English1

T his article was prepared in connection with an experience in the maintenance group of a major

US oil refinery. A new project manager had been assigned to the refinery's maintenance organization just as the company was reconciling current year finances and preparing to embark on another year of maintenance activity.

After one month, the recently appointed project manager was informed that first quarter maintenance expenditures had caused the yearly budget to overrun. He was given the daunting task of providing adequate justification and outlining his course of action, such that a relapse would not occur.

Following the assembly of his project controls team, the manager was able to discern why the overrun had occurred. During the company's accrual period, in mid-December of the previous year, a failure to accurately forecast vendor commitments had caused several fourth quarter invoices to be overlooked.

Lack of an integrated and interactive cost control tool was forcing the project team to rely on spreadsheets to compile financial data, subjecting its forecasts to

countless inaccuracies as the spreadsheet changed hands within the organization.

Decreased fourth quarter staffing resulting from end of year vacations and downtime during periodic plant shutdowns made it impossible to recover from the inadequacies of the final month's forecast.

Failing to see how current procedures and practices would prevent a reoccurrence of such an event, the manager and his project control staff set out to rectify the situation.

While the above scenario is real, for the purpose of this article, all quantities, vendor names, and associated costing, are theoretical. The author's example is being provided to demonstrate how commitment tracking was achieved through the assimilation of data in real-time, with minimal disruption to the project work environment.

The intent of this article is two-fold.

• to define the elements of cost control, more specifically cost tracking, as they relate to a project-oriented organization; and

• to explore the framework and benefits of a forecasting tool designed to aid in

the real-time cost tracking of vendor commitments.

Accounting vs. Cost Control To accurately define cost control, one

must first rectify the common misconception that frequently exists within today's project-oriented work environment: the tendency to assume that accounting and cost-control are identical.

Such tendencies may, to some degree, limit management's ability to make informed decisions, and in turn, prevent the successful completion of a project. Successful completion refers to the optimal blend of cost, time and quality [1]. In general, accounting is defined as the art of recording, classifying, and summarizing economic transactions and events in terms of money [2]. Financial accounting, simply put, is the collection and comparison of historical transactions to report where a company "has been". It is a status indicator, a reflection of what has been done and how well it has been done, up to a point in time.

Many of today's organizations that play a role in the day-to-day operation of refineries, utilities or manufacturing plants will attest to the fact that accounting is a fundamental element of cost control. However, accounting alone does not constitute complete cost control. The term "cost control" (or cost management) involves using the status indicator, provided by traditional accounting methods, as a guideline to shape the project's final cost.

In essence, the goal of cost control is to identify, and anticipate, cost trends using constant analysis of project expenditures to ensure efficient scheduling, expediting, and application of project resources such that the project is completed at the lowest cost in the shortest time.

Work Breakdown Structure Before project cost control can

commence, it is necessary to segregate the project work scope into smaller, more manageable elements. Segmentation of the work scope allows for the identification of all work tasks needed to establish a definitive timeline and budget.

The primary tool for work scope development is known as the Work Breakdown Structure (WBS). The WBS is a treelike structure made up of a series of cost elements or cost accounts that group

18 Cost Engineering Vol. 47/No. 9 SEPTEMBER 2005

CERTIFICATION PAPER

COSTMAN: A Real-Time Commitment to Cost Management

ABSTRACT: For a refinery maintenance organization, performance is often based on how pro- ductivity and budget spending relate to neighboring refineries. In other words, how well the organization can make use of its time and money versus the competition. The measurement of time and money relies heavily on the refinery's ability to accurately status and forecast its proj- ect-spending level. Fluctuations in spending levels, if detected early, can improve manage- ment's ability to minimize overruns or maximize its available budget. The potential volume of projects worked by a maintenance organization may often require a large amount of contract labor to supplement the company labor force. The combination of the two labor forces will allow managers to achieve productivity and performance goals in times of increased mainte- nance activity. However, the frequent oscillation in the size of the contract work force will facil- itate the need for accurate commitment tracking to ensure all costs are accounted for when reporting project spending levels. Many organizations are capable of tracking their own costs, but will fail to forecast proper cost data if not supplied with adequate tools to forecast and man- age contract work. This article attempts to demonstrate how one major US refinery attempted to diagnose and treat its failing cost tracking abilities through the development of an in house real-time cost tracking tool. By capturing the flow of contractual activity, data that is complied in real-time can be used to identify project accruals, provide a more complete monthly forecast, and ensure that project budget is being used to its full extent.

KEY WORDS: Budget, commitment, cost management, performance, and productivity

Stefan C. Michalski, CCE

all work activities which must be controlled for project performance. Each activity embedded within the WBS system of accounts can be assigned a budget and work-hour quantity [3].

Schedule-Budget Baselines As the WBS starts to evolve, the

planner is able to identify the labor component at each elemental level of the project. Work activities are created, logically sequenced and rated in order of importance, such that a project schedule can be recognized. These activities are assigned duration hours and, if the timeline agrees with the project objective, the WBS, schedule, and hours are used to estimate the project budget.

Estimation of the project budget usually involves an extension of the WBS, known as a cost breakdown structure (CBS). The CBS is created by adding to the WBS all other project accounts that have either a cost or a cost and work-hour budget, but are not used to measure progress (taxes, overhead, contingency, etc.) [3].

The project schedule and budget baseline serve as the roadmap to recognize where a project is, where it is intended to be, and how to get there. Comparison of baseline data to actual data will identify and isolate trends in productivity and spending. These trends will, in turn, alert management of potential problems that may prevent successful completion of the project. As a result, remedial action can be taken before these potential problems escalate.

Performance Measurement Having established the basis for

control, it is now necessary to understand what reporting tools are important for trend identification. For the purposes of this article, the focus of attention will be on several cost-tracking tools, namely, the cost performance index (CPI) and the cost variance (CV).

Cost performance is measured by comparing what was done to the cost incurred. To do this, earned workhours are compared to actual workhours. The amount earned represents the budgeted cost (or quantity) of work performed, whereas the actual amount of work performed is represented by the incurred cost or quantities. The relationships are expressed by the following formulas.

Cost variance (CV) = (earned work- hours or $) - (actual work-hours or $)

(equation 1)

Cost performance index (CPI) = (earned work-hours or $ to date) / (actual work-hours or $ to date)

(equation 2)

Note: A positive variance and an index of 1.0 denotes favorable performance.

The importance of these tools as it relates to the introductory discussion will be provided in remarks at the end of this article [4].

Real-Time Cost Tracking Prior to the identification of cost

trends and the suggestion of corrective action, it is necessary to properly forecast the project's current spending level. An accurate estimate of the total cost is required if analysis is to be meaningful.

The term expenditure refers to the amount of money that has actually been spent on a project, i.e., costs recorded to- date. An expenditure is recorded in a company's general ledger, either at the time an invoice is received or at the time an invoice is paid. Most companies can ensure the timely entry of their own labor, equipment, and material costs into the general ledger.

However, the nature of contractual documents (e.g., service contracts and purchase orders) is such that, for the purposes of performance measurement, expenditure forecasts must include both commitments and expenditures. Commitments and expenditures represent the incurred costs mentioned in the previous section.

Accuracy of data and timely cost tracking are essential if a company is to make proper decisions regarding performance and support future process improvements. Institution of a real-time cost tracking system would allow for instant recognition of a company's commitments and end-of-year accruals, thereby, providing a complete and accurate expenditure forecast.

Contract Commitment In the simplest of terms, Commitment

is an agreement by one party to do something for another party. A commitment is the amount of money set

aside to cover the forecasted final cost of all purchase orders, contracts, and subcontracts [5].

An in-house application, known as COSTMAN, was developed to restore confidence in the refinery's ability to track its vendor contract commitments.

There are three basic types of contracts that COSTMAN addresses: lump sum, reimbursable, and a combination thereof. These are defined as follows [6].

Lump Sum (also known as "fixed price"). — These are contracts that set a price for a defined scope of work, whereby both the scope and price are agreed to in advance. The lump sum includes the contractor's direct costs, overheads, and fees. The lump sum may be paid in full upon completion of the work, but it is most often paid in increments according to progress.

Reimbursable Contracts (also referred to as "time and material") —These are contracts in which the contractor's direct costs to do the work are reimbursed fully, in addition to which the contractor is paid for their overheads and fees. This type of contract provides an all-in rate for each hourly service provided, as well as a markup on materials and services procured on behalf of the client.

Reimbursable Contracts With Fixed Fee — In this type of contract, the fixed fee is based on the agreed estimate of worker- hours required to do the initial scope of work. As changes are issued and the scope of work grows, the fee is adjusted according to an agreed to formula. Primary Objectives

As previously stated, cost control is a service provided to the project manager that forecasts potential problems before they become problems. Inherent with this function is the responsibility of the project control staff to make appropriate recommendations to the project manager for corrective actions to minimize the effect of possible problems.

In the introductory discussion, a maintenance project manager and his project control staff were attempting to improve upon the refinery's ability to predict end of year costs. Accruals and/or plans to maximize underrunning budgets had to be made at appropriate intervals, so as to avoid starting the year off in debt because of a prior oversight. COSTMAN was designed to aid cost control by

Cost Engineering Vol. 47/No. 9 SEPTEMBER 2005 19

20 Cost Engineering Vol. 47/No. 9 SEPTEMBER 2005

supplementing the company's general ledger with the real-time assimilation of vendor commitments.

The proceeding section is intended to expose the elements of the COSTMAN application, thereby relaying the benefits of a real-time cost tracking system. Before introducing COSTMAN, however, the primary objectives must be provided. They include the following.

• To prevent unforeseen costs from spoiling an otherwise successful budget year (accrual identification).

•- Remain competitive within the industry by minimizing maintenance cost overruns through management of both company and contractor labor forces.

• To potentially free unused money for pending maintenance issues that would otherwise be ignored (maximize available budget).

The refinery work environment is one that will reject change if it detects anything other than a seamless integration between the old and the new. Contractors and staff alike will be reluctant to cooperate in real- time data collection if it adds disruption to their daily workflow. Therefore, the design must also recognize the importance of a reduced learning curve as it may dictate the successful completion of the primary objectives.

COSTMAN As with any system attempting to

establish control, the idea was to first isolate, and control in detail, those elements with the greatest potential to impact the final cost. In this case, the project manager and his staff had concluded that company labor, as well as equipment/material costs could be controlled with reasonable accuracy. The greatest variable was the contract labor.

Master Vendor List Within the refinery, the ability to draft

reimbursable and fixed price contracts is not restricted to any one department or individual. Therefore, it was necessary to make project controls the central point for the establishment and maintenance of all future service contracts.

COSTMAN's master vendor list is the initial attempt to capture the flow of contractual activity.

The master vendor list (figure 1.0) serves to identify every vendor that is permitted, by the project control staff, to perform work. In other words, each vendor in the master list has a valid contract to perform work in the maintenance arena. Again, many individuals are capable of establishing contractual agreements so the term "valid" is referred to those contracts that are created and forwarded through project controls. The potential for contracts to bypass project controls still exists and will be addressed in a subsequent section (see Areas for Improvement).

As each vendor is added to the master vendor list, the operator is given the opportunity to identify a contract type such that hourly rates can be established for time and material vendors. These rates differ depending on vendor craft type. The craft's work schedule and hourly rate are input per the original contract. Cost type vendors are those who have contracts based on a fixed-fee or lump sum payment structure (see figure 1)

Reimbursable Labor In this example, the company had

previously developed a means of capturing reimbursable labor by way of electronic timesheet entry. The purpose of electronic entry was to enable vendors to input labor, equipment, and material charges as soon as the work had been completed.

Data could then be uploaded to a database on the company network. This would permit immediate validation and approval of the vendor information, thus creating a shorter turnaround time for receiving vendor invoices. All relevant information, once approved for invoicing on the company database, would generate a commitment to be copied into the general ledger.

At this juncture, one may argue then that the company already had a means of

forecasting a portion of vendor commitment. Although the refinery had an electronic timesheet system that could adequately forecast T&M (time and material) vendor labor, equipment and material, not all vendors were capable of lending staff to support electronic entry. As a result, many vendors were still excluded from the pre-paid forecast.

To facilitate a true real-time capture of reimbursable labor, COSTMAN housed two modules that would forecast work at the same time it was being performed, while requiring minimal input from field staff.

In each module, the operator has been given the opportunity to add a weekly forecast, one for planned staffing and the other for actual staffing. When a weekly forecast is added, the T&M (time and material) master vendor list appears so that pertinent vendors may be confirmed (indicated by the checkmark box supplied in master vendor table - see figure 1).

Planned staffing is linked directly to the maintenance schedule, which ideally is prepared in advance and updated as planners reshuffle the work. The actual staffing table (figure 2) is completed daily by owner supplied contract representatives (i.e., company employees responsible for managing contract staff and respective service contracts) prior to the start of work. This representative also has the flexibility of updating hourly rates and base work schedule so that the most accurate of forecasts can be provided to management.

The pop-up window for the highlighted vendor, First Coat Painting, illustrates this updating function. COSTMAN then uses a simple rate-based calculation to predict the daily commitment needed to support reimbursable work.

Input from owner-supplied representatives responsible for the management of contract staff allows for

Figure 1— Master Vendor List (Cost Type)

verification of all planned work, pre- approval of labor and does not exclude vendors that had been incapable of electronic entry.

Fixed Costs Lump sum and fixed fee jobs are often

resolved via hard copy invoice. The vendor invoices, at specific intervals known as job milestones (fixed fee), or when the work has actually been completed (lump sum). Upon receipt of an invoice, the recipient is granted time to review and approve payment for completed work based on terms set forth in the contractual agreement. A payment lag ensues as result of this review period. If not committed in advance of this lag, the costs for completed work may have a negative impact on the current budget.

If COSTMAN is to provide a comprehensive forecast of vendor commitments, it must address the payment lag created by hard copy invoices. The fixed cost module (figure 3) is intended to facilitate the entry of lump sum and fixed fee invoices at the time a vendor is approved for planned work.

The fixed cost module is similar to the others, in that each time a weekly forecast is added, the fixed cost (fixed fee and lump sum) master vendor list appears so that pertinent vendors may be confirmed. Planned costs are schedule driven and should comply with pre-established contract amounts. Each time that work is completed, or a milestone is achieved, the company representative populates the actual cost field. Data Analysis

COSTMAN offers a variety of reporting tools to inform staff and management of the current project spending level. All levels of the project control team are capable of viewing a COSTMAN forecast as it relates to the daily, weekly, monthly and year-to-date activity. Figure 4 lists COSTMAN's current reporting capabilities.

Every forecast generated by COSTMAN displays the vendors, worker hours planned / worked and dollars committed. Fixed vendors are appropriately labeled. Using the hours and cost variance column(s), management can identify such things as deficiencies in work schedule and productivity. A sample of a weekly forecast is given in figure 5.

The most informative report COSTMAN yields is the comparison between forecasted costs (expenditures + commitments) and actual costs (expenditures only). This is the tool that identifies accruals and allows for maximum use of the project budget.

Areas for Improvement Although COSTMAN has proved to

be an effective tool during its first year of operation, the project controls group had identified several areas for improvement.

In order for management to compare forecasted and actual expenditures, COSTMAN requires integration with the

Cost Engineering Vol. 47/No. 9 SEPTEMBER 2005 21

Figure 2— COSTMAN Reimbursable Labor Entry

Figure 3— COSTMAN Fixed Cost Module

Figure 4— COSTMAN Report Capabilities

22 Cost Engineering Vol. 47/No. 9 SEPTEMBER 2005

company's general ledger. At present, this integration is facilitated by project controls through a manual transcription of the month's actual expenditures. Actual costs are extracted and sorted by vendor, then manually input into the COSTMAN application. This process is time consuming and prone to error. This process needs to become automated such that actual expenditures can be downloaded into the COSTMAN application.

As previously stated, COSTMAN is dependent on the owner appointed contract representatives to route all service contracts through project controls prior to the commencement of work. To receive an accurate portrayal of committed cost, project controls must have some insurance that all field staff reporting through the common source, namely COSTMAN. A report listing all opened contracts would enable project controls to verify that all vendors are accounted for.

At present, COSTMAN allows one fixed entry per vendor for each week. Again the volume of employees capable of drafting a contract creates a problem. If more than one contract is created for the same vendor in any given week, it may create confusion among COSTMAN operators as to what contracts have previously been entered.

For example, consider the vendor named "Franck's Tank Repair" in figure 3. Once the initial fixed cost entry is entered for this vendor, operators can edit the planned and actual amounts as necessary. Each additional fixed cost for the week must be added to the existing entry. Many contracts can be embedded into one entry. If someone is expected to constantly edit a fixed cost number each week, they should be able to identify what has already been accounted for. Enabling users to enter multiple fixed costs entries for the same

vendor and supplementing with an identifier such as a referenced service contract number may eliminate this problem.

C ompanies use multiple databases to store invoice information, track cost at the work order level, store

equipment and material inventories, store vendor information, track vendor spending against company PO's, etc.—all of which are tools to eliminate a paper trail, provide instant access to historical data, track company costs, and at the same time facilitate forecasting of future work and spending levels.

Many systems are available to integrate these databases and help analyze cost data, but vendor commitments are often the missing piece to a complete and accurate forecast.

In a maintenance environment, budget decisions are made based on how the refinery and its maintenance department have performed historically in terms of company and industry standards (Solomon indices). Deficiencies in real- time forecasting would prove costly as comparative analyses (CV and CPI) drive decisions to improve productivity and adjust contract staff. These decisions have the potential to significantly alter a maintenance organization's budget.

Though there are many areas for improvement, the initial signs are that COSTMAN is a success. Accrual identification has been facilitated by capturing all the open vendor commitments. The accuracy achieved by real-time data input has improved current spending level forecasts and made the CV and CPI reporting tools a more effective indicator on when to reduce spending or maximize the remaining budget.

Permitting real-time visibility for existing vendor commitments (T&M /

lump sum) via the COSTMAN application has allowed for a comprehensive look at project expenditures and provided an immediate response to eliminate the potential for budget deficiencies. ◆

ACKNOWLEDGEMENTS 1. Edmundo J. Iglesias, COSTMAN

Application Director, Total Solutions, Inc. (Ph: (610) 485-9500 email: [email protected] html: www.totaltrainingsols.com/costman.htm

2. Paul Symington, Project Control Coordinator, Sunoco Toledo Refinery. e-mail: [email protected] html: www.totaltrainingsols.com/costman.htm

REFERENCES 1. Clark, Forrest D. and A. Lorenzoni.

Applied Cost Engineering. New York: Marcel Dekker, Inc., vol.1 (1978): 139-144.

2. Jelen F.C. and J.H. Black. Cost and Optimization Engineering, 2nd ed., Chap. 17. New York: McGraw-Hill Book Company (1983).

3. Project Management & Control, Section 7.3, pg. L5 and Section 3.5.2, pg. J28-J33. Unpublished.

4. Woodward, C.P., and T.C. Chen. Skills and Knowledge of Cost Engineering, 4th ed., Chapter 7: Planning; and page 11-3. Morgantown, WV: AACE International (1999).

RECOMMENDED READING 1. Humphreys, Kennerth K.. Cost

Accounting. Project and Cost Engineers' Handbook, 2nd Edition, pg 20-22. New York, New York: Marcel Dekker, Inc. (1984).

2. Humphreys, Kennerth K.. Cost Reporting and Control. Project and Cost Engineers' Handbook, 2nd Edition, pg 95-97. New York, New York: Marcel Dekker, Inc. (1984).

3. Forrest, Clark D. and A.B. Lorenzoni,. Applied Cost Engineering, pg. 104- 105, 140-152. New York, New York: Marcel Dekker, Inc. (1978).

4. Lack of Real Time = Lack of Control. Time Industrial: www.timeindustrial .com/home/learn/press/n_pipeline_ realtime.html.

5. Solomon Refinery Performance Indicators. www.lottracking.com/ solomon.shtml

Figure 5— Sample Forecast Based On Weekly Vendor Commitments

Cost Engineering Vol. 47/No. 9 SEPTEMBER 2005 23

6. Pressoir, Serge. Cost Control and Project Accounting are Getting Married. 1988 AACE Transactions (1988).

7. Orczyk, Dr. Joseph J. Tracking Cost and Schedule Performance. Skills & Knowledge of Cost Engineering, 4th Edition. Pg. 13.1 - 13.8. Morgantown, WV, (1999).

8. Orczyk, Dr. Joseph J. Progress Measurement and Earned Value.

Skills & Knowledge of Cost Engineering, 4th Edition. Pg. 11.1 - 11.5. Morgantown, WV, (1999).

About the Author Stefan C. Michalski, CCE, was with

Sunoco Toledo Refinery at the time he wrote this article. He can now be contacted by sending e-mail to: [email protected]

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