and revenues always relate to future outcomes and are
critical to accepting or rejecting alternative capital budget projects that
are also future-oriented decisions.
Opportunity costs must be included in an investment decision and are
typically treated as a cash outlay at the onset of the project.
Sunk costs are ignored because they are historical costs that are not relevant
to the investment decision.
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Topic 5: Analyzing and Interpreting Financial Documents
The goal of financial analysis is to assess organizational performance in the
context of stated goals and strategies. Such analysis provides insights into
financial health and highlights problems and opportunities. Ratio analysis
is the principal tool organizations use for financial analysis. In FM, specific
facility management metrics and ratio analysis are also used.
Financial
statement ratio
analysis
Financial statement ratio analysis assesses how various line items in
financial statements relate to one another. Such ratio analysis is a more
useful exercise than discovering the dollar amount spent because of the
variables affecting an organization’s spending that uniquely apply to it.
Many organizations use ratios to analyze budget and financial report data.
However, ratios are useful at any given point in time.
Many different ratios can be used to analyze financial data. We examine
the following that are most relevant to facility managers:
•
•
Liquidity/short-term debt ratios
Asset management ratios
•
•
Profitability ratios
Return-on-investment ratios
All ratio calculation examples are shown in U.S. dollars (USD). Note that
in practice, some ratios may have different formulae. The point here is to
understand what the ratio measures.
Also, no financial statements are shown here; hypothetical numbers are
used to illustrate each ratio.
Liquidity/short-term
debt ratios
Liquidity ratios primarily show an organization’s solvency—its ability to
pay bills and other short-term obligations without undue hardship. For each
of the following liquidity or short-term debt ratios, the higher the ratio, the
stronger the liquidity.
Current ratio
The current ratio answers the question, “Does the organization have
sufficient current assets to pay its bills during the year?” It indicates the
general availability of cash to pay off liabilities (debts) as they come due.
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The equation for the current ratio and an example are shown below. The
example is based on a situation in which:
•
•
Current assets = US $250,000.
Current liabilities = US $100,000.
Current ratio =
=
Current assets
Current liabilities
US $250,000
= 2.5 times to 1
US $100,000
The ratio indicates that the organization has US $2.5 in current assets for each
dollar of its current liabilities, or 2.5 times the current assets.
The current ratio cannot provide data on cash flow timing, however. Lowering
current ratios over time shows declining liquidity but if too high could show
that the organization has too much invested in low-yield short-term assets.
Quick (acid-test) ratio
The acid-test ratio provides a quick measure of an organization’s immediate
liquidity. It is generally considered a more rigorous test of liquidity than the
current ratio. It eliminates inventories and prepaid expenses (for example,
insurance premiums) from the current assets and then compares these quick
assets to the current liabilities (excluding long-term liabilities, other liabilities
and net assets) to assess the organization’s ability to pay the current
liabilities.
The equation for the quick ratio and an example appear below. The example is
based on a situation in which:
•
Cash = US $200,000.
•
Cash equivalents = US $10,000.
•
Accounts receivables = US $10,000.
•
Current liabilities = US $100,000.
Quick ratio =
Cash + Cash equivalents + Receivables
Current liabilities
=
US $200,000 + US $10,000+ US $10,000
US $100,000
= 2.2 times to 1
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Finance and Business
The quick ratio may be a more accurate indicator than the current ratio of an
organization’s ability to meet its financial obligations in a short span of time.
Since the quick ratio excludes the least liquid current assets, primarily
inventory, comparing it to the current ratio shows the effect of inventory on
liquidity. A stable current ratio plus a declining quick ratio imply increasing
inventory that could be temporary or permanent.
Asset management
ratios
Asset management ratios measure how efficiently an organization’s assets are
used to generate income—in other words, how well the organization uses
resources to generate revenue.
Average inventory turnover
Average inventory turnover is a ratio showing how many times an
organization’s inventory is sold and replaced over a period.
Average inventory turnover is calculated as shown below. The example is
based on a situation in which:
•
•
Sales = US $1,500,000.
Average inventory = US $300,000.
Inventory turnover =
=
Sales
Average inventory
US $1,500,000
= 5 times
US $300,000
If relatively high, the inventory turnover ratio shows that the inventory is
efficiently managed, while a declining ratio could show excess inventory due
to poor sales or obsolescence. Too high a ratio could mean lost sales due to
stockouts (ineffective buying).
Average inventory turnover is generally calculated using sales, but it may also
be calculated with cost of goods sold (COGS). Although the first calculation is
more frequently used, COGS may be substituted because sales are recorded at
market value, while inventories are usually recorded at cost. Also, using
average inventory instead of the ending inventory levels helps to minimize
seasonal factors.
Profitability ratios
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Profitability ratios measure an organization’s earning power. They help judge
operating performance (sales versus related expenses), leverage and risk.
Profitability ratios answer the question “How well did the organization operate
during the period?” They indicate the effectiveness of management in controlling
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Chapter 2: Financial Management of the Facility Organization
expenses and earning a reasonable return for owners (and shareholders in public
companies).
Gross, operating and net profit margin are three measures often compared to
each other. For example, if compared to industry averages over several years
gross profit margin has been holding steady but operating profit margin and
net profit margin have been declining, then the cause must be from indirect
costs since gross profit equals net sales less COGS while operating profit and
net profit deducts COGS and a number of indirect items.
Gross profit margin
This ratio relates sales to production costs.
The gross profit margin is calculated as shown below. The example is based on
a situation in which:
• Gross profit = US $750,000.
•
Net sales = US $1,500,000.
Gross profit margin =
=
Gross profit
Net sales
(US $750,000 )
US $1,500,000
= 0.50
For each dollar of sales, the organization generates US $0.50 in gross profit.
Operating profit margin
Operating profit margin is net sales less cost of goods sold and selling, general
and administrative expenses. This ratio provides a measure of operating
efficiency.
The operating profit margin is calculated as shown below. The example is
based on a situation in which:
•
•
•
Net sales = US $1,500,000.
COGS = US $1,100,000.
Selling, general and administrative expenses = US $150,000.
Operating profit margin =
=
Operating profit
Net sales
(US $1,500,000 − US $1,100,000 − US $150,000 )
US $1,500,000
= 0.167
For each dollar of sales, the organization makes US $0.167 in operating profit.
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Finance and Business
Net profit margin
Net profit margin provides an indication of how effective an organization is at
cost control. The higher the net profit margin, the more effective the
organization is at converting revenue into actual profit.
The net profit margin is calculated as shown below. The example is based on a
situation in which:
•
Net income = US $140,000.
•
Net sales = US $1,500,000.
Net profit margin =
=
Net income
Net sales
US $140,000
= 0.093
US $1,500,000
Normal net profit margin depends on the industry; a relatively low margin
could mean that competitors are forcing price cuts or that the organization has
poor cost controls.
Return-oninvestment ratios
Return on investment (ROI), or return divided by investment, has a number of
alternate formulae depending on how the user defines return and investment.
Common variations on ROI include the following.
Return on assets
A return-on-assets (ROA) ratio indicates how profitable an organization is
relative to its total assets. ROA gives an idea as to how efficient management
is at using its assets to generate earnings; it is displayed as a percentage.
The return-on-assets ratio is calculated as shown below. The example is based
on a situation in which:
•
Net income = US $140,000.
•
Total assets= US $1,800,000.
Return on assets (ROA) =
=
Net income
Total assets
US $140,000
= 0.116 = 11.6%
US $1,200,000
For each dollar invested in total assets, the organization makes US $0.116 in
net income, or 11.6 percent. A variation adds interest expense to net income to
give organizations with high debt financing a more appropriate ratio.
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Chapter 2: Financial Management of the Facility Organization
The ROA percentage gives an idea of how effectively the organization is
converting the money it has to invest into net income. The higher the ROA number,
the better, because the organization is earning more money on less investment.
Return on equity
Return on equity (ROE) reveals how much profit an organization earned in
comparison to the total amount of shareholder equity found on the balance
sheet. The ratio is usually expressed as percentage.
The equation for the ROE ratio and an example appear below. The example is
based on a situation in which:
•
•
Net profit = US $120,000.
Equity = US $900,000.
Return on equity =
=
Net profit
Equity
US $120,000
= 0.133 = 13.3%
US $900,000
This 13.3 percent is the return the organization is earning on shareholder
equity. An organization that has a high return on equity is more likely to be
capable of generating cash internally.
Return on capital employed
Return on capital employed (ROCE) measures the profitability of an
organization by the pretax profit (earnings before interest and taxes, or EBIT)
achieved on an organization’s capital employed. The capital employed is taken
to be EBIT as a percentage of the net of total assets minus current liabilities.
The equation for the ROCE ratio and an example appear below. The example
is based on a situation in which:
•
EBIT = US $1,000,000.
•
Total assets = US $400,000.
•
Current liabilities = US $320,000.
Return on capital employed =
EBIT
Total assets – Current liabilities
US $1,000,000
(US $400,000 – $320,000)
US $1,000,000
=
= 12.5 = 12.5%
(US $80,000)
=
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Finance and Business
The ROCE ratio measures the efficiency and profitability of capital
investments undertaken by an organization. An organization acquires capital
assets such as vehicles, computers and so forth to help make its operations
more efficient, cut down on costs and realize greater profits or acquire more
market share. Return on capital employed also indicates whether the
organization is earning sufficient revenues and profits in order to make the
best use of its capital assets. The higher the percentage, the better.
A summary of the financial ratios just discussed follows in Exhibit 2-24.
Exhibit 2-24: Summary of Financial Ratios
Ratio
Description
Calculation
Liquidity/short-term debt ratios
Current ratio
Indicates the general availability of
cash to pay off liabilities (debts) as
they come due
Current assets
Current liabilities
Quick (acid-test)
ratio
Provides a quick measure of an
organization’s immediate liquidity
Cash + Cash equivalents + Receivables
Current liabilities
Asset management ratios
Average inventory
turnover
Shows how many times an
organization’s inventory is sold and
replaced over a period
Sales
Average inventory
Gross profit margin
Relates sales to production costs
Gross profit
Net sales
Operating profit
margin
Provides a measure of operating
efficiency
Operating profit
Net sales
Net profit margin
Provides an indication of how
effective an organization is at cost
control
Net income
Net sales
Profitability ratios
Return-on-investment ratios
Return on assets
(ROA)
Gives an idea as to how efficient
management is at using its assets
to generate earnings
Net income
Total assets
Return on equity
(ROE)
Reveals how much profit an
organization earned in comparison
to the total amount of shareholder
equity found on the balance sheet
Net profit
Equity
Return on capital
employed (ROCE)
Measures the efficiency and
profitability of capital investments;
also indicates whether there are
sufficient revenues and profits to
indicate the best use of capital
assets
EBIT
Current assets – Current liabilities
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Ratios such as the ones described highlight organizational strengths and
weaknesses. They either provide assurance of financial health or detect early
warning of any significant financial difficulties. However, ratios should not be
relied upon as sole indicators for decision making. There are many other
evaluative measures that may be used in conjunction with ratio analysis.
Balanced scorecards, best practices and surveys are a few of the possibilities.
Financial ratios can be extremely useful as benchmarks by which to compare
financial performance with industry averages for organizations of similar type,
scope and size and even key competitors. Benchmarks from comparable
organizations enable facility managers to identify areas of conformity and
variance from the norm with similar or competing organizations. For example,
knowing that your organization spends a certain percentage of revenue on
external building maintenance allows for a comparison to the roof, skin (siding,
masonry, sash, glazing, window washing, etc.) and exterior signage expenditures
of any other comparable organization.
A note of caution about using ratios as benchmarks: Keep in mind that every
organization’s circumstances are different. When using ratios for benchmarking,
consider any mitigating circumstances that might explain variance or conformity
with a norm. Ratios themselves have many variations. Even though they share a
common name, one organization may use different numerators or denominators
than another in performing the calculation.
Facility
management
metrics and
ratio analysis
Demonstrating the bottom line performance of facility management to senior
management can be challenging, but nonetheless it is a critical task for a facility
manager. Facilities do not generate sales, so facility managers have to be
creative in promoting the financial contributions of FM. Documenting cost
avoidances and cost savings (which we cover next) are two ways this can be
accomplished. Developing specific facility metrics (ratios) to relate, compare or
measure performance against quantifiable standards is another.
It is challenging to apply metrics across all FM departments. Initiatives such as
the European benchmarking standards processes are developing metrics for real
estate and facility management across states and borders.
While no universal metrics exist per se, several possibilities are shown in
Exhibit 2-25. Computer software can be used to accumulate and process the
required data and calculate ratios. The metrics chosen to track and report should
be appropriate to the organization and whatever senior management considers
important to financial well-being.
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Finance and Business
Exhibit 2-25: Sample Facility Management Metrics
General FM metrics
• Total occupancy cost/square foot
• Total occupancy cost/total staff
• Total occupancy cost/FM staff
• Budget variance/total budget
• Total FM budget/FM staff
• Total FM budget/total staff
• FM salaries/FM staff
• FM budget/total organizational
administrative budget
Leasing FM metrics
• Average lease cost/square foot
• Leased costs/owned costs (for various
aspects of FM)
Operating and maintenance FM metrics
• Total utility cost/square foot
• Total utility cost/total staff
• Individual utility costs/square foot
• Operations and maintenance costs/square
foot
• Operations and maintenance costs/total staff
• Custodial costs/square foot
• Grounds costs/acre (paved and planted)
• Garage costs/parking space
• Cost/service request
Relocation FM metrics
• Moving costs/staff moved (box move only,
with construction, and with construction and
furniture moved)
• Cost/workstation provided or cost/square foot
(administrative personnel, professional staff,
managerial and executive)
Topic 6: Cost-Containment Strategies
Cost containment in FM is hardly new. No matter what the type of
organization, the size, the industry, for profit or not-for-profit, few
organizations function successfully without controlling their costs.
Exacerbating the situation of constant cost pressures is the time-proven
reality that more costs rise than fall. Thus, as a large consumer of
organizational financial resources, facility managers have a never-ending
challenge to contain costs.
The challenges of FM cost containment might be (a bit facetiously)
compared to a tale from Greek mythology—the tale of Sisyphus.
Sisyphus was once king of Corinth. After insulting the Greek gods
with trickery, he was punished by being forced to push a huge
rock up a steep hill without ever reaching the summit. The rock
always escaped from him and rolled back down before he
reached the top of the hill, forcing him to begin again. This was to
be Sisyphus’s fate for eternity.
Today, “Sisyphean” is often used as an adjective meaning that an activity is
unending, which is not unlike cost-containment pressures in FM.
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Chapter 2: Financial Management of the Facility Organization
In this topic, we look at some practices that can help transform the potential
bleakness of a Sisyphean situation into positive cost-containment actions no
matter what your unique organizational demands. We first consider ideas for
cost containment in FM, and we conclude with guidelines for implementation.
Costcontainment
opportunities
Cost containment requires maintaining organizational costs within a specified
budget and controlling expenditures so that they meet financial targets. Costcontainment strategies often involve reducing expenditures or the rate of
growth of expenditures.
There are many possibilities for FM cost-containment initiatives. In Exhibit 226, several self-explanatory suggestions based on the collective experience of
numerous practitioners are listed.
Exhibit 2-26: Cost-Containment Opportunities in Facility Management
•
Implement zero-based budgeting.
•
Promote efficiency programs—to reduce
resource units consumed in each activity.
•
Work on supply chain consolidation:
• Reduce costs of buyer administration
and management through managing
fewer suppliers.
• Remove duplication of supply chain
management, administration and
overhead costs.
• Leverage volume purchasing
opportunities.
•
Develop multiskilling staff—to reduce total
resource requirements, program out slack
time and so forth.
•
Reduce staffing levels to meet norms, not
peaks of activity, and procure temporary
resources for peak activity periods.
•
Subcontract services—to remove margin-onmargin pricing markups and replace with
transparent costing for costs of procurement
and administration.
•
Implement service level reviews—to
understand and act on opportunities to
reduce service levels, activity frequencies
and so forth to save materials and other
resource usage.
•
Implement process reviews—to remove
unnecessary stages in processes and thus
remove time or cost.
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•
Market test—to check value for money
from current service delivery structures
(whether internally or externally sourced).
•
Consider opportunities for activity
deferral—to delay expenditure to another
budget period.
•
Invest in planned maintenance so as to
reduce reactive maintenance costs (e.g.,
planned revamping rather than reactive
replacement).
•
Review risk profiles and consider
accepting heightened risk on some
facilities or services.
•
Invest in productivity improvements (e.g.,
energy-efficient plant).
•
Change core business activity cycles or
processes that create high facility costs
(e.g., replan space allocations, contribute
to production planning decisions).
•
Revamp property disposal through
improved space usage effectiveness:
• Sublease vacant leased space.
• Sell vacant property.
•
Sell used furnishings and equipment.
•
Analyze risk sharing with vendors.
•
Introduce effective chargeback practices
to service users.
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Finance and Business
Costcontainment
implementation
In theory, few would dispute the merits of cost-containment strategies. In practice,
however, implementing cost containment is not exactly like driving on a wellgroomed racetrack. There can be twists and turns and speed bumps. Oftentimes,
management embraces any and all ideas for cost savings but employees and
customers may be cynical and resistant if change potentially disrupts the status quo.
Some cost-containment initiatives may be transparent to employees and
customers. But for those that necessitate employee or customer buy-in,
provisions should be made to remove any fear of change and resistance issues
should be resolved. At a minimum, these types of undertakings necessitate
clear communication about the purpose and the opportunity for two-way
communication with employees and customers. And management needs to
“walk the talk” and set the example. Management can verbally promote costcontainment strategies but if their actions fail to confirm this, the initiatives
will suffer. Without these basic provisions in place, the likelihood of cynicism
and mistrust increases. Cost-containment initiatives can derail, damage
morale, and even damage the organization’s growth, performance and
reputation in the marketplace.
Successful cost-containment implementation has its challenges, but it need not
be elusive or difficult. Exhibit 2-27 offers simple guidelines that enhance the
chances for success.
Exhibit 2-27: Guidelines for Cost-Containment Implementation
•
Institutionalize cost reduction, especially in
decision-making processes.
•
Identify areas with high cost-containment
potential and act on those first.
•
Minimize waste.
•
Mitigate fraudulent practices.
•
Generate specific savings ideas.
•
Develop a methodology to track actual savings.
•
Integrate cost containment as part of the FM
departmental objectives, job descriptions,
performance reviews.
•
Provide a format to gather cost-containment
suggestions that promote employee
involvement and buy-in.
•
Establish a procedure to ensure that
accepted suggestions are implemented.
•
Provide incentives for meaningful and
accepted cost-containment suggestions.
•
Celebrate successes.
•
Lead by example.
When implementing cost-containment initiatives, keep in mind:
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•
•
Strategies need to fit the organization.
Actions should be quantifiable and measureable.
•
Strategies should be chosen carefully to mitigate any harm to the business
or people.
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Chapter 2: Financial Management of the Facility Organization
Perhaps the best cost-containment strategy of all is to plan ahead. Ultimately,
your goal should be to focus on being proactive instead of simply reactive.
What does that mean? Being proactive implies that you have anticipated, as
best you can, the opportunities for improvement. And, in the long run, being
proactive costs a lot less than being reactive.
Topic 7: Chargebacks
What is a
chargeback?
To answer this question, let’s consider a hypothetical example.
Facility management in a manufacturing environment bills business
units for facility management services according to their use.
A chargeback (also known as cross-charging or recharging) describes the
ability of facility management to charge its services to another group that is
requesting those services. A chargeback system is a system where companies
require service departments to charge other departments for services rendered.
The concept of allocating costs was introduced earlier in this chapter in the
discussion of cost measurement systems. A chargeback system would be the
opposite of general allocation practices. It is an accounting practice that allows
facility management to apply the expenses for goods and services where they
are actually used. A chargeback is a cost control that requires the requesting
party to pay for work done to its area, a service provided, or some allocation
of costs to tenants or end-user departments in an organization.
In a budget, a chargeback is recorded as either revenue or expense recovery to
FM. If the chargeback is for another department within an organization, it is
recorded as a cost or expense by the department occupying the facility and
using the FM services.
In most chargeback systems, FM still budgets and controls funds for building
services such as heating, ventilation and air conditioning (HVAC), grounds
maintenance, and janitorial services, and end users are charged an allocated
fee for them. Typically, discretionary FM goods and service requests such as
space alterations, signage and furniture must be performed or purchased
through FM to ensure compliance with applicable standards. Customers may
have the option to obtain optional services such as picture framing or catering
at a competitive cost from facility management or the ability to purchase from
an outside vendor.
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Advantages
and disadvantages of
chargebacks
Chargebacks offer an organization and FM some important benefits. The main
advantages of chargebacks include:
•
In organizations, they make FM costs more apparent and understandable to
line managers.
•
In manufacturing environments, they allow FM costs to be more easily tied
to a product.
•
•
They promote cost-conscious behavior and encourage thrift and efficiency.
For those FM services where end users have options to use an outside
provider, facility management must earn the business and that can lead to
department efficiencies.
Particularly in the manufacturing area, the FM chargeback has real benefit to the
FM customer as the FM services are part of the process to determine the real
cost of producing a product.
Chargebacks also have a downside. Some of the primary disadvantages are:
•
•
Chargebacks may not be market-competitive costs.
Systems may lack flexibility and can be time-consuming and difficult to
administer.
•
Chargebacks are not determined by negotiation with the customer. Thus,
customers often have no choice in whether to use the internal supplier and
(usually) no say in service levels.
•
If customers have a choice, a facility manager may have to prepare many
more annual costs estimates for customers to convince them that FM is a
vendor of choice.
•
•
Chargebacks may involve unrealistic cost allocation rules.
Chargebacks may penalize departments that have problems in reducing head
count or space occupancy.
Systems may deprive FM of any discretionary budget.
•
In an office setting, chargebacks can lead the FM department to focus on costs
and politics instead of services. When this happens, chargebacks may not be
worth the time or effort.
Chargeback
systems
Chargebacks are not done in every organization. If they are, the practices must
be tailored to the organization.
Systems for administering chargebacks may be broad or quite specific. FM
may:
• Charge actual direct costs.
•
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Charge actual direct costs plus an overhead charge.
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•
Charge an allocation based on specified criteria (such as space occupied or
number of employees).
•
Use flat fee (tiered or negotiated) rates tied to internal service-level
agreements that define objectives.
•
Use a combination of these approaches, or use different ones.
Even more complex chargeback methodologies are based on external marketbased or industry-wide pricing. The possibilities are endless.
Facility
manager’s role
in chargebacks
Managing a chargeback system is challenging at best; facility managers need
to be able to calculate true costs for products and services, including
overheads. Even with that done, allocation rules can seemingly be unrealistic.
Example: Within an organization, two operating units occupy
approximately the same gross square footage. However, one is located
in a brand new property and the other is space in a 30-year-old rental.
Should each unit be charged the same base rent? How can FM account
for the qualitative differences so that allocations do not appear
arbitrary?
If a facility manager is required to implement and administer a chargeback
system, he or she will need to ensure that the department has software and
hardware to administer a chargeback budget. Further, the facility manager will
need to define, justify and apply chargeback procedures so that:
• What costs to charge back, on what basis the charges are computed
(square foot or per use, for example) and on what terms services will be
provided are determined, documented and communicated.
• Agreements with customers on what services to deliver are tracked and
charges incurred during the course of the agreements are documented and
communicated.
•
•
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The system used to do the chargebacks is in keeping with the entire
organization’s philosophy and policies regarding chargebacks.
Actual operational costs are determined.
•
A standard method for defining and charging occupied and vacant space is
determined and communicated to the appropriate parties.
•
Business units understand the financial implications of facility-related
requests.
•
The method used to determine and calculate what is charged back and at
what rate is documented and communicated to the relevant business unit
or operation.
•
The services to be charged back are adequately communicated and agreed
to by the customer.
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•
Where appropriate, a contract or service level agreement is entered into
with the customer.
•
The true cost of the space and services is reflected in the profit and loss
statement of the business unit.
If an organization determines that chargebacks are to be used, a businesslike
system is required to make it effective and minimize any perceptions about
unfair or unrealistic allocations or charges. It is common for business units in
an organization or clients to challenge the fairness of a chargeback model or to
dispute invoices. A bit facetiously, it has been said that chargebacks are 20
percent reporting and 80 percent politics.
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Chapter 2: Financial Management of the Facility Organization
Progress Check Questions
Directions: Read each question and respond in the space provided. Answers and page references follow
the questions.
1. True or false? The treasurer’s office prepares a forecast to help in FM cash flow planning. The facility
manager takes the forecast into consideration when preparing the operating budget. Because the
forecast was the first planning document, the treasurer has responsibility for keeping the cash
expenditures in line during the budget period.
( ) a. True
( ) b. False
2. Which budgeting method requires a facility manager to justify all budgeted expenditures, not just
changes in the budget from the previous year?
( ) a. Incremental
( ) b. Continuous
( ) c. Zero-based
( ) d. Activity-based
3. When reviewing a financial statement, what is the primary distinction between a current liability and
a long-term liability?
4. True or false? When estimating cash flows, beginning accounts receivable and payable balances are
$40,000 and $20,000. The facility manager estimates ending balances for accounts receivable and
payable as $50,000 and $10,000, respectively. Based on these projections, cash available will decline.
( ) a. True
( ) b. False
Match each term with its application.
5.
Present value
6.
Net present value
7.
Internal rate of return
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a. Estimates the discount rate that makes the present
value of net cash inflows equal to the initial
investment
b. The monetary value today that an investment project
earns after yielding the desired rate of return for each
period during the life of the investment
c. The equivalent dollar value today of future net cash
inflows
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8. All of the following statements accurately characterize sunk costs except
( ) a. They can be eliminated in whole or in part by eliminating an activity.
( ) b. They are the same regardless of the alternatives being considered.
( ) c. They cannot make a difference in any future profit levels.
( ) d. They should be ignored in decision making.
9. An organization has a declining current ratio. This most likely indicates a problem with
( ) a. equity financing.
( ) b. collecting accounts receivables.
( ) c. liquidity.
( ) d. operating profits.
10. How do chargeback systems help with cost containment?
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Chapter 2: Financial Management of the Facility Organization
Progress check answers
1. b (p. 36)
2. c (p. 50)
3. A current liability is a debt to be paid within 12 months of the financial statement date; a long-term
liability is money owed but not due to be paid within the coming year (p. 67).
4. b. This statement is true.
A/R = 40,000 to 50,000 (A/R increases.)
A/P = 20,000 to 10,000 (A/P decreases.)
The result is that cash decreases. (p. 80)
5. c (p. 92)
6. b (p. 95)
7. a (p. 95)
8. a (p. 117)
9. c (p. 119)
10. Specific answers may vary. Generally, chargeback systems provide the discipline for end users to
keep costs of services under control. (p. 130)
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Chapter 3: Procurement in the Facility Organization
After completing this chapter, students will be able to:
•
Apply procurement principles and procedures in compliance with the organization’s policies
and guidelines.
•
•
Analyze an outsourcing proposal.
Describe the fundamental aspects of customary facility management outsourcing
relationships.
Topic 1: Procurement Procedures
What is
procurement?
Procurement is the systematic process by which an organization reaches formal
agreements for the purchase of the supply of goods and/or services. When dealing
with members of a supply chain, the procurement process may be called supply
management. The terms procurement and purchasing are sometimes erroneously
interchanged. Purchasing is different; it refers to the specific buying activity or
the placing of orders under the umbrella of a procured goods or service contract.
Procurement policies and procedures are designed to govern the purchase of
goods and services of the right quality, in the right quantity, at the right time, at
the right price and from the right sources. Procurement rules are intended to
maximize cost-effectiveness and to protect unwary would-be purchasers.
Procurement is customarily achieved through open competition processes that
promote fair and equal treatment of all bidders.
A facility manager has the responsibility to procure real estate, equipment,
products or services. In this capacity, the facility manager administers
procurement procedures for product and equipment purchases and the outsourcing
of services, contractors and designers, the facility management of whole buildings
and so forth.
At times, the procurement process and FM needs may not align. Consider a
few such scenarios.
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•
FM situations may arise necessitating a swift response not conducive to a
prolonged open bidding process.
•
A facility manager may have a preference for a particular vendor because
of superior quality and best value.
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•
Shortly after goods are procured through competitive bidding, unforeseen
events may necessitate a small additional quantity.
•
Proprietary equipment or spare parts are obtainable only from one source.
A procurement officer must follow procurement procedures. But in situations
such as those described above, a facility manager may struggle with
procurement rules if they seemingly hinder his or her ability to expeditiously
deliver a product or service. Keep in mind that procurement processes exist to
protect both the buying manager (the facility manager in this case) and the
organization from fraud and corruption by creating a clear, agreed-upon, and
auditable process for the procurement and purchase of goods and services.
To avoid conflict and be effective, a facility manager should have good
rapport and an excellent working relationship with the procurement officer.
Even though procurement and FM priorities may sometimes differ, the basic
management practices of negotiation and a willingness to explore alternatives
together can often address both parties’ needs and requirements.
Typically, FM procurements take time to complete and involve collaboration
and cooperation between facility management, procurement and others. Each
party has an important role:
Procurement
principles
•
The facility manager provides the technical input and defines the
requirements.
•
Procurement manages the form and process.
•
Purchasing and legal contribute expertise as required.
All procurement actions should be based on conformance with all applicable
laws and regulations. All prospective suppliers and their representatives
should be treated fairly and impartially. Additional general procurement
principles include (but are not limited to):
•
•
Achieve the best value for money on all procured goods and services.
Reduce procurement process costs and ensure continuous improvement.
•
Ensure that all procurement activity adheres to organizational policies
(such as sustainability, diversity, equality and workforce issues).
Ensure that procurement is undertaken in accordance with high
professional standards and ethics.
•
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•
Ensure that procurement activity is organized in an effective, structured
way and is embedded in the organization.
•
Develop management information and the use of performance measures
of procurement.
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Procurement practices should consider ability, capacity, integrity, financial
status, performance, reliability, quality of product or service, and delivery
when evaluating prospective contractors.
Traditionally, procurement activities were paper-based. Like many other
organizational functions, procurement is constantly expanding the scope for
doing business electronically to promote competitive bidding, improve
customer-supplier relations in evaluating a potential supplier before and
during a purchase contract, and assist in driving down transaction costs. The
use of e-enabling tools and services to share information is generally
considered a good business practice.
Sustainable
procurement
practices
To optimize sustainable practices, environmental considerations should
become part of normal purchasing practice. Facility managers should seek to
minimize environmental damages associated with their purchases by
increasing the acquisition of environmentally preferable products. From a
sustainability standpoint, the first guiding principle in procurement is:
Environment + Price + Performance = Environmentally preferable purchasing
In the practice of sustainable facility management and good corporate
citizenship, procurement should consider rapidly renewable resources,
embedded energy, virtual water, packaging and the effect of materials on
indoor environmental quality. Consideration should be given to the life cycle
of resources from harvest through manufacture/production, transportation, use
and disposal of materials.
This may entail collecting information from product and service providers
and may require the development of contract language to ensure that vendors
provide environmental information.
Environmental factors are becoming a source of competition among vendors
seeking contracts. In turn, this increased competition among vendors will
stimulate continuous environmental improvement and increase the
availability of environmentally preferable products and services with no cost
premium.
Procurement
process
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Procurement practices differ across different organizations. Whether the
procurement is government or private sector, preselection or open bid are
all factors.
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Consider but a few distinctions between the following calls for bids.
•
Request for proposal. The request for proposal (RFP) is an official
statement to vendors about the business activity in works, supply or
service required. Prospective suppliers are invited (often through a
bidding process) to submit a proposal. Vendors typically try to
respond, point by point, to the RFP when they make their proposals.
The RFP may dictate to varying degrees the exact structure and
format of the vendors’ response. The creativity and innovation that
suppliers choose to build into their proposals may be used to judge
proposals against each other. At the risk of failing to capture
consistent information between bidders, suppliers are allowed to
make their best efforts in their response. Effective RFPs typically
provide sufficient details upon which suppliers will be able to offer a
matching perspective.
•
Invitation to tender. An invitation to tender (ITT) process (or tender
process) is a special procedure for generating competing offers from
different bidders looking to obtain an award of business activity in works,
supply or service contracts. This method for managing the supplier
selection process typically involves creating a suite of formal tender
documents and specific instructions to suppliers for compiling and
submitting information. The intent is to help interested third parties
produce a competitive tender with information requested in the specified
format. Using a formal ITT process helps to ensure that all parties are
given equal consideration and that the preferred supplier was selected
fairly.
•
Request for quotation (RFQ). A request for quotation (RFQ) is used
when discussions with bidders are not required (mainly when the
specifications of the business activity in works, supply or service are
already known) and when price is the main or only factor in selecting the
successful bidder. An RFQ may also be used as a step prior to going to a
full-blown RFP to determine general price ranges.
The type and complexity of the acquisition and the level of the expenditure
also influence the practices and process. Along a continuum, simple
procurements with a low monetary value generally take a lot less time and
rigor than procurements of high monetary value or those that require a public
bidding process.
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Finance and Business
Even though organizational procurements vary, most FM procurement
processes conceptually involve the activities described in Exhibit 3-1. (The
activities as they are listed here provide a general sense of customary order
and are not intended as prescriptive steps.)
Exhibit 3-1: Typical Activities in Procurement (continued on next page)
Activity
Identify the need.
What It Involves
•
Clarify the need.
•
•
Review current arrangements (if any exist) or similar previous
procurements.
Identify stakeholders and other parties who have an interest in
the procurement and should be involved in the process (e.g.,
FM staff, other organizational personnel, customers, providers
and suppliers, statutory authorities, the general public).
•
Perform due diligence to identify employment or public procurement
legislation and other compliance requirements (e.g., internal and
standards).
•
Develop applicable service specifications and service level
agreement(s).
•
Identify specifications that should be included in the bidding process
and/or contract terms and conditions.
•
Prepare evaluation criteria (e.g., how vendor submissions will be
rated or scored).
Finalize the request
and submit it to
procurement.
•
Review evaluation criteria. (If necessary, involve stakeholders for
verification and buy-in.)
•
Revise request as necessary.
Review the request.
•
Determine the scope and scale of the procurement request.
•
Identify the monetary value.
Prepare the request.
Draft contract.
Prepare the contract, involving FM, finance and legal as necessary.
Supply market
assessment (market
survey).
•
Compile a long list of potential bidders.
•
Issue a request for information (RFI), which is also known as a
prequalification questionnaire (PQQ), to the bidders on the long list.
•
Screen for basic conditions and proof of competence and
experience, financial stability and adequate resources.
•
Select a short list of bidders to be issued the RFP or ITT.
•
Open the contract for bids. For the private sector, a prequalified list
of selected bidders is a usual practice. For the public or government
sector, bidding is almost always open to any qualified vendor.
•
Hold a briefing, if warranted. (Depending on the procurement scope,
scale and monetary value, this may require a briefing of prospective
vendors. Such information may also be done with e-enabled tools.)
Solicit bids.
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Chapter 3: Procurement in the Facility Organization
Exhibit 3-1: Typical Activities in Procurement (concluded)
Activity
What It Involves
Evaluate bids.
Award contract.
•
Review submissions. In the private sector, bids and evaluations
are usually performed in private. In the public or government
sector, bid openings are generally performed in public.
•
Schedule formal interviews with bidders as necessary.
•
Use the evaluation criteria to assess bids and convert to scores.
•
Select the best bid.
•
Hold a precontract meeting (if necessary) to review items such as:
•
•
•
•
The vendor’s plan for contract initiation.
Insurance coverage with respect to statutory requirements and
eventualities.
Contract administration—payments, meetings and other key
events.
Assign and generate purchase orders (POs).
Award selection criteria (which are specified early on in the procurement
process) can range from lowest price to unique service aspects.
•
Lowest responsive bid. This is a straightforward award, based on
the lowest bidder who can meet the specified requirements. It is
typically used for reorders, routine and well-defined user
requirements.
•
Evaluated/best value for money bid. This award is based on
evaluation of technical criteria (qualifications, experience, expertise,
etc.) as well as bid price. Vendors are rated against a floor (a
minimum passing score). Public-sector rules in Europe allow for a
competitive negotiation as well, with a very short list of bidders.
•
Unique service. This type of award may be based purely on
technical evaluation criteria, with the price and terms negotiated
after selection. For example, if a unique service is required, the
provider with the highest technical quality might be selected on
technical merit and the final contract price and terms negotiated.
The monetary value of the procurement may require the involvement of
a formal procurement review committee or team.
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Finance and Business
Depending on the scope and scale of the procurement, consideration should
also be given to:
•
•
Life-cycle costs.
Best-value judgments of quality and costs.
•
Risk assessment.
No matter how the procurement process is executed, it should be carried out
in compliance with organizational policies and existing laws and regulations.
Exhibit 3-2 provides general tips to help ensure procurement success.
Exhibit 3-2: Tips for Successful Facility Management Procurement
•
Do not try to outsource known problem
areas without resolving them first.
•
Ensure that you understand completely
the current levels of contracted and
actual expenditure on the services.
•
Ensure that you understand all
constraints, especially:
• Existing contract end dates.
• Ownership of materials and
equipment.
• Ownership of software used in the
services.
• Data ownership and location.
• Planned process of transfer
between contractors.
• Any key staff whom you might want
to retain (and who employs them).
• The roles and availability of client
team members, especially decision
makers and signatories.
• Labor unions or work councils
•
Assemble all the information that
bidders will need to know to provide a
complete and accurate price.
•
Create a complete service specification
that lends itself to objective
measurement through performance
indicators.
•
Provide suggested performance
indicators, based if possible on current
performance.
•
Do not prescribe service methodologies
or specialist subcontractors unless it is
absolutely essential; focus on the
outputs (performance) you require.
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•
Be clear about any elements of a normal
service specification that you don’t require (for
example, if they are provided by internal
teams).
•
Make clear the resources (accommodation, IT,
storage facilities and so on) that will be
available to the contractor.
•
Set out a clear pricing model to allow
comparison between proposals/bids.
•
Be clear about the evaluation criteria before
issuing the solicitation (e.g., RFP, ITT or
RFQ), and tell the bidders what they are.
•
To get the best out of the bidders, offer an
opportunity for alternative proposals as well as
(but instead of) a compliant proposal.
•
Ensure that you request a mobilization plan
and mobilization costs from the bidders.
(Mobilization is the initial phase of
implementation; it puts in place the necessary
physical and organizational arrangements
needed for the activity.)
•
Establish and publish the process for
management during the bid process
preparation phase, including:
• The overall timetable.
• A bidder briefing.
• Sample site visits.
• How you will manage questions and
clarification requests.
• What the process for returning the
proposals to the client is.
• The period allowed for negotiation (if any).
• The period allowed for mobilization.
•
Establish clear variation and change control
processes.
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Chapter 3: Procurement in the Facility Organization
Topic 2: Procurement and Facility Management
Outsourcing
Before concluding our discussion of procurement and beginning our coverage
of contracts, a baseline discussion about outsourcing is appropriate. The three
topics are intertwined, because procurement often leads to outsourcing and
outsourcing agreements require contracts.
Outsourcing generally describes the process of contracting with another
company or person to do a particular function. Stated another way,
outsourcing encompasses anything not done with in-house labor. In facility
management, the terms “outsourcing” and “contracting out” are often used
interchangeably.
Forms of
facility
management
outsourcing
Facility management outsourcing can take many forms. Organizations may
hire a full-service, single-source vendor to provide many services bundled
together, or an organization may “out-task” and hire individual, specialized
vendors to provide one or more functions.
Example: FM may out-task and hire an outside firm to handle all
grounds maintenance including landscaping, irrigation systems and
snow removal. Or multiple outside firms firm may be hired to perform
each distinct process.
Other examples of out-tasking include discrete processes such as
cafeteria/food service operations, janitorial services, and heating,
ventilation and air conditioning (HVAC) maintenance.
Additional forms of outsourcing in FM include:
• Management contracting.
•
Managing agent.
•
•
Principal contractor.
Total FM contractor.
Exhibits 3-3 to 3-7 illustrate various FM outsourcing models. Shading is
used to differentiate what is outsourced from what is provided internally
across strategic, tactical and operational levels. The models are supplied
courtesy of Agents4RM, an international group of facilities specialists
whose mission is to improve client productivity through better systems and
processes.
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Exhibit 3-3: Traditional In-House Delivery Model
Strategic
Tactical
Client
Finance
Procurement
Audit
Client
People management
Finance
Procurement
Health and safety
Project management
Technical
On-Site
FM Team
Service Delivery
Operational
Supply Chain
 Agents4RM International Limited. Used with permission.
In the traditional FM delivery structure, all management and key service
delivery functions reside with the client (buyer) organization and only highly
specialist activities are procured from the external marketplace. This model
remains the norm in many smaller companies and in emerging economies as
well as in many public and other not-for-profit organizations.
Exhibit 3-4: Hard and Soft Services Split
Client
Strategic
Hard Services
Manager
Soft Services
Manager
People management
Finance
Procurement
Health and safety
Project management
Technical
Site-Based
Site Based FM
FM
Tactical
Finance
Procurement
Audit
Soft Services
Delivery
Hard Services
Delivery
Specialist Services
Supply Chain
Specialist Services
Supply Chain
Operational
 Agents4RM International Limited. Used with permission.
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A common first step in outsourcing is to outsource noncritical services only
in a number of discrete work packages. Often, this is accompanied by a
split in the internal management to apply specialist skills to the external
suppliers and enable effective supervision. This can be counterproductive,
as it creates additional layers and costs of management and may inhibit
integration and coordination. However, the arrangement may be key to
establishing service levels and contracting structures as a step toward more
sophisticated procurement solutions.
Exhibit 3-5: Managing Agent
Strategic
Tactical
Operational
Client
Finance
Procurement
Administration
Client
People management
Finance
Procurement
Health and safety
Project management
Technical
On-Site
FM Team
Off-Site
Support
Supply Chain
 Agents4RM International Limited. Used with permission.
The managing agent brings in an external specialist facility management
provider, in a model similar to that sometimes employed in property
management. This stage is usually intended to reintegrate the
management roles controlling the day-to-day service delivery activity and
to reduce the layers of management. The client organization retains
control of the procurement of all services and merely delegates the
supervisory and control activities to a management provider. The client
organization also continues to provide the vast majority of the support
activities (financial management and reporting, health and safety, and so
on) rather than package these with the FM scope of work. This model
maintains direct client control over specifications but risks delegating
responsibility for delivery to the managing agent without delegating the
direct power to resolve problems. Because facility management is so
complex and delivery so time-sensitive, this model quite often exposes
this gap between power and responsibility and rarely delivers satisfactory
outcomes.
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Exhibit 3-6: Principal Contractor
Client
Representative
Strategic
Tactical
PC Director
Operational
On-Site FM
Team
People management
Finance
Procurement
Health and safety
Project management
Technical
Off-Site
Support
Supply Chain
 Agents4RM International Limited. Used with permission.
The shortcomings of the managing agent model often lead organizations to the
next stage, which is to procure a specialist management provider that is
independent of the supply chain. The principal contractor directly procures the
service delivery contracts. In this scenario, the client will usually retain control
of the specification of services and often imposes key contract terms to be
passed down to the supply chain. Occasionally, clients may specify suppliers
to be used for critical equipment maintenance or to meet warranty obligations,
but otherwise the client has no involvement in the relationship between the
principal contractor and their suppliers. The impact of this is that the client
receives a single monthly invoice and is able to reduce other resources and
costs for supporting management activities that become the responsibility of
the principal contractor. Integration of services and management is much more
effective, and the client is able to benefit from the procurement of best-in-class
specialist service providers under a single management regime.
Exhibit 3-7: Self-Directed Total FM Package
Strategic
Tactical
Finance
Procurement
Audit
Client
Client
On-Site
FM Team
On-Site
Support
People management
Finance
Procurement
Health and safety
Project management
Technical
Main Service Elements Delivery
Operational
Specialist/Minor Services Supply Chain
 Agents4RM International Limited. Used with permission.
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Chapter 3: Procurement in the Facility Organization
Market developments in the more mature FM markets have resulted in a
consolidation of management providers with service providers, for a
variety of reasons. The result has been the creation of FM businesses
with both management and service delivery capability, known as total
facility management (TFM) providers. TFM combines most of the
benefits of the principal contractor model, while more closely aligning
delivery and management. There remains some residual subcontracting
of specialist services, either because the TFM company doesn’t provide
all services, or because the client insists on some elements being markettested, or just that the services are highly specialized (for example, low
voltage electrical systems or fire systems maintenance). The client role
is reduced to strategic planning, performance management and
budgetary control.
TFM is a good solution to outsourcing of very large portfolios of
property or for outsourcing high-value services. It requires rigorous
preparation of volumetric data and costs and is generally considered not
to be suitable for first-generation outsourcing.
Why
outsource?
There are many reasons to outsource in FM. Outsourcing offers cost
reduction opportunities. Other reasons include (but are not limited to):
•
•
Access to expertise not available in-house.
Improved resource flexibility.
•
•
•
Improved cost flexibility.
Improved career opportunities for FM staff.
Access to investments or systems that would require capital that
cannot be justified in the host organization (as noted in the business
case issues raised previously).
•
Management time freed up to focus on strategic issues and planning.
From a finance and business perspective, outsourcing provides a costcontainment opportunity. Outsourcing—in whole or in part—is the
difference between fixed and variable costs.
There are also qualitative reasons to outsource. Facility customers may be
demanding more in terms of services and amenities than the department can
provide. Outsourcing offers smaller departments the resources and expertise
for capabilities they may not have internally. Even in larger departments,
outsourcing can improve specific functions.
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Many times, the function being outsourced is considered non-core, and
outsourcing it allows the organization to concentrate its activities and
resources on its core competencies. Outsourcing allows an organization to
capitalize on the expertise of other firms that are more efficient, effective or
knowledgeable at specialized tasks that are peripheral to those core
competencies.
Outsourcing
benefits and
cautions
Although outsourcing offers many attractive advantages, it may not be the
answer for all activities or functions. In the U.S. federal government, for
example, certain functions described as “inherently governmental” may
not be outsourced. These functions are typically found in jobs that require
decisions about the use of resources (e.g., spending money, accepting
work, management, and ownership/landlord functions).
At best, outsourcing has some potential cautions. Exhibit 3-8 lists notable
advantages and disadvantages.
Exhibit 3-8: Common Advantages and Disadvantages of Outsourcing
Advantages
Disadvantages
•
Can save FM administration and
management time
•
May cost more to go outside for specific
expertise
•
Increases FM ability to focus on core and
strategic revenue-generating activities
•
Potential loss of control
•
Potential for poor staff morale
•
Provides flexibility (by allowing staff to
complete other projects)
•
May necessitate a learning curve by the outside
organization
•
Can improve efficiency and effectiveness
(by gaining access to staff and skill sets)
•
•
Can reduce operational expenses (extends
staff capabilities without incurring fixed
staffing/benefit costs)
Managing the relationship may require different
supervisory skills than used for internal staffing
and a change management approach with
customers, staff and management
•
Potential for privacy and confidentiality issues
•
May lead to sharing of savings with the
outsourced firms on a risk/shared reward
basis
•
May improve the quality and/or timeliness
of FM services
•
May provide FM staff hired by the
outsource company with training and career
paths that would not be available in the FM
department
•
May provide specialized FM services or
best practices that the FM department
cannot provide or would not have the
financial resources to provide
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Chapter 3: Procurement in the Facility Organization
It is also important to realize that some national laws and regulations and
standards and legal conventions set forth by international organizations such
as the International Labour Organization, the Organisation for Economic Cooperation and Development, and the European Union have implications for
outsourcing.
Example: In the United States, there are liability cautions in hiring
contract employees. Government regulations are very specific in terms
of what characteristics differentiate an external contractor from staff. In
the European Union, the Acquired Rights Directive specifies several
points about business transfers from one entity to another (as in a sale
of a business unit or a merger); there are liabilities for all statutory
rights and claims arising from contracts of employment, including the
transfer of services (e.g., office cleaning, catering, security).
For multinational organizations, national laws in many countries apply to
internationally owned subsidiaries operating within a nation’s borders. The
lesson behind this: A facility manager should be aware that hiring and
employment laws in the countries in which the organization operates as well
as employment laws developed by global and regional bodies can impact
outsourcing. Human resource practitioners and/or employment law specialists
in the organization should be consulted to ensure compliance.
Setting the
stage for
outsourcing
Facility managers have responsibility for developing, managing and
overseeing contracts. But even before reaching the point of contract, the
facility manager needs to spend up-front time on properly defining the
outsourcing objectives and requirements and the quality needed to meet those
requirements. To do so helps to mitigate problems in the procurement process
and performance execution of the contract terms.
This often involves having secured approval from senior management and
working with procurement personnel and possibly legal counsel in the
organization. To be prepared to do so, a facility manager should have invested
due diligence regarding items such as (but not limited to):
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•
Definition of objectives and key attributes of services required (including
description of the current arrangement and identification of stakeholders).
•
Adequate documentation of direct and indirect costs for in-house delivery
and outsourced services to facilitate comparison and decision based on
best value.
•
Identification of special demands (uniqueness) of the service.
•
Identification of high-priority services (and risk assessment of these areas
so the consequence of failures is documented and the speed of response
can be planned).
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•
Consideration of flexibility and variability in demands.
•
Consideration of management implications (effort and involvement
required to manage service providers).
Appropriate bid evaluation criteria (soft and hard measures and
comparison of all costs, not just lowest price).
•
Having discussed procurement and covered basic information about
outsourcing, we now move to contracts in the next chapter.
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Progress Check Questions
Directions: Read each question and respond in the space provided. Answers and page references follow
the questions.
Match the following procurement terms with their description.
1.
Request for proposal
2.
Invitation to tender
3.
Request for quotation
a. A special procedure for generating
competing offers from different bidders
b. An official statement to vendors about the
business activity in works, supply or
service required
c. Procedure used when discussions with
bidders are not required
4. A facility manager is working with the procurement officer to secure a new provider for janitorial
services. At what point in the procurement process should a service level agreement be drafted?
( ) a. While FM prepares the procurement request
( ) b. At the time the contract is drafted
( ) c. While the bid is out for solicitation
( ) d. After contract award but before a PO is assigned
5. The award selection criteria appropriate for reorders, routine and well-defined user requirements is
( ) a. lowest responsive bid.
( ) b. evaluated/best value for money bid.
( ) c. unique service.
( ) d. standard bid.
6. Facility management decides to outsource administrative services. Which of the following potential
advantages is the organization most likely to realize?
( ) a. Greater flexibility, because the vendor will be able to customize employee benefits
( ) b. Improved staff morale by gaining outside expertise
( ) c. More technically competent level of service
( ) d. Greater leverage to secure employee benefits at reduced costs
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Progress check answers
1.
2.
3.
4.
5.
6.
b (p. 139)
a (p. 139)
c (p. 139)
a (p. 140)
a (p. 141)
c (p. 148)
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Chapter 4: Contracts in the Facility Organization
After completing this chapter, students will be able to:
•
Identify the principles involved in the development and oversight of facility management
contracts.
•
•
Develop key performance indicators.
Administer contracts.
•
•
•
Monitor contractor performance.
Analyze and interpret financial contract elements.
Resolve vendor conflicts.
Topic 1: Contract Development, Management and Oversight
Contracts and
facility
management
Now more than ever, facility managers are under increasing pressure to manage
and maintain their facilities effectively. Few organizations have the capacity and
capability to manage all aspects of operations through an internal workforce.
Thus, various aspects are procured from external providers. Almost every
organization sources some services in this way.
Contracts are one of the primary vehicles through which organizations identify
and define opportunities for products or services procured from external
providers. In a complex, globally networked world, many believe that the quality
of contract management has become a key indicator of an organization’s
performance and integrity. Ideally, the contracting process provides a framework
for regulatory compliance, reputational risk management and effective change
control as well as offering a source for added value and innovation. Added value
has the potential to go much further than simple price cuts or cost reduction to
drive measures such as improving the safety and reliability performance of
contractors or ensuring continuous upgrading of speed and quality of services.
A contract defines the basis of understanding for the delivery of goods, services
or construction efforts between the owner and the contractor or consultant. This
is true in facility management—no matter whether for planned services (e.g.,
preventive maintenance, planned replacement/refurbishment maintenance,
planned minor works), unplanned services (e.g., breakdown maintenance,
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unplanned property services, unplanned replacement/refurbishment maintenance,
unplanned minor works), property services (e.g., cleaning services, hygiene
services, security services, grounds maintenance, waste management),
environmentally sustainable services (e.g., energy, water and waste services)
and/or other areas.
Facility managers must address many contract issues to ensure that their
organization receives the right quality, in the right quantity, on time, with the
right services, at the right price. Thus, we begin this chapter on contracts with an
overview of fundamental contract elements. Customary types of contracts and
terms found in FM contracts are discussed. The topic concludes with a
discussion of fraud and irregularities in contracts.
Contract
fundamentals
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A contract is a legal device used by two or more persons to indicate they have
reached an agreement. It implies a meeting of the minds, with terms and
conditions that describe the agreement and constitute a legal obligation. To be
deemed valid, a contract typically requires the following elements.
•
Mutual agreement. The meeting of the minds is an express or implied
agreement that helps to ensure that both parties understand and agree to the
essential details, rights and obligations of the contract. While this may seem
obvious, such mutual agreement should explicitly clarify the terms of the
deal so that when the parties subsequently agree to formally enter into the
contract they are agreeing to the same thing.
•
Consideration. Once the parties have had a meeting of the minds, they
must each exchange something of value in order to create a contract. While
consideration can take many forms, customary exchanges are cash, goods
or a promise to do something (e.g., the price paid by one side and the goods
supplied by the other). The Latin term quid pro quo (meaning “something
for something”) is sometimes used to refer to contract consideration.
•
Competent parties. This element means that the person who signs the
contract must have the legal authority to sign on behalf of an organization
or another person. Also, the parties involved must have the capacity to
understand the terms of the contract. For example, minors cannot enter into
contracts without the additional signature of their parents or guardians.
Individuals considered to be lacking sound mind (e.g., mentally
handicapped or impaired by the use of drugs or alcohol) usually cannot
enter into contracts.
•
Proper subject matter. The contract must have a lawful purpose.
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•
Mutual right to remedy. Both parties must have an equal right to
remedy a breach of terms by the other party.
•
Agreement to enter into the contract. Once both parties understand
the deal and understand what type of consideration will be exchanged
by each party, they are ready to form an agreement. Usually the parties
demonstrate that negotiations have ended and an agreement has been
reached when the parties sign the contract.
Contract administration is an important responsibility for facility managers.
Contracts establish agreements between an organization and landlords or
tenants, suppliers and customers as well as other businesses. They are
negotiated for a wide variety of products and services.
Contracts are legal documents developed with the direct or indirect review
and input of lawyers/solicitors. Even simple contracts have legal jargon.
The content that follows won’t make you an expert in contract “legalese,”
but the fundamentals presented should enable you to achieve far better
negotiated results on behalf of FM and help in contract administration and
management.
Contract
classifications
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Contracts are classified in a variety of ways.
•
Express and implied. An express contract is one in which all elements
are specifically agreed upon; they are stated either orally or in writing. In
an implied contract, the existence of the contract is assumed by the
circumstances; the agreement of the parties is indicated by their conduct
or performance.
•
Bilateral and unilateral. A bilateral contract is most common and
is one in which both parties make a promise. In unilateral contracts,
one party makes a promise (such as an insurance contract).
•
Void, voidable and unenforceable. Void contracts are considered
never to have come into existence (such as being based on an illegal
purpose). A voidable contract is one in which one of the parties has
the option to terminate the contract (such as a contract with a minor).
An unenforceable contract is one in which neither party may enforce
the other’s obligations (if it violates the statute of frauds, for
example).
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An informal verbal agreement can be as binding and legally valid as a written
contract. It is also possible to bind yourself to a contract through e-mail,
either deliberately or inadvertently. For example, if an e-mail or chain of emails clearly states an offer for entering into a deal with all of the material
terms, and the other side responds by e-mail accepting the terms, there is a
high probability that a valid contract has been formed—even though no
signatures were exchanged up to that point.
When the intent is solely to negotiate the issues through e-mail leading to a
formal written and signed contract, that should be clearly stated in the e-mail
correspondence. During contract negotiations, “subject to contract” wording
should be included in any document exchanged by parties (e-mails or hard
copy). The expression “without prejudice” is often used when “subject to
contract” is meant; it denotes that the document is not an offer or acceptance
and negotiations are ongoing.
Types of
contracting
mechanisms
Facility managers may be involved with the administration, management and
oversight of contracts in many different areas. Contracts may be performancebased or prescriptive.
Prescriptive contracts outline the exact specifications expected or acceptable
ranges; they are less flexible than performance-based contracts. While
prescriptive contracts are appropriate for some situations, experience has
shown that they can sometimes stifle innovation and morale. Contractors
may have little incentive or motivation to do anything beyond what is
specified.
On the other hand, performance-based contracts describe expected results but
leave flexibility for the vendor regarding achievement of those results. With a
responsible contractor, performance-based contracts have the potential for
cost efficiencies and improvements. The contractor may take more pride in
work and look for ways to increase effectiveness and efficiencies and add
value.
How much flexibility to allow a contractor can be problematic. Trust and
experience with the contractor as well as contract scope and monetary value
are often considerations. (The prescriptive and performance-based categories
of contracts will be discussed further in the explanation of service
specifications in Topic 2 in this chapter.)
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Contract documents typically specify the following information to potential
suppliers:
•
•
The scope of services
The conditions of delivery (detailed specifications)
•
Terms and time frame of delivery and/or performance
•
Basis for compensation
•
General and special conditions and/or clauses
Individual contract terms will be covered in more detail later, but general and
special conditions merit further explanation here.
•
General conditions. These terms and conditions provide the legal
framework for the relationship between the organization and the vendor.
Purchasing drafts them. As necessary, legal counsel reviews them. These
pre-established terms and conditions are incorporated directly in the
contracting document. Typically, general conditions do not change.
•
Special conditions. As the name implies, these terms and conditions relate
to a specific procurement. They define items such as working hours,
security requirements, special access, safety rules and so forth. Purchasing
drafts special conditions based on requirements defined by FM. In simple
contracts, special conditions may be incorporated directly in the contract.
For complex procurements, special conditions may be put in a
performance work statement.
In FM, materials, supplies, labor and services may be obtained through a
variety of agreements. It is not possible to explain in depth all the different
types of contracts possible in FM. The content that follows is an overview of
some of most widely used types.
Purchase orders
A purchase order (PO) is a written contract between an organization and a
vendor using a preprinted standard form. One-time purchase orders and
blanket purchase orders are common practice in FM.
One-time purchase order
A one-time purchase order expires with the individual delivery of a finite
good or service.
Example: Provide 1,500 reams of 80 gsm* white copier paper.
*
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Weight of paper is measured by the amount that a square meter weighs.
Here it is a value given in grams per square meter (gsm). It may also be
measured in pounds per ream (lb).
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A one-time purchase order should state:
•
•
The quantity and quality of the items being ordered (as above).
The agreed unit price.
•
Any discount from list price (if agreed).
•
The agreed total price net of any sales taxes.
•
•
The total price, including taxes.
A reference purchase number to be quoted on the invoice for the sale.
•
•
Date of the purchase order.
The name, signature and contact details of the person raising the PO.
“Errors and omissions excepted” (or “E&OE”) is usually included in the
United Kingdom.
There may be additional details such as:
•
Earliest/latest date for delivery.
•
•
•
Delivery address.
Instructions on packaging or access.
Reference to standard terms and conditions of contract.
•
•
Reference to payment terms.
Statement that substitution is not acceptable.
Blanket purchase order (BPO)
This type of purchase order allows a stream of procurements over a length of
time and/or within a dollar ceiling. When the duration for a BPO is a year, it
may be called an annual PO. BPOs should contain all of the same information
as a one-time PO, plus usually some form of maximum periodic commitment
for the year plus each supply period, above which a variation order is
required.
Example: Provide electricity to [address] from 1 January 20XX to 31
December 20XX.
Fixed price
contracts
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A fixed price contract (also called a fixed sum or lump sum contract)
requires a contractor to successfully perform the contract and deliver
supplies or services for a price agreed to up-front. A firm fixed price
contract is appropriate for supplies and services that can be described in
sufficient detail to ensure that both parties completely understand the
contract requirements and the inherent risks associated with performing the
contract as written.
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Fixed price contracts often include:
Costreimbursement
contracts
•
Economic price adjustment factors to allow for situations where costs
fluctuate frequently.
•
Various incentives that can be used to reward good performance or to
impose provisions to deduct for poor performance.
•
Repricing provisions that permit issuing an order on a fixed price basis
and allow for revisiting the reasonableness of that pricing later during the
contract performance.
•
A specified level of effort.
A cost-reimbursement contract (also called a reimbursable or variable price
contract) allows for payment of all incurred costs within a predetermined
ceiling that can be allocated to the contract, that are allowable within cost
standards, and that are reasonable. This type of contract places the least cost and
performance risk on the contractor and requires the contractor only to use his or
her best efforts to complete the contract. It is appropriate when the uncertainties
of performance will not permit a fixed price to be estimated with sufficient
accuracy to ensure that a fair and reasonable price is obtained.
The following are cost-reimbursement contracts:
•
Cost type—involves payment of all incurred costs within a predetermined
total estimated cost.
•
Cost sharing—the organization and the contractor agree to split the cost of
performance in a predetermined manner. No fee is given.
•
Cost plus fixed fee—allows for payment of all incurred costs within a
predetermined amount plus an agreed-upon fee that will not change.
•
Cost plus incentive fee—provides for adjustment of the fee using a
predetermined formula based on the total allowable costs in relation to total
targeted costs.
•
Cost plus award fee—provides for negotiation of a base fee with an award
fee that can be given based on an evaluation by the organization of the
contractor’s performance and cost control.
The last two cost-reimbursement contract types require considerable monitoring
and are usually reserved for the larger dollar value, more visible procurements.
Indefinite delivery
quantity, line item
contracting
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Indefinite delivery quantity, line item contracting (known as IDQLI) is one
way to deliver certain FM services and also significantly reduce procurement
time. They are actually very similar to BPOs except that the IDQLI is more
often for services and the BPO is typically for goods.
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The IDQLI contract is not a general, umbrella contract covering a multitude
of trade skills needed to accomplish a specific project. Instead, the IDQLI
contract system is composed of small, separate, trade-specific contracts that
can be called upon by the facility manager over and over again as needed.
Distinct line item services and tasks are precisely specified, but delivery times
and quantities are left unspecified at the time of award of the base contract.
Typical IDQLI contracts can cover such typical and atypical FM services as:
•
•
Painting and plastering.
Floor covering.
•
•
Systems furniture disassembly, relocation and reassembly.
Furniture repair and cleaning.
•
Interior electrical work.
•
Plumbing.
•
•
Carpentry.
Paving (concrete and asphalt).
•
•
•
Roofing repair and replacement (all types).
Fencing.
Railroad track repair and replacement.
The most essential element of the IDQLI contract is the line item menu of FM
goods and services to be provided. Very specific component tasks that are
normally required to complete common, trade-oriented work requests are
listed individually. Each of these line item tasks is then unit-costed according
to an accepted measure of quantity such as:
• Dollars per linear foot (conduit, wire, etc.).
•
Dollars per square foot (painting, floor covering, etc.).
•
•
Dollars per item (receptacle, valve, etc.).
Dollars per service (clean restroom, assemble workstation, etc.).
Whenever possible, the line item cost is a complete cost. It includes labor,
material, overhead, profit and so forth. Execution delivery times and required
quantities for these line item tasks remain indefinite or on call. They are
contracted for by purchase order on an as-needed basis only and at the
discretion of the facility manager. Only the overall IDQLI base contract itself
has a specific start and expiration date.
A key thing to understand about the IDQLI contract system is that it is more
than just a contract document. In administering IDQLI contracts, the FM
function acts as a general contractor to execute single trade tasks or to
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Chapter 4: Contracts in the Facility Organization
coordinate multi-trade projects requiring more than one IDQLI contractor. A
fully operational system, therefore, includes a full-time, in-house contract
management staff to provide dedicated contractor control.
National buy
contracts
National buy contracts are specialized procurement contracts, primarily
applicable to large organizations. They may also be called national
purchasing contracts, or they may be referred to as framework contracting.
National buy contracts can provide favorable, below-retail costs in exchange
for an extended agreement to purchase from a sole source provider. Systems
furniture vendors commonly provide national buy contract options to large
customers with distant and dispersed regional offices.
Advantages from such procurement contracts include:
•
Decreased administrative costs through simplified procurement and
remittance cycles.
•
•
•
Faster product selection.
Elimination of unnecessary purchases and inventories.
Control over local purchasing and delivery.
•
•
Consistent quality throughout the organization.
Streamlined reporting.
National buy contracts have two significant cautions:
Additional contract
types
•
A national contract may lock FM into a bad deal if market prices drop
below the negotiated prices.
•
There can be additional charges for extras not included in the initial,
prepriced, itemized list of goods and/or services.
There are still other types of contracts, such as the following:
•
Open book contract— the cost of the delivery is passed on in the price,
with a profit margin (percentage) agreed on top.
•
Labor hour/time and materials—pay for services rendered at fixed rates
and for materials at cost plus a handling fee.
Appropriate contracts help to ensure that the organization successfully meets
its strategic objectives and FM fulfills departmental objectives. Furthermore,
valid contracts avoid the risks associated with excessive costs, project delays,
quality issues and similar problems. Evaluating the soundness of the contracts
is an important aspect of a facility manager’s job.
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Contract terms
Notwithstanding legal constraints that make a contract valid, the form and
substance of an FM contract will vary. Exhibit 4-1 provides a checklist of
customary terms found in FM contracts. Not all of these provisions will be
included in every contract, and some contracts will have additional inclusions
that relate specifically to the particular subject matter. A facility manager must
review all terms of a contract, understand what they mean, and be able to
execute the various terms.
Exhibit 4-1: Checklist of Facility Management Contract Terms (continued on next page)
Item

Date of agreement

Identity of the parties
Provisions to be Covered
•
•
•
•
Individuals or business entities?
If businesses, what type (e.g., partnership, corporation,
other)?
Name of person signing on behalf of the business and
indication he or she has authority to bind the business
Signer’s official title

Addresses of the parties

Purpose(s) of the contract and
relevant definitions

Underlying assumptions

Respective roles and responsibilities
•
•

Description of the work involved and
outcomes expected
Reports (types and frequency)

Performance levels and how quality
will be judged
•
•

Terms for incentives and penalties

Staffing levels

Personnel requirements
(certifications, bonding, insurance,
security clearances, criminal record
checks and so forth)
The organization’s right to check qualifications and competencies of
contractor personnel and approve the use in advance

Schedule
•
•

Duration
Term of the contract

Rights of access to locations

Protocols when on location
•
•
Hours of operation, dress, badges, where to eat and so forth
Use of physical property (for example, computers and office space)

Communication
•
•
How communication with facility staff and occupants is to be done
Reports and liaison meetings

Restrictions on subcontracting

Novation/contract transfer provisions
Provisions regarding the substitution of a new contract in place of the
original

Payment terms and pricing
mechanisms
•
•
•
•
•
•
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Locations to be serviced
Duties of each party
Rights of each party
Service specifications and service level agreements
Monitoring
Timelines and deadlines
Other relevant dates
Lump sum, COD, installments?
Payment due dates
Length of period from invoice issue to due date
Taxes
Interest
Late fees
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Chapter 4: Contracts in the Facility Organization
Exhibit 4-1: Checklist of Facility Management Contract Terms (concluded)
Item
Provisions to be Covered

Termination options
Default, bankruptcy, escape clause and other dissolution
procedures

Service suspensions

Force majeure provisions
What disruptions in service (not excused by a force majeure clause) are
allowable, such as server failures, software glitches, disputes with copyright
owners, licensor labor disputes
What unforeseen or planned events suspend contract time limits, such as:
•
Natural disasters (earthquakes, hurricanes, floods)
•
Wars, riots or other major upheaval
•
Performance failures of parties outside the control of the
contracting party (e.g., disruptions in telephone service
attributable to the telephone company or labor actions)

Dates by which performance
obligations are scheduled to be
met will be extended for a period
of time equal to the time lost due
to any delays

Contract variations

Severability of individual
provisions

Audit rights

Dispute resolution clause
Mechanisms for dispute resolution and how disagreements or
disputes are to be handled

Ownership
Copyright issues, patents and intellectual property specifications

Confidentiality and restrictions on
information obtained/learned

Arrangements for transfer of
assets at start/end of contract

Arrangements for handover to
succeeding contractor at end of
contract

Contingency arrangements

Liquidated damages
Also referred to as liquidated and ascertained damages, the specified
monetary amount the parties designate during the formation of a contract
should one of the parties breach the contract (e.g., late performance)

Indemnification agreement
Documentation of who is liable for what and to what extent in the liability
clauses (e.g., which party agrees to pay for any losses that arise; limitations
on liability)

Safety
•
•
•

Antidiscrimination policy

Drug-free workplace policy

Quality assurance

Statement that contract
constitutes entire agreement

Signatures of authorized
signatories

Notarization
If required by applicable law

Governing law
Which country or regional laws apply to the contract
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•
•
•
The handling of changes in the organization’s requirements
Change order request/change proposal process
Contract amendments
Safety gear
Special health and safety hazards
Accidents to contractor personnel
Provisions related to quality management systems/continuous improvement
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Some contracts may require translation into multiple languages.
Additional information is often put in appendices to the contract. Resumes of
staff employed, request for proposal (RFP)/tender documentation, invitations
to bid, prequalification questionnaires, contracting party’s responses, and
similar documents are all possible inclusions in appendices.
When reviewing contracts to ensure that they are complete and clear and
comply with legal requirements, some commonsense principles also apply. In
Exhibit 4-2, a simple list of contract do’s and don’ts is shown.
Exhibit 4-2: Facility Management Contract Do’s and Don’ts
Do:
•
•
•
•
•
•
•
•
•
•
•
•
Entitle the document “Contract” so that there
can be no mistake as to its intent.
Include the date in the first paragraph for easy
reference after contract execution (e.g., so the
contract can later be identified by date, such
as “the January 4, 20XX, Contract for
Property Snow Removal.”
Make sure the parties are properly identified
in the first paragraph, names are spelled
correctly and addresses are accurate.
Use commonsense headings to make it
easier to find particular contract provisions.
Number the paragraphs for ease of reference.
Pay attention to punctuation and conjunctions
(especially “and” and “or”) since grammar
errors and words chosen can change
meaning.
Use plain language whenever possible.
Make sure the contract addresses all possible
contingencies and that nothing is left to
chance.
Have an attorney review every contract before
signing.
Sign in blue or other colored ink to make the
original easily distinguishable from
photocopies.
Initial every page of the contract and make
sure the other party does the same so that
nothing is missed
Retain a copy of the contract for your records.
Don’t:
•
Include legalese or archaic phrases such as
“the party of the first part” or “heretofore” as
they generally add little in terms of clarity.
•
Include overly long sentences; break
sentences down into easily digestible
thoughts.
•
Be repetitive unless it is absolutely necessary.
(It is preferable to refer to a previous provision
according to its number or heading rather
than to repeat it verbatim.)
•
Assume the other party defines terms the
same way. If there is any doubt, include a
definition in the contract.
•
Accept the other party’s oral explanation of a
confusing term; include everything in writing.
•
Start acting according to the terms of the
contract until both parties have executed it.
•
Assume that use of a standard or form
contract eliminates the need for legal review.
Even if a standard contract worked well in the
past, a change of circumstances, date or
party can change the whole equation.
•
Agree to a contract modification without
documenting it in writing.
•
Rush reading the contract. It takes time to
understand all of the possible nuances of the
language used.
•
Sign any contract unless you understand what
it aims to do and what the terminology means.
Clarify any questions with legal counsel.
A guiding principle in FM contract management is that payment is dependent
upon performance. A facility manager must ensure that service providers and
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Chapter 4: Contracts in the Facility Organization
other contractors perform according to their commitments. Contracts should
clearly specify how payments will be adjusted when performance deviates.
Service specifications and service level agreements are two mechanisms that
help to achieve required results. They will be covered in more detail in Topic 2
in this chapter.
Prevention of
fraud and
irregularities in
contracts
Fraud is generally defined as an intentional deception made to gain an advantage
or damage another individual. It encompasses a variety of illegal acts
characterized by deceit, concealment or violation of trust. These acts are not
dependent upon the application of a threat of violence or physical force. Frauds
are perpetrated by parties and organizations to obtain money, property or
services; to avoid payment or loss of services; or to secure personal or business
advantage.
Consider the following occurrence of fraud in a contract award process:
The procurement manager for an organization solicited and received bids for
an extensive FM renovation project. Although qualified contractors were
required to submit bids by a specified date and time, there was no formal bid
opening process. Instead, the procurement manager received all bids and
opened them in his office. He then called his friend at XYZ Construction and
disclosed the bids. Based on this information, XYZ submitted the lowest bid
and was awarded the contract. Some time later, it was learned that XYZ
Construction performed construction work at the manager’s home in return
for the renovation contract.
Good procurement practices, valid contracts and preventive controls help to
deter such collusion (conspiracy or complicity) and corruption (the exchange of
money, goods or services) and prevent contract fraud.
Types of contract
fraud
Fraud as it relates to contracts can take many forms. The primary ones are
described below.
Collusion between personnel or agents
Collusion generally encompasses a variety of behaviors that would not reflect
the application of care or skills expected of a reasonably prudent, competent
and honest individual. Examples include:
•
•
Acceptance of bribes or kickbacks.
Diversion to an outsider of a potentially profitable transaction that would
normally generate profits for the organization.
A reasonably prudent person is alert to the possibility of intentional
wrongdoing, errors or omissions, inefficiencies, waste, ineffectiveness and
conflicts of interest. To ignore such things may be construed as collusion. In
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particular, discretion and care needs to be taken regarding the acceptance of
gifts, hospitality and other perquisites to prevent any conflict of interest in the
awarding of contracts.
Price fixing
Price fixing in contracting describes an agreement among competitors to raise,
fix or otherwise maintain the prices at a specified level. It is not necessary that
the competitors agree to charge exactly the same price.
Price fixing can take many forms such as (but not limited to):
•
•
Establishing or adhering to price discounts.
Holding prices firm.
•
•
•
•
Eliminating or reducing discounts.
Adopting a standard formula for computing prices.
Maintaining certain price differentials between different types, sizes or
quantities of products.
Adhering to a minimum fee or price schedule.
•
•
Fixing credit terms.
Not advertising prices.
If you believe that price fixing is taking place between your bidders or
suppliers, you should consider contacting your legal department to ask for
direction. Also, you might want to include this and related topics as part of your
regular ethics training for FM staff.
Noncompetitive pricing of contracts
Also known as bid rigging, noncompetitive pricing describes how
conspiring competitors effectively raise prices when the organization
acquiring goods or services solicits competing bids. Essentially,
competitors agree in advance who will submit the winning bid on a contract
being let through the competitive bidding process; even the lowest bid
(tender) will be overpriced.
Bid rigging (like price fixing) also takes many forms, but bid rigging
conspiracies usually fall into one or more of the following categories.
•
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Bid suppression. In this scheme, one or more competitors who otherwise
would be expected to bid, or who have previously bid, agree to refrain
from bidding or withdraw a previously submitted bid so that the
designated winning competitor’s bid will be accepted.
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•
Complementary bidding, Also known as cover or courtesy bidding, this
occurs when some competitors agree to submit bids that either are too
high to be accepted or contain special terms that will not be acceptable to
the buyer. Such bids are designed merely to give the appearance of
genuine competitive bidding. Complementary bidding schemes create the
appearance of competition to conceal secretly inflated prices.
•
Bid rotation. In bid rotation, all conspirators submit bids but take
turns being the low bidder. The terms of the rotation may vary; for
example, competitors may take turns on contracts according to the size
of the contract, allocating equal amounts to each conspirator or
allocating volumes that correspond to the size of each conspirator
company.
•
Subcontracting. Subcontracting arrangements are often part of a bid
rigging scheme. Competitors who agree not to bid or to submit a
losing bid frequently receive subcontracts or supply contracts in
exchange from the successful low bidder. In some schemes, a low
bidder will agree to withdraw its bid in favor of the next low bidder in
exchange for a lucrative subcontract that divides the illegally obtained
higher price between them.
Almost all forms of bid rigging schemes have one thing in common: an
agreement among some or all of the bidders that predetermines the winning
bidder and limits or eliminates competition among the conspiring vendors. The
goal is to win a contract and share in the award.
Irregularities during execution of contracts
Fraud may be perpetrated in several ways during the execution of contracts,
ranging from failure to perform to specifications, to deliberate falsification of
records and invoices, to overstatement of work completed. All of these
activities can lead to overpayments. The unauthorized or illegal use of
confidential or proprietary information is another type of fraud possible during
contract execution.
Payments for work not carried out
Sometimes called phantom charges, this type of fraud is commonly perpetrated
through charges for expenses not incurred or work not performed. It may also
involve the misrepresentation of status and/or progress in order to continue
receiving funds.
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Cartels
A cartel is a formal (explicit) agreement among suppliers, producers or
other organizations that agree to coordinate prices and/or production.
Cartels are typically found in markets that are dominated by a small number
of sellers and usually involve homogeneous products. Cartel activities may
include price fixing, allocation of customers, allocation of territories,
reducing competition, bid rigging and more. Some trade organizations,
especially in industries dominated by only a few major players, may serve
as fronts for cartels. In some countries, labor unions have been labeled a
form of cartels, as they seek to raise the price of labor (wages) by
preventing competition.
Most countries have laws intended to repress cartels and promote
competition among entities. However, identifying and proving the existence
of a cartel even with such regulations can be difficult. The effectiveness of
cartel regulations and antitrust laws and the assessment of fines and
penalties for cartel activity is challenging. If a facility manager suspects
and/or must deal with known cartel activity, the organization’s legal
department or counsel should be involved.
Principles of
contract fraud
control
In Total Facilities Management, authors Brian Atkin and Adrian Brooks offer
the following succinct points about fraud and control:
•
•
•
Fraud should be deterred.
Prevention is preferable to detection.
Strong preventive controls should be applied.
Controls generally describe procedures designed to promote sound
management practices. Internal controls are used in many areas of an
organization to promote effective management. Here we focus on preventive
controls—proactive controls—that can deter and prevent fraud risks in FM
contracting.
Segregation of duties
Segregation of duties (or separation of duties) means that no single person has
sole responsibility over the procurement process and award and execution of
a contract. As feasible, the contracting process should not be handled by one
person from start to finish.
Example: One individual would order the work; another person would
be responsible for the certification and authorization of payments.
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Chapter 4: Contracts in the Facility Organization
Proper authorization
Before any transaction or specific activity is undertaken, it should be approved
by the appropriate manager or responsible person. Limits are often set as to
what a person can approve. Authorization helps to ensure that proper
responsibility is taken for all activities and transactions and that delegated
limits are complied with.
Competitive bidding/tendering
Contracts should normally be awarded through a competitive process.
Example: Controls for a competitive renovation bid include specifying a
date and time when bids are due. Since there are multiple bids, all bids
should be opened and logged at the time they are due. A minimum of
three employees should be present at the bid opening, and at least one
person should represent an area other than procurement or purchasing.
This ensures fairness in the bidding and evaluation process.
A decision not to use competitive bidding should require a higher level of
authority.
Documentation and record keeping
Standard documentation (uniform and consistent) helps to ensure conformity
with organizational policies and practices and even compliance with laws and
regulations. Appropriate records enable decisions and transactions to be traced
through organizational systems.
Example: Documentation and record keeping related to the contract for
a large capital construction project prevents loss of resources and
supports accurate financial reporting. It also provides compliance with
laws and regulations, avoids damage to the organization’s reputation
and other negative consequences.
Change order controls
Change orders represent a high fraud risk on contracts. The organization’s
objective is to pay a reasonable price for products and services provided. This
is generally dictated by a competitive bid process or by paying the contractor
for costs as they occur. Change orders do not meet those requirements. While
they typically include the price of the changed work and estimates, the change
order is generally negotiated. Change orders should be reviewed to ensure that
they are both valid and reasonable.
Example: An organization has a sloppy change order process that
neither validates costs nor determines whether the costs were included
in the original bid. A subsequent audit of records shows that a piece of
equipment was paid for three times—once in the original bid and twice
through change orders.
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Finance and Business
Certainly it is essential to review or audit significant change orders, but the
process should be done in a manner that does not delay schedules or impact the
quality of services.
Budgetary controls
Budgets should be aligned to organizational strategies and objectives to help
ensure that expenditures are warranted. Costs must be monitored on a regular
basis appropriate to the contract. It is imperative to quickly discover whether
costs will exceed budget projections.
Effective fraud controls such as these just discussed:
Fraud indicators
•
Increase the likelihood that all financial information in contracting is
reliable.
•
•
•
Promote adherence to organizational policies and procedures.
Help to protect an organization’s assets from misuse.
Lessen the opportunity for dishonesty, fraud, collusion and the like.
Facility managers should be able to recognize fraud indicators in the
bidding/tendering process and the award of contracts. They are signs that
indicate both the inadequacy of controls in place to deter fraud and the
possibility that some perpetrator has already overcome these weak or absent
controls to commit fraud. Such indicators are often referred to as red flags.
Certain patterns of bidding or pricing conduct seem at odds with a
competitive process and suggest the possibility of collusion and fraud.
Several are listed in Exhibit 4-3 on the next page.
It is important to realize that while these indicators may arouse suspicion,
they are not definitive proof. Red flag indicators are only warning signs; they
are not proof that fraud has been committed. Consider the following
examples.
Examples: Bids that come in well above the estimate may indicate
collusion, or they may simply be an incorrect estimate. Also, a bidder
can lawfully submit an intentionally high bid that it does not think will
be successful for its own business reasons (such as being too busy
to handle the work but wanting to stay on the bidders’ list).
Fraud is perpetrated only when a company submits an intentionally high bid
because of an agreement with a competitor. Thus, red flag indicators merely
signal caution and the potential need for further evaluation to determine
whether fraud exists or whether there is an innocent explanation for the
events in question.
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Chapter 4: Contracts in the Facility Organization
Exhibit 4-3: Common Fraud Indicators in Facility Management Contracts
Red flags in bid patterns

The same company always wins a particular procurement. This may be more suspicious if one or
more companies continually submit unsuccessful bids.

The same suppliers submit bids and each company seems to take a turn being the successful
bidder.

Some bids are much higher than published price lists, previous bids by the same firms or
organizational cost estimates.

Fewer than the normal numbers of competitors submit bids.

A company appears to be bidding substantially higher on some bids than on other bids, with no
apparent cost differences to account for the disparity.

Bid prices drop whenever a new or infrequent bidder submits a bid.

A successful bidder subcontracts work to competitors that submitted unsuccessful bids on the same
project.

A company withdraws its successful bid and subsequently is subcontracted work by the new
winning contractor.
Red flags in price patterns
Identical prices may indicate a price fixing conspiracy, especially when:

Prices stay identical for long periods of time.

Prices previously were different.

Price increases do not appear to be supported by increased costs.

Discounts are eliminated, especially when discounts were historically given.

There is a wide spread of prices for the same work package that is not explained by resource levels.
Red flags related to suspicious documents, statements or behavior

The proposals or bid forms submitted by different vendors contain irregularities (such as identical
calculations or spelling errors) or similar handwriting, typeface or stationery. This may indicate that
the designated low bidder may have been involved in preparing the losing vendor’s bid.

Bid or price documents contain whiteouts or other physical alterations indicating last-minute price
changes.

A company requests a bid package for itself and a competitor or submits both its and another’s bids.

A company submits a bid when it is incapable of successfully performing the contract (likely a
complementary bid).

A company brings multiple bids to a bid opening and submits its bid only after determining (or trying
to determine) who else is bidding.

A member of the internal (buyer) team consistently favors one bidder with no clear rationale or puts
hurdles in the way of other bidders or of effective mobilization.
A bidder or salesperson makes:

Any reference to industrywide or trade association price schedules.

Any statement indicating advance (nonpublic) knowledge of competitors’ pricing.

Statements to the effect that a particular customer or contract “belongs” to a certain vendor.

Statements that a bid was a “courtesy,” “complementary,” “token” or “cover” bid.

Any statement indicating that vendors have discussed prices among themselves or have reached an
understanding about prices.
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Fraud can occur in almost any contracting situation, but it is more likely to
occur in some scenarios than in others.
•
Few providers. The fewer the contractors, the easier it is for them to
get together and agree on prices, bids and the like.
•
Little product differentiation. If other products cannot easily be
substituted for the product in question or if there are restrictive
specifications for the product being procured, the probability of
collusion increases.
•
Standardized products. The more standardized a product is, the easier
it is for competing firms to reach agreement on a common price
structure. It is much harder to agree on other forms of competition, such
as design, features, quality or service.
•
Repetitive purchases. Repetitive purchases may increase the chance of
collusion, as the vendors may become familiar with other bidders and
future contracts provide the opportunity for competitors to share the
work.
•
Strong ties. Collusion is more likely if the competitors know each
other well through social connections, trade associations, legitimate
business contacts or shifting employment from one company to
another.
Organizations stand to derive many benefits from recognizing where fraud
may occur during bidding and award of contracts. But awareness and
preventive controls are not enough to ensure the successful execution of a
contract. Facility managers need to provide ongoing assurance, and that is
our next topic for discussion
Topic 2: Contract Administration
Broadly defined, contract administration is any action from the time a
contract is awarded until its closeout. It is the process of ensuring that the
intent, requirements, and terms and conditions of the contract are met. Once
a contract is signed and in place and work has started, a facility manager
will have some level of responsibility for contract administration
(implementation and monitoring).
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Chapter 4: Contracts in the Facility Organization
Ideally, a facility manager is involved with the bidding process and has
firsthand knowledge of the contract terms. In situations where the facility
manager was not involved from the outset, he or she should begin by
reading the contract to become familiar with all terms. In this situation, it
may be appropriate to review with purchasing any major issues that took
place during the procurement and negotiation process of the contract award.
This collaboration with purchasing will help in understanding the tone of
the relationship and the requirements for the completion of a successful
contract.
If the terms of a contract are complete and clear, contract administration
should be relatively straightforward. The primary goals in contract
implementation and monitoring are to:
•
•
•
Assess contractor performance.
Evaluate whether the provider is complying with the terms and conditions
of the contract.
Document the outcomes.
•
Ensure the continuing relevance to organizational needs.
Such contract oversight increases the probability that expectations associated
with a project, product or service are fulfilled in a responsible fashion.
Monitoring also helps to ensure successful completion of a contract; it should
uncover difficulties which, left unattended could lead to project or product
failure or to unsatisfactory service.
Contract
monitoring
The specific nature and extent of contract administration varies from contract
to contract, as does a facility manager’s involvement. It can range from the
simple acceptance of a delivery and payment to the contractor to extensive
involvement throughout the contract term.
General factors influencing the degree of contract administration include the
nature of the work, product or service, the type of contract, and the experience
and commitment of the contractor personnel involved.
Contract performance monitoring and contract cost monitoring are the two
areas for which a facility manager typically has some level of responsibility.
Collectively, implementation and monitoring activities in these areas costeffectively measure the contractor’s performance and provide documentation
to pay accordingly.
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Contract
performance
monitoring
To assess compliance with contract performance provisions, common criteria
include monitoring of items such as (but not limited to):
•
•
Actual progress against work schedules.
Fulfillment of time frames and adherence to milestones.
•
Fulfillment of quality and quantity objectives.
•
Conformance to specifications.
•
•
Conformance to baseline operational performance metrics.
Conformance to service/quality levels outlined within the contract.
•
Conformance to standards.
Ways to obtain vendor performance information vary but may include
any combination of:
•
Inspections.
•
•
•
•
Observations.
Solicited feedback (e.g., customer satisfaction surveys).
Unsolicited feedback from end users (e.g., complaints or
suggestions).
Work management center call reports (if services provided have call
center support).
Vendor reports.
•
•
•
Tests.
Audits.
Regularly scheduled vendor meetings.
•
Documentation formality and format also vary.
Possibilities include:
•
•
FM reports.
Performance score sheets.
•
Vendor scorecards.
Useful tools for monitoring activities include:
• Project software (e.g., Microsoft Office Project programs).
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•
Spreadsheets (e.g., Microsoft Excel, Microsoft Access).
•
Custom applications.
•
Work management center management information systems.
•
Computer-aided facility management (CAFM), where computeraided design is integrated with work management, project
management and asset management databases.
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Chapter 4: Contracts in the Facility Organization
Done properly, contract performance monitoring:
Use of service
specifications and
service level
agreements in
performance
monitoring
•
•
Facilitates early resolution of any vendor performance issues.
Identifies planned and unplanned modifications that may arise throughout
the contract term.
•
Facilitates negotiating and processing contract change orders.
A facility manager has management and oversight responsibilities for services
provided to tenants. (This, of course, is true whether the service is outsourced
or performed by internal FM staff.) All services must be fulfilled according to
expected performance and time standards. The inclusion of service
specifications and service level agreements in a service contract or as an
addendum are extremely helpful in contract administration.
What is a service contract?
A service contract is an agreement for the performance of various labororiented services, funded on a periodic basis.
All service contracts should be in writing. Customary contract terms were
covered in detail previously. Even in the simplest service contracts, the
following are important contract terms to include:
•
•
Identity of the parties
Description of the service to be performed, where and how often
•
Performance standards and measurement metrics
•
•
Costs (specifying hourly, weekly, monthly and annual)
Contract initiation and termination (start and end dates)
•
Special provisions (such as insurance coverage, safety gear, emergency
response and overtime)
•
Termination provisions
•
Signatures of authorized parties
Inclusions of additional terms are contract-specific. Typically considerations
are:
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•
Escalation clauses for contracts that involve substantial labor (acceptable
limits to offset cost increases in labor and materials).
•
Right to audit the contractor’s records regarding labor and material costs.
•
Copies of the contractor’s licenses, liability and workers’ compensation
insurance certificates, and fidelity bonds (a form of business insurance
that covers any loss of money or property incurred due to fraudulent or
dishonest employees).
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What is a service specification?
Service specifications are part of the service contract. Typically, service
specifications are included in a separate document developed and agreed upon
in order to clarify and give further detail on expected service levels and
quality.
A service specification establishes the minimum level of service acceptable to
meet customer requirements. It also provides a framework for monitoring
actual services. Service specifications are often used as benchmarks to assess
the standard and quality of service provided.
A service specification is a precursor for a service level agreement. At a
minimum, service specifications cover:
•
Internal standards—relevant organizational or FM standards and/or
standards that may have been part of previous contracts.
•
External standards—conformance to regulatory requirements,
international standards, health and safety laws and regulations, industry
standards and manufacturers’ recommendations.
•
Procedures—specifications about what the contractor must do to fulfill
any required technical standards.
The level of detail in a service specification naturally varies, depending
upon the complexity and importance of the service or asset item. For
example, specifications included in a parking lot maintenance contract
regarding surface smoothness, pothole patching and crack sealing would
most likely be much more technical and involved than cleaning
specifications for an office area.
A primary consideration when developing a service specification is the
choice between a prescriptive and a performance-based specification.
•
Prescriptive specifications. True to their name, prescriptive
specifications dictate exactly what will be done, how the tasks will be
performed and the frequency. Prescriptive specifications are restrictive;
they are based on specific inputs. Usually, they cannot be modified once
the contract is running.
Example: Rubbish containers and recycle bins will be emptied daily
and cleaned as required. All waste material collected will be removed
and put in the appropriate disposal dumpsters found outside behind
the building.
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Chapter 4: Contracts in the Facility Organization
•
Performance specifications, A performance specification typically
sets quality-related targets that allow the service provider some
flexibility in determining the most appropriate response.
Compared to prescriptive specifications specifying inputs, performance
specifications are focused more on outputs.
Example: Ensure that rubbish containers and recycle bins are emptied
regularly before they are full and contents are deposited in the
appropriate disposal dumpsters. The containers and bins should be
kept clean so they do not pose a health concern or result in tenant
dissatisfaction.
These examples about rubbish removal are singular tasks in a service
specification for office cleaning. A risk in developing prescriptive
specifications is that they can become overly prescriptive and regimented.
The challenge in performance-based specifications is being able to
convey the quality expectation in terms the contractor understands and
can execute in practice.
It is a best practice in procurement to focus on describing required
outputs rather than inputs. Prescriptive specifications should be used only
when there is a clear risk-related reason to do so. Prescriptive
specifications that limit a vendor’s ability to apply the best solution and
that impose resource requirements or methodology should be avoided
except where not prescribing will significantly impact risk for the core
business of the buyer.
Contents found in a service specification should:
•
Describe the objectives of the service.
•
Provide a general description of the service.
•
Explain the service outputs required.
•
Explain the service input requirements (if any).
•
Explain any priorities and constraints (e.g., delivery times).
•
Provide details of any specific exceptions or exclusions to the service
requirement (e.g., geographical or items that would normally be
included but are not in the particular specification).
Exhibit 4-4 illustrates the contents for a service specification for a work
management center.
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Finance and Business
Exhibit 4-4: Sample Service Specification for a Work Management Center
(continued on next page)
Overall Service Objective
Provide a help desk service using the CAFM system to coordinate and manage all fault reports and provide a primary
source of management information.
General Service Description
The help desk will operate on a full 24/7 basis so as to provide emergency response for critical infrastructure. It will:
•
Provide a single point of contact for the reporting of building and equipment faults, service problems and
requests, and incidents requiring a response.
•
Assess priorities and issue work orders or purchase orders to resolve the problem in line with the time scales set
out for those priorities.
•
Track work progress and completion.
•
Manage and report on work completion and exceptions.
•
Provide information on cost center charging for all internally chargeable services, including business card
production, archiving, catering requests, equipment hire and so on.
Service Outputs Required
The contractor will:
•
Ensure that systems and processes are in place to:
• Log each call or request.
• Prioritize those requests in line with the priorities below.
• Place orders for remedial actions with the correct person or contractor, with budget estimates if
appropriate.
• Track and report on work progress.
• Report expected and actual delays to service users.
• Manage orders to ensure on-schedule completion.
• Flag noncomplete works.
• Flag additional works or expenditure required and manage the approval process.
• Escalate serious faults or delays as necessary; approve completed work for payment in accordance with
process.
• Ensure that repairs to items scheduled for maintenance in short term are deferred where possible.
•
Provide means to back up data and retrieve it when required.
•
Provide backup systems to operate the service in the event of any failure of IT or power in the building.
•
Maintain records and report on help desk activities in line with best practice.
•
Maintain a log of customer complaints, special requests and instructions. Items recorded in this log will be dealt
with in line with published processes.
•
Provide a mechanism to receive and take action on fault reports in the event of software, telephone or other
system failure.
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Chapter 4: Contracts in the Facility Organization
Exhibit 4-4: Sample Service Specification for a Work Management Center
(concluded)
Priorities
The contractor will assess each request for breakdown or incident response service and categorize and manage it on
the following basis:
Priority Classification
1A
Emergency (high
priority)
Sites with no
resident client staff
1B
Emergency (high
priority)
Sites with resident
client staff only
Condition
Response Time
(During Normal Working Hours)
Failures or conditions of installation that
constitute an immediate danger to people
or risk immediate operational failure in
critical systems or that threaten the
integrity of security.
Investigate and make safe or
compliant within 4 hours,
OR, if not remediable in 4 hours,
invoke business continuity planning
response to minimize impact.
Failures or conditions of installation that
constitute an immediate danger to people
or risk immediate operational failure in
critical systems or that threaten the
integrity of security.
Investigate within 1 hour and make
safe or compliant within 2 hours,
OR, if not remediable in 2 hours,
invoke business continuity planning
response to minimize impact.
2
Urgent
Failures or conditions of installation that
constitute a potential danger to people or
risk negative operational impact or that
weaken the integrity of security.
Investigate within 4 hours and make
compliant within one working day.
3
Routine
Failure or conditions that affect the
amenity but do not pose a risk to people,
operations or security.
Investigate within 1 working day and
make compliant within 7 working days.
4
Service visit/no callout required
Any reactive work that can be deferred
until the next scheduled service visit by a
supplier.
Investigate within 28 days and/or notify
maintenance supplier to rectify at next
scheduled visit.
5
Parts order
or
request for
quotation
Work required to develop services or
improve cost-effectiveness for which a
preliminary quotation is required to
ensure that a cost-benefit case is
supported.
Assess request within 7 working days
and provide parts or quotation within
28 working days thereafter.
Exclusions
Only if the system is based in the client’s premises, the contractor is not required to provide:
•
Computer hardware.
•
Telephones or telephone lines.
•
Call management software.
•
Telephone software.
•
Any service outside the current specified hours.
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Finance and Business
Service specifications often describe performance requirements in terms of
factors that are critical to the successful provision of the service. Known as
key performance indicators (KPIs), they are related to the criticality and
importance of the service (not the level of the service). Exhibit 4-5 illustrates
examples of KPIs.
Exhibit 4-5: Example of KPIs for a CAFM System and Work Management Center
KPI: CAFM System
Service
Summary*
Output
Required
Method of
Measurement
Target
Required
Measure
Frequency**
CAFM system
Data complete
and up-to-date
Check audit
90%
A
All PPMs
logged
Check audit
98%
Q
CAFM system
meets service
needs
Annual review
Positive report
A
System and
processes
comply with
evidenced best
practice
Annual review
Positive report
A
KPI: Work Management Center
Service
Summary*
Output
Required
Method of
Measurement
Event logging
and followthrough
Effective help
desk available
at required
times
Systems in
place and
operated
effectively
100%
compliant
uptime
A
Events
completed in
line with priority
time scales
Activity reports
98%
completion on
schedule
M
Availability of
activity reports
and data
Agreed
reporting
provided
100%
M
Customer
satisfaction
No complaints
Zero
complaints
M
*
Related back to specification and cross-referenced
**
Frequency key:
A = Annual
Q = Quarterly
M = Monthly
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Target
Required
Measure
Frequency**
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Chapter 4: Contracts in the Facility Organization
What is a service level agreement?
A service level agreement (frequently abbreviated as SLA) is a part of a
service contract where the level of service is formally defined. SLAs are a
negotiated agreement between the service provider (in-house or outsourced)
and the customer.
In an SLA, the service provider commits to deliver an agreed-upon level of
service. Levels of availability, serviceability, performance, operation or other
attributes may be included as formal requirements and targets. Time is a
common SLA metric. The level of service time may be specified as targets
and minimums.
Example: An SLA commitment to respond to replace fluorescent lights
might specify a range of four to eight hours. A snow removal SLA
commitment might be to complete all plowing, shoveling and sanding
by 5:00 a.m. on standard business days of operation.
The key in SLAs is to define the level of service that the provider should
deliver. SLAs also specify incentives and financial penalties. Once
defined, the levels can serve as benchmarks across multiple locations.
They may also be used to compare service delivery between an in-house
department and an external service provider.
Service level expectations should be reasonable and realistic. If, for
example, the building security system breaks down, a facility manager
would have a greater sense of urgency for a service provider to respond
than for a photocopier malfunction. When developing SLA targets for
outsourcing, it is prudent for a facility manager to solicit input from the
service provider to ensure that the expectations are practical.
The service contract may involve the right to terminate if SLAs are
consistently missed. Termination is normally only against specific failures
to achieve the agreed target KPIs (which is implied by the inclusion of the
word “key” in “key performance indicators”). But SLAs should also retain
flexibility to accommodate changes in customer requirements. In
outsourcing, they are often utilized as one of the primary tools for contract
governance.
Service level agreements are formal documents. Increasingly it is best
practice to split SLA issues between the specification and the performance
targets as shown previously in Exhibits 4-4 and 4-5.
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Finance and Business
Service level agreement terms mirror aspects of contracts. Typical inclusions
in an SLA are:
•
Agreement details (identification of the parties, effective date of the
agreement and duration).
•
Definitions.
•
•
Description of the scope of services to be provided.
Quality and performance-related targets.
•
•
Time targets—service priority categories and times.
Pricing—fees and payment terms.
•
Monitoring—performance measures and performance reports.
•
Meetings—customer/service provider communication.
•
•
Subcontracting provisions.
Incentives and penalties.
•
•
•
Procedures for revising the SLA.
Customer rating and feedback mechanisms.
Dispute resolution.
•
•
Default.
Transfer of responsibility.
Both parties should sign the SLA.
Facility managers’ roles in service specifications and SLAs
During the development of service specifications and SLAs, a facility
manager’s responsibilities may include (but are not limited to):
•
Identification and clarification of stakeholder interests relative to the
types of services required and the levels of performance considered
acceptable.
•
•
Definition of critical success factors and key performance indicators.
Consideration of other elements, such as:
•
•
How service effectiveness will be tracked.
•
•
How service-related disagreements will be resolved.
How information about service effectiveness will be reported and
addressed.
How the parties involved will review and modify the specification or
agreement as necessary.
Once service specifications and SLAs are in place and operational, a facility
manager’s responsibilities may include (but are not limited to):
• Serving as the point of contact for problems or concerns.
•
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Coordinating and implementing modifications.
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Chapter 4: Contracts in the Facility Organization
Contract cost
monitoring
•
Periodically assessing the effectiveness of mechanisms selected for
service tracking and reporting.
•
•
Planning and coordinating service reviews.
Regularly assessing and reporting on how the two parties can further
strengthen their working relationship and extend it to other areas.
•
Facilitating or participating in conflict resolution processes.
Cost monitoring goes along with performance monitoring. Monitoring of
contract expenditures includes activities such as (but not limited to):
•
•
Frequency of
performance and
cost monitoring
Ensuring that there are sufficient funds to pay for all services rendered as
required by contract.
Ensuring that invoices are paid consistent with the most favorable
contract payment terms.
•
Identifying low spending levels and reassignment of funds, if appropriate.
•
Ensuring that vendor payments are commensurate with the level of goods
and services received.
•
Reviewing vendor invoices and following the organizational and
departmental standard procedures for processing vendor payments.
Contract work is checked and monitored frequently enough to confirm that
the conditions of contract are satisfied and actual costs are tracked. Activity
levels are dictated by terms of the commitments and responsibilities as laid
out within the contract agreement. The driving factors in frequency are the
complexity and value of the contract.
Monitoring should be done so that:
•
Any discrepancies in the quality or timeliness of the work can be quickly
addressed and resolved.
•
Situations where the contractor requires unanticipated support (utilities,
space) or access to buildings, structures or grounds can be arranged to
minimize negative impact.
As circumstances warrant, monitoring may be daily, weekly, monthly,
quarterly or annually. Special monitoring activities may be appropriate as
well as site visits and audits.
Organizations customarily prepare reports to ensure that performance and
costs are monitored and controlled systematically. In Exhibit 4-6 we see a
sample of a simple performance scorecard; Exhibit 4-7 shows an example of a
cost control report. There are many ways to compile performance and cost
information. These are shown for illustrative purposes.
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Finance and Business
Exhibit 4-6: Sample Facility Management Service Scorecard
Property XYX Monthly Performance Service Scorecard
Vendor: ABC Elevator Repair
Month: March 20XX
Priority Weighting
Monthly Rating*
Score
(Weight x Rating)
Preventive maintenance
5
2
10
Response time to breakdowns
5
0
0
Service Criteria
Total score
10
Performance rating %
50%
(Actual total/maximum x 100)
*
0 = Below expectation
1 = Meets expectation
2 = Exceeds expectation
The overall score found in the Exhibit 4-6 performance scorecard could be
used in conjunction with a performance payment scale to reward the service
provider for scores that exceed expectations. Conversely, low scores might be
tied to penalties for not meeting minimum requirements. It should be clear as
to what triggers any adverse actions.
Exhibit 4-7: Sample Facility Management Cost Control Report
Property XYX Monthly Cost Control Report
Vendor: ABC Elevator Repair
Month: March 20XX
A
B
C
D
Annual
Contract
Sum
Changes
Anticipated
Expense
(A + B)
Gross
Value to
Date
Preventive
maintenance
€20,000
€5,000
€25,000
€12,000
PM program ahead of
schedule
Reactive maintenance
€10,000
—
€10,000
—
No reactive repairs to
date
Total
€30,000
€5,000
€35,000
€12,000
Service
Comments
(Amounts given in euros)
An organization’s accounting system and the various spreadsheets and
database management programs can be used to prepare cost monitoring
reports such as the Exhibit 4-7 sample.
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Chapter 4: Contracts in the Facility Organization
Numerous performance and financial measures are possible. The specific
ones implemented must be appropriate for the contract being managed. They
should be realistic and flexible and aligned to internal financial controls.
Facility managers should own the performance aspects of FM contracts and
the supplier relationships. Specific responsibilities may vary, depending on
the contract and the organization’s norms and policies. Facility managers
should also have at least some level of involvement in managing and
overseeing the legal and financial aspects of a contract.
Contract
closeout
Closeout is an important aspect of contract administration. Contract closeout
occurs when the termination conditions of the contract have been met (and
notice of termination served). It involves the completion of all administrative
actions, settlement of any disputes and resolution of any residual liabilities,
arrangements made for transfer of any continuing responsibilities and actions,
and approval for final payment.
Closeout represents the complete settlement of a contract. As with other
aspects of contract administration, the specific nature of the contract and
organizational norms will dictate the formality of the closeout and the facility
manager’s level of involvement.
During closeout, the contract terms should be reviewed to identify closeout
actions and any requirements for specialized activities (e.g., special property
issues, special payment issues, transfer of routine services). A facility
manager might well have responsibility for certification that all milestones
have been satisfactorily completed and that all deliverable items/reports have
been accepted. Review of expenditures and verification of the amounts as
appropriate is another typical responsibility. Closeout responsibilities will
vary from contract to contract.
Whatever the organizational and contract specifics, it is essential that a
facility manager have a clear understanding of requirements and
responsibilities and correctly execute any assigned closeout tasks. A simple
checklist of required tasks can help. Exhibit 4-8 shows a sample that is
generally applicable to contracts for project work. Outsourced contracts
would have some variations and a different process involving transfer of, for
example, equipment, data, records and (in some cases) staff carrying out the
service. Transfer requirements occur routinely in the European Union under
the Acquired Rights Directive.
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Finance and Business
Exhibit 4-8: Sample Facility Management Contract Closeout Checklist
Closeout Checklist
Contract: Elevator Maintenance
Recipient: ABC Elevator Repair
Performance period: January 1, 20XX, to December 31, 20XX
Task
Description
1
Final technical report received/accepted
2
All milestones satisfactorily completed
3
Disposition of classified material
4
Final voucher submitted
5
Method for verifying costs determined
6
Cost verification process completed
7
Final payment completed
8
Other requirements completed (Specify these)
9
Issuance of completion statement
10
Contract funds review completed and excess funds deobligated
Date Completed
Topic 3: Analyzing and Interpreting Financial Contract
Elements
Facility management contracts involve legal documents, and those documents
have financial implications. Managing the financial elements in procurement
contracts presents both risks and opportunities.
Terms of a contract are intended to frame a contract relationship and poise it
for success. But a contract alone cannot guarantee performance accountability
or the success of an outsourcing relationship. Relationship management skills
and understanding of the terms underlying the agreement (so as to achieve the
outputs the buyer requires while allowing the vendor to make a fair profit) are
important as well.
Most organizations have risk management departments or an individual with
assigned risk management responsibilities. Typically, a facility manager
supports the process by analyzing and interpreting financial contract elements
(lease agreements, service contracts, cost statements and so forth). To do so,
the facility manager needs to develop a clear picture of potential contract risks.
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Chapter 4: Contracts in the Facility Organization
This topic first explores the basic elements of risk management—how to assess
the likelihood that potential financial risks and other risk exposures have been
identified. As we will see, applying a systematic risk management approach
can help to identify and prioritize financial contract risks while improving the
collaboration between the organization and contractors. We then look at several
types of procurement contract management risks a facility manager should
understand.
Risk
management
To a certain degree, every facility manager is a risk manager, whether they
know it or not. They manage risks every day. But they become better risk
managers when they do it consciously, in a disciplined and consistent way.
Risk as it applies to contracts is the possibility of an event occurring that will
have a negative impact on the achievement of contract objectives. Just as no two
organizations are identical, individual contracts have different types of risk.
Further, risk does not present a single point estimate; it represents a range of
possibilities. Without a single outcome, the range is what creates uncertainty
when understanding and evaluating risk. Risk may relate to preventing bad
things from happening or failing to ensure that good things happen. Risks may
present threats to an organization or be the failure to achieve positive outcomes.
Facility managers need to recognize contract elements that warrant attention
as a potential risk or a real shortcoming. Risk management provides a process
to identify, assess, manage and control potential events or situations that
threaten the achievement of contract objectives.
When applied correctly, risk management provides a structured approach that
can help an organization:
•
Save money.
•
Improve decision making.
•
Protect or strengthen its reputation.
•
Reduce the possibility of personal accidents.
•
Reduce the chances of litigation.
•
Ensure that business continuity is maintained whenever possible.
Applied specifically to contracts, risk management facilitates the bidding and
award process. It gives service providers and suppliers a clearer picture of
potential risks and allows the organization to select the prospective service
provider or supplier that represents the best value to the organization. During
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Finance and Business
contract implementation and monitoring, risk management provides better
control. It increases the likelihood that contract objectives and goals will be
achieved and projects delivered on time.
Specific risk management approaches can vary. In addition to internal risk
management departments or personnel, there are many consultants and
organizations that offer risk management services as well as a variety of risk
management software applications. Invariably, risk management approaches all
have the same elements. While a facility manager is not directly involved in or
responsible for the entire risk management process, it is beneficial to understand
the principles of risk identification, categorization, assessment and response.
Risk identification
Risk identification answers the question, “What are the contract risks?” The
objective of risk identification is to search for and capture those risks that, if
they occurred, could threaten the business or specific projects, or simply
where uncertainty of outcome exists.
Risk identification starts before contracting begins with analyses of desired
contract outcomes, likely costs and risk vulnerabilities. The identification of
risks is ongoing and can occur at any point during contract execution.
Risk categorization
Categorization groups the identified FM contract risks into categories such as
(but not limited to):
•
•
Scope of services and nature of work.
Subcontracting.
•
•
Geography and vendor delivery capability.
Pricing and costing options.
•
Contract duration and renewal options.
•
•
Service and resource flexibility.
Vendor company failure.
•
Service failure.
•
Reputational risk.
•
Change and transition.
Categorizing risks in this manner facilitates subsequent assessment and
response. (We will examine these FM contract risks further in just a bit.)
Risk assessment
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Risk assessment (or risk analysis) is the identification and measurement of
risk and the process of prioritizing it.
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Risk is often assessed in terms of likelihood and impact:
•
•
Likelihood is the probability that a given event will occur.
Impact is the result or effect of an event; it relates to the magnitude of
risk (such as the materiality and potential dollar loss, potential
reputation or brand damage, or the importance of the related contract
objective).
Risk events are rated in terms of the likelihood and impact using:
•
•
Qualitative terms—continuums such as high to low or almost certain to
improbable and catastrophic to negligible.
Quantitative measures such as numerical scales of 1 to 5, percentages,
frequency of occurrence or other metrics.
Ratings may combine words and numbers in a risk rating as shown in
Exhibit 4-9.
Exhibit 4-9: Sample Risk Rating
Likelihood Rating
Likelihood
Impact Rating
Score
Impact
Score
Almost certain
5
Catastrophic
5
Likely
4
Critical
4
Moderate
3
Serious
3
Unlikely
2
Marginal
2
Improbable
1
Negligible
1
Sometimes organizations portray the risk factors in a graphical representation
such as the four-quadrant matrix shown in Exhibit 4-10.
Exhibit 4-10: Risk Map for Likelihood and Impact
High
High impact
Low likelihood
High impact
High likelihood
Low impact
Low likelihood
Low impact
High likelihood
Impact
Low
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Variations of the risk rating scales or the risk map are possible. Format
and specific terminology are not as important as developing an effective
risk assessment to evaluate risk events pertaining to contracts.
Contract risk assessment should answer three important questions:
•
To which party does the contract assign the risk of extra costs or time
for a particular event?
•
What is the likelihood of the event occurring?
•
What is the economic exposure to the risk-bearing party if the event
occurs?
Estimating likelihood and impact can be challenging; the process
involves professional judgment and a consistent application of rating
factors. No matter how risk assessment is done, the key is to objectively
assess risks in order to identify those that require management focus.
Risk response
Once risks are identified and prioritized, the next step is to consider the best
response to manage the risk. Risk response (sometimes called risk
mitigation) refers to the measures taken to avoid or reduce the impact of a
risk or to control the effects of a risk.
Risk can be managed in different ways. Customary risk responses are:
• Acceptance—accept and absorb the risk by identifying ways to
manage it such as establishing contingency plans.
•
Control (or reduce)—reduce the likelihood and potential negative
impact of the risk.
•
Transfer—share or transfer the risk to insurance or to other parties
(such service providers or suppliers through a contractual
arrangement).
•
Avoidance—identify ways to prevent risk exposure or exit the
activities giving rise to the risk.
Risk management can help to address a broad range of risks that a
contractual arrangement can create for the buying (client) organization.
The more diverse and complex an organization’s contracts, the more
challenging risk management becomes. But following a structured
approach like the one just presented will usually identify many
commonalities.
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Risks in facility
management
contracts
Next we revisit the list of risks customarily associated with FM contracts. In
an outsourcing relationship, a facility manager must understand the nature of
the contract risks in order to ensure that the vendor relationship is successful.
Scope of services
and nature of work
Whether a contract is for a single service or full service, the scope of services
and nature of work must be well-defined at the outset. These terms and
conditions specify what the contractor will do, by when and for how much.
The terms and conditions should also specify the measures and indicators to
be used to monitor the contractor’s performance. Contractors should have
sufficient time and information to assimilate the detail in the bid phase.
Single service situations with multiple individual contractors exponentially
multiple potential risk scenarios. Full-service contracts reduce the FM
interface required but present other contract concerns (such as potential loss
of control).
Example: An FM organization should require appropriate third-party
protection. This might involve guarantees, performance bonds and
evidence of appropriate insurance coverage.
Subcontracting
Some service providers may contract with third parties. FM can benefit from
the specialization of subcontractors, but there are risks associated with
subcontracting when services are distributed among parties with whom FM
has no direct relationship.
FM should be aware of and approve all subcontractors. To provide
accountability and reduce contract risk, the primary contracting service
provider should be designated in the contract. The contract should also
specify that the primary contracting service provider is responsible for the
services outlined in the contract regardless of which entity actually conducts
the operations. FM should also consider including notification and approval
requirements regarding any changes to the service provider’s significant
subcontractors.
Example: A contract should normally reserve the organization’s right
to terminate it in the event of a change in the controlling interest of the
contractor. Further, it should ensure that the contractor cannot assign
any part of the contract to another party without the organization’s
agreement.
The fundamental objective is to hold the primary service provider to the same
standard regardless of who performs the work. Therefore, the primary service
provider contract should require their subcontractors to meet the same
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obligations they are required to meet. Some of this risk may be mitigated by
requiring the contractor and any subcontractor to have quality assurance or
quality management systems in place.
Geography and
vendor delivery
capability
In all locations, competent and reliable vendors must be found. A
contractor is expected to provide services or complete the work with
certain operator/own/industry performance targets. If performance targets
are not achieved, customer dissatisfaction and other ramifications follow.
The nature of this risk can vary significantly in cross-border situations, as
vendors and their employees may have different attitudes and potential
cultural conflicts (e.g., clothing requirements). Compliance with local laws
and regulations and even political and social unrest in some areas of the
world also shape and influence vendor delivery capability.
Example: If a facility manager in the United States decides to
purchase furniture (e.g., tables, chairs and so forth) at a “good price”
from a Canadian vendor, the facility manager must understand that if
the vendor goes bankrupt, any funds previously paid and the legal
status for his/her claim will most likely be the last in line in the
Canadian Bankruptcy Court. Any down payment or related payment
funds may be lost, and the status of title to his/her furniture sitting in
the vendor’s warehouse may never be cleared.
Pricing and costing
options
When an organization procures services from a contractor, the type of
contract and the basis for payment influence the allocation of risks. Recall the
two broad categories of fixed price contracts, which are for items or tasks
that can be defined fully, and cost-reimbursement contracts, which are for
those that cannot.
Within the fixed price and cost-reimbursement categories, specific contract
types range from firm fixed price to cost plus fixed fee. Along this
continuum:
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•
In firm fixed price contracts, the contractor has full responsibility for the
performance costs and the resulting profit (or loss).
•
In cost plus fixed fee contracts, the contractor has minimal responsibility
for the performance costs and the negotiated fee (profit) is fixed.
•
In between, various incentive contracts (e.g., fixed price incentive fee,
cost plus) are based on the contractor’s responsibility for the performance
costs and the profit or fee incentives offered are tailored to the
uncertainties involved in contract performance.
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Examples: Consider how risk applies to the following contract types:
•
Fixed price/
lump sum
contracts
•
•
•
•
Costreimbursement/
reimbursable/
variable price
contracts
•
•
The contractor performs the work for a fixed
price that includes coverage for risks.
Risks to the buyer organization are minimized.
The contractor bears the greatest risks but
has the maximum profit potential.
The contractor has incentive to minimize costs
through efficient practices.
The buyer organization pays for all contract
costs, plus a fee for profit and overhead.
The buyer assumes considerable risk.
The level of risk sharing (and the contractor’s
incentive to control costs) depend on the type
of reimbursable contract.
Contract type reflects:
•
The degree and timing of the responsibility assumed by the contractor for
the costs of performance.
•
The amount and nature of the profit incentive offered to the contractor for
achieving or exceeding specified standards or goals.
In Exhibit 4-11 we see a graphic representation of contract types and the risks
associated with pricing and costing options.
Exhibit 4-11: Contract Types and Risks
High risk
Client
organization
risk
Contractor
risk
Contract Risks
(Technical and
Other
Performance
Uncertainties)
Low risk
Lump sum
Contract Types
Reimbursable
Ideally, the contract type and price (or estimated cost and fee) results in
reasonable contractor risk and provides the contractor with the greatest
incentive for efficient and economical performance.
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Contract duration
and renewal options
This type of contract risk involves understanding specifics about the contract
term—whether it has a specific end date and termination, automatic renewal
provisions, or continuance contingent on performance (as evaluated by the
client organization). Many risk considerations are a part of contract duration,
such as vendor learning curves, capital investments and amortization.
Example: Consider a contract life cycle. In a cleaning services (janitorial)
contract, it takes time for a new supplier to fully understand how a building
is used and thus how and when best to clean it. This learning curve may be
up to six months. At the contract end, reprocurement begins around 12
months ahead of the contract renewal date, so that vendors and their
management will tend to concentrate their efforts on contract bidding in
that last 12 months. The effect of this is that in a 36-month contract, only
18 months (half the duration) might be at the optimum levels of
performance. Facility managers will therefore seek to extend this period in
various ways, for example by extending the length of the contract term to
four or five years, by including specific performance-related extension
options, or by amending the reprocurement process to reduce the time
spent on bidding by the incumbent provider’s management.
Example: A vendor contract may have a statement that the contract will be
automatically renewed if the facility manager does not notify the vendor
within a specific time frame before the initial contract termination date. A
contract may add an automatic increase percentage to the cost of products
or services at the automatic renewal of the contract—again, unless
stopped by the facility manager per the contract requirements. A facility
manager should not agree to automatic renewals unless he or she sees a
specific benefit to the organization.
Service and
resource flexibility
Regarding the product or service provided, FM needs to consider what things
might change during contract duration. Are there foreseeable external events
that may warrant additional people on standby? Will there be extra associated
costs? Can there be substitutions in labor categories? (Or do labor regulations
prohibit substitutions?)
Examples: Types of things that might impact service needs can be either
short-term (flooding or other emergency; sudden changes in production
patterns to meet additional demands) or longer-term (an extended
economic recession). Or they may be structural to the client organization
(a merger with another company or the addition of operational capacity
by adding premises). Effective FM contracts deal with these
contingencies by having clear pricing structures that balance fairness for
both buyer and vendor, with the ability to predict and model price
changes based on the changed circumstances.
Vendor company
failure
If contractors have consistently low or negative profit margins and/or
accumulated losses, the result is a viability-threatening situation.
Example: A contract should describe the arrangements that would
facilitate another contractor to take over a service at short notice in the
event of the contractor’s financial failure.
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An effective prequalification process can help to establish a vendor’s
financial solvency and mitigate this risk.
Service failure
Minor mistakes or problems can (and do) happen in service execution. For
example, an individual piece of equipment (e.g., a single printer or desktop
computer) may break down. These do not necessarily constitute a service
failure. However, the consistent inability to manage a contract, repeated poor
performance versus the contractual intent, or an entire service becoming
unavailable (e.g., the entire printing service, Internet access and e-mail) are
service failures that pose potential serious risks.
Vendors should have a process with defined goals for response to service
failures. Contingency plans should be in place. For some situations, an
organization may need business continuity insurance.
Reputational risk
Bad press and a tarnished organizational image can result from
inappropriate vendor actions and noncompliance or from sourcing and
contracting failures. There are many reputation risks such as (but not
limited to):
• Discrimination against minorities.
•
•
•
Unequal treatment of men and women.
Violations of a drug-free workplace policy.
Noncompliance with immigration laws.
•
Occupational health and safety violations and/or inappropriate
corrective actions.
Contracts statements should specify that all duties are to be performed in
compliance with governing laws and regulations.
Example: In Mexico, the Mexican Federal Labor Law (FLL)
stipulates minimum working conditions that cannot be waived by
employees and concerns both individual working and collective
(organized by a labor union) relationships. Under provisions of the
FLL, maximum working time is set to six days, 48 hours per week.
General contract provisions should state that the contractor and all
subcontractors must be in compliance with the terms of the law
during the full term of the agreement.
Change and
transition
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Contracts should have an appropriate mobilization process. There should be
provisions for the transfer of assets at the contract start and end as well as
mechanisms for dispute resolution and arrangements for transition to a
succeeding contractor at the end of the contract.
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Some transitions are subject to regulatory requirements.
Example: In the United Kingdom, a contract must accommodate
provisions of the Transfer of Undertakings (Protection of Employment)
Regulations, which protect the rights of employees in relevant transfer
situations. Generally referred to as TUPE, the regulations preserve
the continuity of employment for employees with the same terms and
conditions as their former job. To comply with TUPE, a contract
should stipulate that the existing contractor will have to provide other
tenders (bidders) with information about staff who would transfer to
them.
(TUPE is the U.K. application of the European Union Acquired
Rights Directive. Member states in the EU are bound to transpose
EU directives into national law. As such, other EU member states
may have national laws governing transfers.)
Good transition management should provide for a seamless implementation
with minimal disruption. Typically, considerations to facilitate a smooth
transition to a new contract commence during the planning stage of the
procurement and continue throughout the procurement process. The
process continues following the awarding of the contract.
Large, complex contracts, with significant transitional issues or where
major change is involved, may necessitate a contract transition plan to
identify key issues, risks, tasks, responsibilities, resources, time frames,
policies and procedures and so forth.
A contract should be flexible enough to accommodate client-approved
changes. But it should also describe what will happen should the vendor
default on any terms of sufficient magnitude that require the organization
to change from that vendor to another. In other words, the contract should
plan for an exit and transition process (e.g., the change and transition
procedures for poor performance).
Example: It is not unusual for a janitorial contractor to begin
their work with great effort and care. Over time, this effort and
care may decline to the point where the facility manager
observes performance problems and may start receiving
complaints from internal customers. The contract must provide a
notice period for the vendor to improve and provide the level of
service agreed. If this does not happen, the facility manager
must have the ability to quickly and formally replace this vendor
with a change and transition process that does not disrupt his or
her customers.
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Communication is also important in any contract change and transition. A
facility manager should be prepared to facilitate communications regarding
new contract arrangements with all stakeholders, including:
• The new contractor.
•
The previous contractor (if relevant).
•
•
Staff impacted by the change.
Clients impacted by the new contract arrangements.
The organization’s finance and legal personnel would, of course, be involved
to ensure that appropriate details are in place. Communication helps to ensure
that all stakeholders are aware of the changes, that any issues are identified
early, and that the new arrangements are implemented as smoothly as
possible.
Importance of
examining
financial
contract
elements
The establishment of any contract creates a range of issues and potential risks
that need to be managed. A facility manager needs to review contracts to
understand the conditions, what potential risks exist, and how much risk the
organization can accept.
When facility managers analyze and interpret financial contract elements
(lease agreements, service contracts, cost statements and so forth), it allows:
• The terms of the agreements to be clearly understood in reference to their
financial, risk and security implications.
• An understanding of the controllable and variable items in the contract to
aid cost and resource flexibility.
• Identification and prevention of situations or requests that violate the
terms of the agreement.
•
•
Identification and improved control over (or avoidance of) situations or
requests that may impact the budget through increased costs due to
unplanned time, usage or additional services.
Appropriate review of situations or requests that may reduce costs to
determine that all contracted services have been met satisfactorily and
that a reduction in billed services is appropriate.
Analyzing and interpreting financial contract elements in the context of a
systematic risk management strategy helps to address a broad range of issues
and risks in contract relationships. In fact, it has been said that a good risk
management program is not about holding a vendor’s feet to the fire but
rather sharing the warmth of the fire. It can facilitate collaboration rather than
“policing.”
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There is great potential for many mutual benefits through systematic risk
management. Among the possibilities are:
•
•
Reduced contract risks.
Increased revenues.
•
Reduced costs and fewer cost overruns.
•
Improved contract performance.
•
•
Improved compliance.
Strong communication and trust between all parties.
Topic 4: Resolving Vendor Conflicts
Nature of
vendor
conflicts
There’s an idiomatic expression in the English language that perfectly
applies to vendor conflicts in facility management: “An ounce of prevention
is worth a pound of cure.” Generally, the expression means that is better to
try to avoid problems in the first place rather than to try to fix them once
they arise.
As we have read, a facility manager may have a variety of administration,
management and oversight responsibilities associated with contracts. It’s
certainly in the best interest of all parties involved—the organization, the
contractor and the facility manager—if conflicts can be prevented.
Conflict can generally be described as the perceived absence of a prominent
alternative. When two or more parties are in conflict, they tend to believe that
what each wants is fundamentally incompatible with what the other wants.
From this belief stems a common misunderstanding: that conflict is inherently
negative. This is not necessarily the case.
Constructive and
dysfunctional
conflict with
vendors
Conflict is an inevitable part of interactions with vendors. Resolving conflict
is seldom easy. But the way conflict is handled is what distinguishes between
constructive experiences and dysfunctional ones for both parties.
As the name implies, constructive conflict (or positive conflict) leads to
beneficial results. Constructive conflict can transform the ways in which
individuals interact and improve the quality of conflict outcomes. Examples
of such positive outcomes include:
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•
Surfacing important problems during contract execution so they can be
addressed.
•
Thorough problem analysis and decision making.
•
More effective collaboration and partnering and contract outcomes.
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Conversely, dysfunctional conflict (or destructive conflict) leads to
experiences that erode relationships and derail progress toward goals. It is
detrimental to both parties and ultimately has a negative impact on contract
execution and outcomes. In situations where dysfunctional conflict surfaces, a
facility manager needs to take quick action to diffuse the situation and
minimize the impact and any negative consequences that can result.
Some organizations may try a partnering process such as a conflict dispute
avoidance strategy to minimize conflict occurrences. Through partnering, a
neutral individual facilitates exchanges to help parties anticipate likely
sources of potential disputes in order to prevent them.
Unfortunately, in practice, avoiding issues that lead to conflict and contract
disputes is often easier said than done. Even very carefully drafted contracts
do not always succeed in preventing contract disputes. The key is to
proactively manage conflict when it arises and mitigate escalation. Discussion
of the issues at hand and negotiation can sometimes help the parties resolve
the matter and achieve an agreeable outcome. If not, there is contract dispute
resolution.
Contract
dispute
resolution
The potential scope of disagreements involving some aspect of a vendor
contract can range from small claims to large litigious situations and appeals.
Most organizations and vendors do not want to become involved in lawsuits.
Litigation can entail lengthy delays, high costs, unwanted publicity and ill
will. Reflecting on the earlier content explaining contract terms, vendor
contracts should have a dispute resolution clause—a specified alternate
protocol for handling any claims that may arise during the contract term.
Alternative dispute resolution (commonly referred to as ADR) is a term
encompassing a variety of techniques for resolving disputes without litigation.
Common ADR procedures found in facility management vendor contracts
include management escalation, mediation, arbitration or some combination.
•
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Management escalation. It is generally thought that the quality of the
contract management is often the difference between issues being quickly
and easily resolved and issues swirling and turning into a major dispute.
The contract itself should facilitate this by making clear who is
responsible for contract management on both sides and by allowing for
appropriate management escalation of issues.
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Throughout contract execution, the parties should clearly document all
changes and address problems. A provision for escalation to senior
management in both parties is often the first action to deal with issues as
they arise. Resolving issues through private management discussions is
preferable to allowing them to grow into something larger.
•
Mediation. Mediation is a method in which the parties to a dispute reach
a voluntary settlement with the help of a skilled facilitator. Mediation
proceedings are confidential and private. Mediation may be binding or
not.
In nonbinding mediation, the mediator’s role is advisory. The mediator
may offer suggestions, but resolution of the dispute rests with the parties
themselves.
A binding mediation process can often achieve a final resolution to a
dispute in one session. This method allows the parties to directly
participate in the mediation process from beginning to end with the
assistance of a trained mediator. If at the end of the mediation session,
any issues remain unresolved, the mediator makes the final and binding
decision(s). An advantage of binding mediation is that it is carried out
without the formality, extra expense and extra time needed for arbitration.
•
Arbitration. Arbitration is submission of a dispute to one or more qualified
and impartial persons for a final and binding decision. Arbitrators may be
attorneys or persons with expertise in a particular field. In arbitration, the
parties control the range of issues to be resolved by arbitration, the scope of
the relief to be awarded, and many of the procedural aspects of the process.
Arbitration is less formal than a court trial. The hearing is private. Few
awards are reviewed by the courts because the parties have agreed to be
bound by the decision of their arbitrator. In some cases, it is prearranged that
the award will be only advisory.
Sometimes a contract dispute resolution clause will specify graduated terms
and certain processes for specified dollar amounts. A graduated clause might
specify binding mediation to settle all disputes under a specified dollar
amount and arbitration for all disputes over a specified dollar amount. Again,
the goal of all of these alternatives is to address the needs of parties involved
in contract disputes and avoid court proceeding.
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An additional caveat about the dispute resolution clause in the contract deals
with the selection of the mediator and arbitrator. Many think that there is a
definite advantage to have a mediator or arbitrator who has extensive experience
in the particular field. As an example, if the dispute is of a specialized nature
such as green building/remodeling, it would be wise to have a mediator or
arbitrator who has experience in the construction industry and sustainability.
Dispute resolution is often described as a continuum:
•
At one end of the continuum (although not very common), disputes never
arise.
•
At the other end of the continuum, a solution is imposed upon the parties
to a dispute by the public courts.
•
The various dispute resolution alternatives are found in between.
In Exhibit 4-12 common dispute resolution clauses are listed.
Exhibit 4-12: Common Types of Dispute Resolution Clauses for FM Contracts
•
•
•
•
•
•
•
Management escalation
Mediation (nonbinding)
Binding mediation
Mediation (premediation binding mediation or
arbitration elective); parties share expenses
Mediation (premediation binding mediation or
arbitration elective); parties share expenses
up to the binding mediation or arbitration
award
Arbitration (split fees and costs)
Arbitration (prevailing party receives fees and
costs)
•
•
•
•
Arbitration—three arbitrators (for anticipated
large disputes)
Performance guidelines and arbitration
Performance guidelines and binding
mediation
Binding mediation or arbitration (graduated
processes)
Provisions for:
Disputes less than (amount)
Disputes over (amount)
but less than
(amount)
Disputes over (amount)
As they are shown here, the types are self-explanatory. What is drafted in the
actual clause is key. In the United States and many other countries, when
parties agree to an ADR process to settle all disputes they give up their right
to a trial by a judge or jury. All contract dispute clauses generally include
verbiage acknowledging that the parties are knowingly forfeiting their right to
use the court system.
Example: Mindful of the high cost of litigation, not only in dollars but
also in time and energy, the parties intend to and do hereby establish
the following out-of-court alternate dispute resolution procedure to be
followed in the event any controversy or dispute should arise out of or
relating to this contract or relating to any change orders or other
changes or addendums to this contract.
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This verbiage should not be construed as legal advice. It is shown here merely
as an example. Given the significance of including a statement like this in a
contract, organizational legal counsel should always review and approve a
dispute resolution clause before a contract is signed.
Alternative dispute resolution allows parties to customize the process. A
facility manager needs to understand the specific terms of the dispute
resolution clause in a vendor contract. Should the situation arise that a
contract disagreement necessitates dispute resolution, the facility manager
should work to ensure that:
•
•
The resolution process complies with the terms in the agreement.
The cause of the dispute is clarified and confirmed.
•
The dispute is resolved with little or no negative impact on the work
schedule or inconvenience to occupants.
The dispute does not negatively impact other work being done.
•
Dispute resolution provides the potential for a simpler, more expeditious, and
less expensive process than litigation through the court system. Well
executed, it has the potential to yield a more fair and equitable decision or
award than would be rendered through litigation.
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Progress Check Questions
Directions: Read each question and respond in the space provided. Answers and page references follow
the questions.
Match the following contract terms with their description.
1.
Competent parties
2.
Consideration
3.
Breach
a. Something of legal value must be offered by one party
and accepted by another.
b. Any of the terms or conditions of a contract may not be
violated without legal excuse.
c. Individuals entering into the contract must be of legal age
and must be able to understand the nature or
consequences of their actions in the contract.
4. A contract where both parties promise to do something—one promise is given in exchange for
another—is described as
( ) a. open book.
( ) b. bilateral.
( ) c. fixed.
( ) d. unilateral.
5. Which of the following items would not be part of the general condition clauses in a construction
contract?
( ) a. Change orders
( ) b. Specifications control over drywall drawings
( ) c. Terms of progress payments
( ) d. Alternate dispute resolution mechanisms
6.
Which type of contract would be used for frequently required trade tasks and not one-time annual
services?
( ) a. Prescriptive contract
( ) b. Unique service award
( ) c. IDQLI contract
( ) d. Evaluated bid award
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7. A labor strike has disrupted a construction project. Which contract provision suspends or excuses a
contract party’s performance?
( ) a. Novation clause
( ) b. Terms for incentives and penalties
( ) c. Indemnification agreement
( ) d. Force majeure clause
8. A facility manager is assessing a contractor’s performance for an elevator maintenance contract. All
of the following would be valid performance evaluation criteria except
( ) a. car speed.
( ) b. receipt of an industry award.
( ) c. service level expectations.
( ) d. door operation.
9. True or false? Service level agreements reflect expectations for the quality, performance and value of
service; service specifications reflect standards of service required.
( ) a. True
( ) b. False
10. Which of the following statements describes risk assessment?
( ) a. Ongoing management activities that set the basis for how risk is viewed
( ) b. Identification of measures to control the effects of a risk
( ) c. The analysis of risks, considering likelihood and impact
( ) d. Defining ways to transfer ownership of a risk to a third party
Match the dispute resolution technique with its application.
11.
Binding mediation
12.
Arbitration
13.
Graduated processes
a. Any dispute over $10,000 but less than $50,000 in
value shall be subject to mediation followed by
binding arbitration.
b. A binding award is rendered upon the parties that is
enforceable in any court of competent jurisdiction.
c. This final resolution process will allows the parties to
work together with the assistance of a trained
facilitator.
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Chapter 4: Contracts in the Facility Organization
Progress check answers
1. c (p. 154)
2. a (p. 154)
3. b (p. 155)
4. b (p. 155)
5. b (p. 157)
6. c (p. 160)
7. d (p. 163)
8. b (p. 174)
9. a (p. 175)
10. c (p. 189)
11. c (p. 200)
12. b (p. 200)
13. a (p. 200)
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Bibliography
The following resources were used during the development of the Finance and Business course.
Anderson, D. Brent, Jeffrey L. Campbell, Carol E. Farren, Christopher P. Hodges, Jon Hosford,
Scott Hulick, Diane H. MacKnight, Jon Martens, Anne M. Moser, and James P. Whittaker.
The Business of FM. Houston, Texas: International Facility Management Association
(IFMA), 2006.
Ansari, Shahid, and Carol Lawrence. Cost Measurement Systems: Traditional and
Contemporary Approaches. New York: Irwin/McGraw Hill, 1999.
Anthony, Robert N., and Vijay Govindarajan. Management Control Systems, 11th edition. New
York: Irwin/McGraw Hill, 2004.
“Asset Lifecycle Model for Total Cost of Ownership Management—Framework, Glossary and
Definitions,” www.ifma.org/know-base/fm-knowledge-base/knowledge-base-details/assetlifecycle-model-for-total-cost-of-ownership-management.
Atkin, Brian, and Adrian Brooks. Total Facilities Management, 3rd edition. Chichester, United
Kingdom: Wiley-Blackwell, 2009.
Baker, H. Kent, and Gary E. Powell. Understanding Financial Management: A Practical
Guide. Malden, Massachusetts: Blackwell Publishing, 2005.
Barringer, H. Paul. “A Life Cycle Cost Summary,” Barringer & Associates, Inc., 2003,
www.barringer1.com/pdf/LifeCycleCostSummary.pdf.
Blocher, Edward J., Kung H. Chen, and Thomas W. Lin. Cost Management: A Strategic
Emphasis, 2nd edition. New York: Irwin/McGraw Hill, 2002.
“Business Contracts Legal Terms and Definitions Glossary,” www.businessballs.com/
businesscontractstermsdefinitionsglossary.htm.
Clayton, John. “Crafting a Powerful Executive Summary.” Harvard Business School Working
Knowledge, hbswk.hbs.edu/archive/3660.html.
Cotts, David, and Edmond P. Rondeau. The Facility Manager’s Guide to Finance and
Budgeting. New York: AMACOM, 2003.
Cotts, David G., Kathy O. Roper, and Richard P. Payant. Facility Management Handbook, 3rd
edition. New York: AMACOM, 2010.
© 2015 IFMA
All rights reserved
206
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Bibliography
Epstein, Shari F. Benchmarks V, Annual Facility Costs—Research Report #30. Houston, Texas:
International Facility Management Association (IFMA), 2008.
Fuller, Sieglinde. “Life-Cycle Cost Analysis (LCCA),” National Institute of Standards and
Technology (NIST), www.wbdg.org/resources/lcca.php.
Garrison, Ray H., and Eric W. Noreen. Managerial Accounting, 10th edition. Boston: McGraw
Hill/Irwin, 2003.
Harvard Business Essentials. Finance for Managers. Boston, Massachusetts: Harvard Business
School Press, 2002.
Hoots, Michael L. Finance for Facility Managers: An IFMA Competency-Based Course.
Houston, Texas: International Facility Management Association (IFMA), 2006.
Horngren, Charles T., George Foster, and Srikant M. Datar. Cost Accounting, 12th edition.
Upper Saddle River, New Jersey: Pearson Prentice Hall, 2006.
Kieso, Donald E., Jerry J. Weygandt, and Terry D. Warfield. Intermediate Accounting, 10th
edition. New York: Wiley, 2001.
Legal HelpMate. “Legal Dictionary,” www.legalhelpmate.com/legal-dictionary-result.aspx?
legal=Contract-Law.
“Life-Cycle Cost Analysis Primer,” Office of Asset Management, U.S. Department of
Transportation, August 2002, isddc.dot.gov/OLPFiles/FHWA/010621.pdf.
Martin, David M. The A–Z of Facilities and Property Management. London: Thorogood
Publishing, 2006.
McWatters, Cheryl S., Dale C. Morse, and Jerold L. Zimmerman. Management Accounting:
Analysis and Interpretation. Boston: McGraw-Hill Irwin, 2001.
Melaver, Martin, and Phyllis Mueller, editors. The Green Building Bottom Line: The Real Cost
of Sustainable Building. New York: McGraw Hill, 2009.
Mowen, Maryanne M., and Don R. Hansen. Management Accounting: The Cornerstone for
Business Decisions. Mason, Ohio: Thomson/South-Western, 2006.
Nutt, Bev, and Peter McLennan, editors. Facility Management: Risks and Opportunities.
London: Blackwell Science, 2000.
Record Information Services. “Glossary of Legal Terms,” www.public-record.com/
content/general/legalterms.asp.
© 2015 IFMA
All rights reserved
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Finance and Business
Rondeau, Edmond P., Robert Kevin Brown, and Paul D. Lapides. Facility Management, 2nd
edition. Hoboken: New Jersey: John Wiley and Sons, 2006.
Roper, Kathy O., Jun Ha Kim, and Sang-Hoon Lee. Strategic Facility Planning: A White Paper
on Strategic Facility Planning, Houston, Texas: International Facility Management
Association (IFMA), 2009.
Schmidt, Marty J. Business Case Essentials, 3rd edition. Boston: Solution Matrix Ltd., 2009.
Theriault, Michel. “Sparring Partners.” Building Operating Management, May 2010.
United States Department of Justice Antitrust Division. “Price Fixing, Bid Rigging, and Market
Allocation Schemes: What They Are and What to Look For,” www.justice.gov/atr/public/
guidelines/211578.pdf.
Van Horne, James C., and John M. Wachowicz, Jr. Fundamentals of Financial Management,
11th edition. Englewood Cliffs, New Jersey: Prentice-Hall Inc., 2004.
Zechnich, David, and Chris Lee. “Contract Risk and Compliance For All (Economic) Seasons.”
Financial Executive, September 2009, www.deloitte.com/assets/Dcom-UnitedStates/
Local%20Assets/Documents/AERS/us_aers_foct_crc_FEIreprint.pdf.
© 2015 IFMA
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Index
benchmarking
and business case, 89
state/cross-border, 57–58
benefits/costs, quantifying in business case, 86–97
benchmarking, 89
best value, 87
capital investments, 90, 93–97
life-cycle costing (LCC), 87–89
time value of money, 90–93
best value, 87
bid
rigging, 166–167
rotation, 167
suppression, 166
bidding
competitive, 169
complementary, 167
bilateral contracts, 155
blanket purchase orders, 157–158
BPOs (blanket purchase orders), 157–158
budgetary controls, and fraud/irregularities in
contracts, 170
budgeting, 33, 34–37
activity-based, 51
and facility management, 51–53
fixed, 48
incremental, 7, 49
multinational considerations, 56–58
state/cross-border, 57–58
variable, 48
zero-based, 9, 50–51
budget(s), 5, 33–34, 35
analysis, 53–55
approaches, 37–40
assumptions, 39–40
capital, 5, 45–46
closeout, 55–56
expense projections, 47
methods, 49–51
monitoring, 53–55
operating, 8, 40–44
periods, 48–49
revenue projections, 47
types of, 40–46
business, 3
business cases, 83–84
components of, 84–86
costs/benefits, quantifying, 86–97
sample, 99–103
A
ABC. See activity-based costing
accelerated depreciation, 76
accounting, 5, 10
accrual basis, 5, 56
cash basis, 56
cycle, 26–28
double-entry, 6, 23–26
financial, 7, 11–12
goals of accounting system, 10
management, 8, 11–14
principles for financial statements, 29–30
records, 17–23
standards, 14–17
accounts, chart of, 5, 17–21
accounts payable journal, 22
accrual basis accounting, 5, 56
accumulation, cost, 109
acid-test ratio, 119–120, 124
activity method of depreciation, 76
activity-based budgeting, 51
activity-based costing, 109–110, 113–115
advantages/disadvantages, 115
allocation, 114
apportionment, 115
ADR (alternative dispute resolution), 199–202
agreement to enter into contract, 155
allocation
in activity-based costing, 114
base, 106
cost, 109
alternative dispute resolution, 199–202
annual budget analysis, 54
annual work plan, 41–43
apportionment, in activity-based costing, 115
arbitration, 200, 201
asset management ratios, 120, 124
assets, 5
in balance sheet, 66
capital, 5, 45, 78–79
in chart of accounts, 17–18
assignment, cost, 109
audited financial statements, 61–62
authoritative budget approach, 38
average inventory turnover, 120, 124
AWP (annual work plan), 41–43
B
balance sheet, 5, 62, 63, 66–70, 79
balance, trial, 9, 27, 28
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Finance and Business
contract(s) (continued)
duration, 194
and e-mail, 156
examining elements of, 197–198
express, 155
fixed price, 158–159
fraud in, 165–172
IDQLI (indefinite delivery quantity, line item),
159–161
implied, 155
indefinite delivery quantity, line item, 159–161
informal, 156
irregularities in, 165–172
mechanisms, 156–161
monitoring, 173–185
mutual agreement, 154
mutual right to remedy, 155
national buy, 161
performance monitoring, 174–183
prescriptive, 156
proper subject matter, 154
purchase orders, 157–158
renewal options, 194
risk management, 187–198
service, 175
service level agreements, 175, 181–183
service specifications, 175, 176–180, 182–183
terms, 162–165
unenforceable, 155
unilateral, 155
void, 155
voidable, 155
cost allocation systems. See cost(s): measurement
systems
costing
activity-based, 109–110, 113–115
job, 111, 112
job order, 111, 112
life-cycle, 87–89
options, in facility management contracts, 192–
193
process, 111–112
traditional, 109–112
cost-reimbursement contracts, 159
cost(s), 5, 104, 105
accumulation, 109
allocation, 109
assigning to cost objects, 107–108
assignment, 109
containment, 126–129
decision making, use in, 116–117
differential, 116
direct, 107
drivers, 106
fixed, 7, 48, 106–107
indirect, 107–108
C
capital assets, 5, 45, 78–79
capital budget, 5, 45–46
capital expenditures, 45, 90
capital investments, 90, 93–97
and capital rationing, 94
and cash flow, 93
independent vs. mutually exclusive, 93
and risk, 94, 97–99
capital projects, and due diligence, 46
capital rationing, 94
capitalization vs. expense, 77–78
cartels, 168
cash basis accounting, 56
cash disbursement journal, 21
cash flow(s), 5
and capital investments, 93
forecasting, 80–81
statement of, 9, 62, 63, 70–72, 79
cash receipts journal, 21
CEN (European Committee for Standardization), 57–
58
change and transition, in facility management
contracts, 195–197
change order controls, and fraud/irregularities in
contracts, 169–170
chargebacks, 129
advantages/disadvantages, 130
facility manager’s role, 131–132
systems, 130–131
chart of accounts, 5, 17–21
closeout
of budgets, 55–56
of contracts, 185–186
collusion, 165–166
combined budget approach, 37, 38
comparability, and generally accepted accounting
principles, 16
competent parties, in contracts, 154
competitive bidding/tendering, 169
complementary bidding, 167
consideration, in contracts, 154
consistency, and generally accepted accounting
principles, 16
containment, cost, 126–129
contract(s), 153–154, 186–187
administration, 172–186
agreement to enter into, 155
bilateral, 155
closeout, 185–186
competent parties, 154
consideration, 154
cost monitoring, 183–185
cost-reimbursement, 159
dispute resolution, 199–202
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Index
cost(s) (continued)
measurement systems, 108–115
mixed, 107
monitoring, in contracts, 183–185
object, 106
opportunity, 9, 116–117
relevant range, 106
semivariable, 107
sunk, 117
total, 107
tracing, 109
unit, 109
variable, 9, 48, 105
costs/benefits, quantifying in business case, 86–97
credit, 6, 23, 24, 25
cross-border benchmarking/budgeting, 57–58
cross-charging. See chargebacks
current ratio, 118–119, 124
cycle, accounting, 26–28
facility management (continued)
investments, “smoothing,” 81–82
and management accounting, 12–14
metrics, 125–126
outsourcing, 143–150
facility managers
role in chargebacks, 131–132
role in finance/business, 1–2, 3–4
role in service specifications/service level
agreements, 182–183
finance, 3
financial accounting, 7, 11–12
financial leverage, 7, 67
financial operations, guidelines for, 82
financial statements, 7, 28, 59–60, 62–63
accounting principles for, 29–30
audited, 61–62
balance sheet, 5, 62, 63, 66–70, 79
external, 60
income statement, 7, 62, 63–66, 79
internal, 60
notes to, 72–73
pro forma statements, 9, 79–82
ratio analysis, 118–125
statement of cash flows, 9, 62, 63, 70–72, 79
statement of shareholders’ equity, 9, 62, 63
financial terminology, 4–9
fixed budgeting, 48
fixed costs, 7, 48, 106–107
fixed price contracts, 158–159
forecasting, 35, 80–81
fraud/irregularities, in contracts, 165
and authorization, 169
bid rigging, 166–167
bid rotation, 167
bid suppression, 166
and budgetary controls, 170
cartels, 168
and change order controls, 169–170
collusion, 165–166
competitive bidding/tendering, 169
complementary bidding, 167
and documentation, 169
indicators of, 170–172
irregularities during execution, 167
noncompetitive pricing, 166–167
payment for work not carried out, 167
phantom charges, 167
price fixing, 166
and record keeping, 169
and segregation of duties, 168
subcontracting, 167
full disclosure, 30
future value, 91–92
FV (future value), 91–92
D
debit, 6, 23, 24, 25
depreciation, 6, 73–77
accelerated, 76
activity method, 76
Modified Accelerated Cost Recovery System,
77
straight-line method, 76
and tax rules, 75–76
differential costs, 116
direct costs, 107
discounting methods, 94, 95, 96
dispute resolution, 199–202
double-entry accounting, 6, 23–26
drivers, cost, 106
due diligence, and capital projects, 46
E
earned, in accrual basis accounting, 30
e-mail, and contracts, 156
equity, 6, 67
European Committee for Standardization, 57–58
expenditures, capital, 45, 90
expense(s), 7
in chart of accounts, 19
operational, 90
projections of, 47
vs. capitalization, 77–78
express contracts, 155
external financial statements, 60
F
facility management
and budgeting, 51–53
cost containment opportunities, 127
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Finance and Business
life-cycle costing, 87–89
liquidity/short-term debt ratios, 118, 124
acid-test ratio, 119–120, 124
current ratio, 118–119, 124
quick ratio, 119–120, 124
G, H
GAAP (generally accepted accounting principles), 7,
15–16, 74
generally accepted accounting principles, 7, 15–16, 74
geography and vendor delivery capability, in facility
management contracts, 192
gross profit margin, 121, 124
hard and soft service split model of FM outsourcing,
144–145
historical cost, 29
M
MACRS (Modified Accelerated Cost Recovery
System), 77
management accounting, 8, 11–14
management escalation, and contract dispute
resolution, 199–200
managing agent model of FM outsourcing, 145
matching principle, 75
mediation, 200, 201
midyear budget analysis, 54
mixed costs, 107
Modified Accelerated Cost Recovery System, 77
monthly budget analysis, 54
mutual agreement, in contracts, 154
mutual right to remedy, in contracts, 155
mutually exclusive vs. independent capital
investments, 93
I
IDQLI (indefinite delivery quantity, line item)
contracts, 159–161
IFMA FMP Credential Program, 1
IFRS (International Financial Reporting Standards),
8, 15
implied contracts, 155
income statement, 7, 62, 63–66, 79
incremental budgeting, 7, 49
indefinite delivery quantity, line item contracts, 159–
161
independent vs. mutually exclusive capital
investments, 93
indirect costs, 107–108
informal contracts, 156
internal financial statements, 60
internal rate of return, 8, 94, 95, 96
International Financial Reporting Standards, 8, 15
inventory purchases journal, 22
invitation to tender, 139
IRR (internal rate of return), 8, 94, 95, 96
irregularities, in contracts. See fraud/irregularities, in
contracts
ITT (invitation to tender), 139
N
national buy contracts, 161
nature of work, in facility management contracts, 191
net assets, in chart of accounts, 18
net present value (NPV), 8, 94, 95, 96, 98
net profit margin, 122, 124
noncompetitive pricing, 166–167
nondiscounting methods, 94, 95, 97
notes to financial statements, 72–73
NPV. See net present value
O
J, K, L
object, cost, 106
one-time purchase orders, 157–158
operating budget, 8, 40–44
operating profit margin, 121, 124
operational expenses, 90
opinions, in audited financial statements, 61
opportunity costs, 9, 116–117
outsourcing, facility management, 143, 149–150
advantages/disadvantages, 148–149
hard and soft service split model, 144–145
managing agent model, 145
principal contractor model, 146
reasons for, 147–148
self-delivery total FM model, 146–147
traditional in-house delivery model, 144
job costing, 111, 112
job order costing, 111, 112
journal(s), 8, 21–23
accounts payable, 22
cash disbursement, 21
cash receipts, 21
entries, 8, 22–23
inventory purchases, 22
payroll, 22
key performance indicators, 180, 181
KPIs (key performance indicators), 180, 181
LCC (life-cycle costing), 87–89
lease or purchase considerations, for capital assets,
78–79
ledgers, 8, 21
liabilities, 8
in balance sheet, 67
in chart of accounts, 18
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P, Q
participative budget approach, 38
payback method, 95, 97
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Index
payment for work not carried out, 167
payroll journal, 22
performance monitoring, in contracts, 174–183
performance specifications, 177
phantom charges, 167
prescriptive contracts, 156
prescriptive specifications, 176
present value (PV), 9, 91–92
price fixing, 166
pricing
and costing options, in facility management
contracts, 192–193
noncompetitive, 166–167
principal contractor model of FM outsourcing, 146
pro forma statements, 9, 79–82
process costing, 111–112
procurement, 136–137
and facility management outsourcing, 143–150
principles, 137–138
process, 138–142
sustainable practices, 138
profitability ratios, 120–121, 124
gross profit margin, 121, 124
net profit margin, 122, 124
operating profit margin, 121, 124
proper subject matter, in contracts, 154
purchase or lease considerations, for capital assets,
78–79
purchase orders, 157–158
PV (present value), 9, 91–92
qualified opinion, in audited financial statement, 61
quarterly budget analysis, 54
quick ratio, 119–120, 124
return on assets, 122–123, 124
return on capital employed, 123–124
return on equity, 123, 124
return-on-investment ratios, 122, 124
revenue(s), 9
in chart of accounts, 18
projections of, 47
recognition, 29–30, 75
RFP (request for proposal), 139
RFQ (request for quotation), 139
risk
assessment, 188–190
and capital investments, 94, 97–99
categorization, 188
in facility management contracts, 191–197
identification, 188
management, 187–198
reputational, 195
response, 190
ROA (return on assets), 122–123, 124
ROCE (return on capital employed), 123–124
ROE (return on equity), 123, 124
S
Sarbanes-Oxley Act, 59–60
scenario analysis, 97–98
scope of services, in facility management contracts,
191
segregation of duties, and fraud/irregularities in
contracts, 168
self-delivery total FM (TFM) package model of FM
outsourcing, 146–147
semivariable costs, 107
sensitivity analysis, 98–99
service contracts, 175
service failure, 195
service level agreements, 175, 181–183
service/resource flexibility, in facility management
contracts, 194
service specifications, 175, 176–180, 182–183
shareholders’ equity, statement of, 9, 62, 63
short-term debt ratios. See liquidity/short-term debt
ratios
SLAs (service level agreements), 175, 181–183
“smoothing” facility management investments, 81–82
SOX (Sarbanes-Oxley Act), 59–60
specifications
performance, 177
prescriptive, 176
service, 175, 176–180, 182–183
standards, accounting, 14–17
state/cross-border benchmarking/budgeting, 57–58
statement of cash flows, 9, 62, 63, 70–72, 79
statement of shareholders’ equity, 9, 62, 63
straight-line method of depreciation, 76
strategic plans, 35, 36–37
R
ratio analysis, 118, 125
asset management ratios, 120, 124
and facility management metrics, 125–126
liquidity/short-term debt ratios, 118–120, 124
profitability ratios, 120–122, 124
return-on-investment ratios, 122–124
realizable, in accrual basis accounting, 30
realized, in accrual basis accounting, 29
recharging. See chargebacks
recognition, revenue, 29–30, 75
relevance, and generally accepted accounting
principles, 15
relevant range, 106
reliability, and generally accepted accounting
principles, 16
renewal options, in contracts, 194
reputational risk, 195
request for proposal, 139
request for quotation, 139
resource/service flexibility, in facility management
contracts, 194
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Finance and Business
subcontracting, 167, 191–192
sunk costs, 117
sustainable practices, and procurement, 138
U, V
unenforceable contracts, 155
unilateral contracts, 155
unit costs, 109
unqualified opinion, in audited financial statement,
61
variable budgeting, 48
variable costs, 9, 48, 105
vendor
company failure, 194–195
conflicts, 198–202
delivery capability, in facility management
contracts, 192
void contracts, 155
voidable contracts, 155
T
tax rules, and depreciation, 75–76
terminology, financial, 4–9
TFM (total FM) model of FM outsourcing, 146–
147
time value of money, 9, 90–93
total costs, 107
total FM (TFM) model of FM outsourcing, 146–
147
tracing, cost, 109
traditional costing, 109–112
traditional in-house delivery model of FM
outsourcing, 144
Transfer of Undertakings—Protection of
Employment regulations, in European Union,
196
transition, in facility management contracts, 195–
197
trial balance, 9, 27, 28
TUPE (Transfer of Undertakings)—Protection of
Employment regulations, in European Union, 196
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W, X, Y, Z
weekly budget analysis, 53–54
work, nature of, in facility management contracts,
191
working capital, 9, 67
year-over-year/year-to-date budget analysis, 54
zero-based budgeting, 9, 50–51
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