CONSTRUCTION COST ESTIMATES
Cost estimating is a management function common to all projects. This is true whether the project involves a high-rise office building, refinery, manufactured product, Super Fund site cleanup, or family vacation. Cost Estimating is clearly not unique to the construction industry, but rather is common to a broad spectrum of projects in which time, cost and quality must be managed.
As its name suggests, cost estimating is the art and science of “approximation” that rarely predicts exact future performance. Nevertheless, the cost estimate is the first benchmark against which time and cost performance is measured. Since cost is often a function of project time, estimates of work activity durations are developed concurrent with activity costs.
COST VARIANCE ANALYSIS
As mentioned in Part I of this series, variance between planned and actual cost performance is perhaps the most fundamental component of contract disputes. It is, therefore, not surprising that the construction project dispute resolution process typically involves inquiries into “why and when” actual time and cost varied from the estimate, bid and/or control budget.
Because cost estimates play a key role in both project management and dispute resolution, all construction industry professionals benefit from understanding the basic elements of estimating. This article provides an overview of the construction cost estimating and disputes including:
3. Estimate types and applications
COST ESTIMATES DEFINITIONS
A cost estimate is a compilation of all costs of the elements of a project included within an agree-upon scope. To the A/E or construction contractor, this is the cost that is likely to be incurred in completing the project, as defined by the current scope documents. This cost includes internal costs, as well as outside costs of subcontractors, consultants, vendors, suppliers and third parties.
The owner’s costs include its costs for administering the project, the cost that its contractors charge for the work and the fees of any consultants, engineers and suppliers. Also included in an owner’s project cost estimate will be the price of land, provisions for interim and permanent financing and the numerous elements of life-cycle costs associated with ownership, such as operating and maintenance costs. (Owner costs are not always included in contractor cost estimates.)
Cost estimates are prepared in sequential steps:
1. Take-off–Measuring and cataloging the quantities of work derived from the contract or scope documents.
2. Costing–Using the take-off and the information presented in the scope documents to assign cost values to the elements of work.
3. Pricing–Determining the amount to be charged to the owner/client so as to fully include all direct and indirect cost items, as well as contingency, overhead and profit.
COST ESTIMATING TERMINOLOGY
Some of the basic elements of the estimating process that consistently arise in contract disputes include:
An amount added to the total estimated cost to allow for unanticipated events that will likely be required, based on experience and statistics. Contingency is generally not used for changes in scope or unforeseeable major events such as strikes or acts of God.
Defined differently by contractors in their estimates and bids, but can include corporate overhead, profit and other indirect costs. When mark-up is applied to the bid price for a particular item, system or other construction price, any or all of the above percentage applications may be included.
A term applied to those elements of cost that will be expended or incurred on a time-unit basis (i.e., hourly, weekly, monthly), and that are often a subset of indirect costs such as field overhead.
A management function that is targeted at the project design itself. The objective of value engineering is to develop or design a facility or item that will yield the least life-cycle costs and/or provide the owner the greatest value while satisfying all performance, quality, esthetic and other criteria established for it.
An increase in the cost of goods and/or services over time. Escalation has the same effect on project cost as interest does on the value of a savings account: Each year becomes a new base for calculating escalation for the following year. Thus, cost escalation is compounded, not added, for multiple years. Therefore, one method of applying escalation to a multi-year project is to develop a project cash flow analysis and calculate escalation for each year.
TYPES OF CONSTRUCTION COST ESTIMATES AND THEIR APPLICATIONS
Are prepared without detailed engineering and design information. Examples include an estimate made from cost capacity curves, an estimate using scale-up or scale-down factors, and an approximate ratio estimate. An estimate of this type would normally be expected to be accurate within +50% or -30%.
Order-of-Magnitude estimates are generally prepared using only basic criteria such as desired plant output, total square footage, or number of units. For buildings, the typical unit of measure is square feet of floor area or cubic feet of volume. For process and power plants, the order of magnitude may be expressed in plant capacity for input and/or output. Order-of-Magnitude estimates for roadways are usually defined by mile of a particular type of surface.
The word “budget” here applies to the owner’s budget, not to the contractor’s budget as a project control document. Budget estimates for industrial projects are often prepared using flow sheets, P&ID’s, site layouts and equipment details. An estimate of this type is normally expected to be accurate within +30% or -15%.
Budget estimates are also referred to as design development, semi-detailed, appropriation, and control estimates. Since the budget estimate is more detailed than the order-of-magnitude estimate, it is better suited for determining project feasibility and establishing definitive budgets. The accuracy and usefulness of a budget estimate depends to a large extent on the amount and quality of available engineering and design information.
These are estimates prepared from advanced engineering and design data. On industrial projects, this data often includes fairly complete plot plans and elevations, piping and instrumentation diagrams (P&IDs), single-line electrical diagrams, equipment data sheets and quotations, structural sketches, geo-technical data and sketches of major foundations, building sketches, and a complete set of specifications.
The definitive estimate category includes all types of estimates, from the minimum Order-of-Magnitude type described above to the maximum Definitive type, which would often be prepared from issued-for-construction drawings and specifications. Definitive estimates are sometimes called check, lump-sum, tender, or post-contract change estimates, and are generally expected to be accurate within +15% or -5%.
The cost estimate is not only one of the first documents a project manager asks for when being assigned to a new project, but is also one of the first documents included in discovery requests prepared by attorneys and experts working in contract disputes. The estimate (and subsequent bid) provides the basis of the A/E and contractor’s internal control budgets and performance measurement systems, and also forms the basis of the expert’s delay and cost variance analyses. Regrettably, the 26 biweekly issues of this newsletter do not provide enough space (nor does our diverse readership necessarily have the interest or patience) for HCG to address all of the permutations of the estimating, budgeting and performance measurement processes. However, future articles will address selected project control, value engineering and constructability topics.
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The Holloway Consulting Group, LLC
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