Measuring Overhead

From my experience, it is not easy to measure overhead costs, especially if we are talking about project overhead costs which include company overhead costs. Let us see one by one the factors which effect these costs.

Factors affecting the company overhead costs are as follows:

1. Payments realization

Payments realization is very important for the company’s cash flow. Delayed payments may increase company overhead costs which will eventually affect the project overhead costs. Therefore, it is very important to ensure the employers in issuing payments on time.

2. Availability of new projects

The availability of new projects also affects the company overhead cost. If there is happened a shortage of new projects, the company overhead may increase for marketing purposes etc.

3. Inflations

Inflations also can increase the company overhead costs.

4. Regulations

Some new or changes of governmental regulations can affect the company overhead costs.

 

And now, factors affecting the project overhead costs are as follows:

1. Type of contract

What contract type does the project have? A lump-sum contract will give different portion of overhead costs with joint venture contract.

2. Project complexity

The more complex a project is, the more project overhead costs incurred. If you have a typical project, then you can save some expenses and this can reduce your project overhead costs.

3. Location and size

Project location and size also affect the amount of project overhead costs. If the project is executed in urban areas will have more advantages rather than countryside projects. And usually, the bigger your project, the more overhead costs incurred (by the terms of amount, and not proportion).

4. Project duration

5. Payment schedule

6. Project’s cash availability

7. Employer’s strictness in supervision or nature of the clients

8. Subcontracted work

How many percentage of the work is being subcontracted will affect your project overhead costs because usually you will spread your overhead costs in some work items. If these work items are being subcontracted, then you must bear your overhead costs more because you cannot include these costs in these work items anymore.

9. Number of competitors

10. The consultants involved

With its unpredictable nature, construction industry faces difficulty in deciding the optimum level of overhead costs that enables contractors to win and efficiently managing their projects. Since the construction industry is a multidiscipline industry, there will be many factors influencing the construction industry and eventually the project overhead. And unfortunately, these factors or activities are not yet clearly defined or accurately known. It is the major problem in measuring project overhead costs.

There are at least 3 (three) methods in measuring overhead costs. First method is by setting a percentage of overhead costs. Contractors who choose an easy way in measuring overhead costs by simply calculating the total direct costs and setting a percentage for overhead costs may end up in under or over estimating these costs. And this will affect to the accuracy of the contractor’s bidding price.

Another method that maybe used by contractors is by comparing the current project with similar projects which have been completed. Contractors may compare the similarities of project’s characteristics with other similar projects and conclude the amount of overhead costs (maybe in percentage or in a sum).

And the last method that I know is by checking contract requirements and estimating resources needed by the current project. Here, the contractors will need a particular person who has the experience to read the contract and measure the estimate expenses for overhead item. This method gives a more accurate estimation of overhead costs rather than the other two methods.

 

by Seng Hansen

How To Do Risk Management?

What a simple yet complicated question. Risk management actually is a management based on individual’s experiences. This is happened because risk management needs analysis from professionals while the inputs are uncertain. So it means that risk management will differ from one person to another. If that is the case, why we still need risk management while we already know that the outputs will be different in terms of its interpretation and implementation? That is because we still need to minimize any potential which may be occurred during project. Here we of course consider that the risk management which is made by professional will become a good one, and not a bad risk management.

And now, how to do a good risk management? As I said before, risk management actually is based on someone’s experiences. Here it does not mean that on doing a particular project, they must have the experience of exactly same project because no projects are exactly the same. If there is a project which no one have been experienced before, then at least we must choose professionals with the almost similar experiences to do risk management. From their experiences, then they could do some imaginations or draw some predictions about the will-be project. This imaginations or predictions will then be materialized in responses. From these responses, then they could make estimation about the risk probability (high/middle/low) and significance (heavy/medium/minor). After they conclude this into a risk diagrams and reports, then we must ensure steps and provisions of risk implementation in our project.

The process of risk management can be divided into 3 steps:

1. Risk Identification: to determine which activities are considered as risk based on their probability
2. Risk Analysis: to know how far their implications to the project (not only as individual implication but also collective implication)
3. Risk Outputs: how to manage these implications (by minimize them and allocate appropriate contingencies (time, money and quality)

The last thing we should consider in doing risk management is doing risk reduction. How to do this? By obtaining additional information, performing additional simulations or tests, allocating additional resources, and improving communication and managing organization.

Hopefully from this short explanation, we can get a whole picture in how to do risk management.

Why Overhead?

Overhead costs can be defined as indirect expenses that cannot be charged to individual costs or bid items. It covers items such as directors’ fee, secretariat’s fee, marketing’s fee, general equipment costs, etc not only for project necessities but also for headquarters necessities. Therefore we can divided the overhead costs in 2 (two) types: project overhead and company overhead. Usually overhead costs are expressed in percentage of total direct cost and which then will be added into the contractor’s tender price. And since it cannot be charged as an individual cost, we cannot find this item in Bill of Quantities.

Another characteristic of overhead cost is that it will benefit more than one cost objective. So basically overhead is a summary of expenses which then will be used for the activity of some other works, not a cost which is used only for a particular work item. With this characteristic, overhead cost is usually spread to some related work items. Although these costs are not a component of the actual construction work, they have significant roles to support the work. Total overhead costs may vary from 10-30% of the total direct costs, depending on the project characteristics and company’s objectives.

As what I said earlier, there are two types of overhead costs; first is project overhead cost and the other is company overhead cost. Project overhead cost is the costs specific to a project, incurred for the sake of the construction process and execution. The examples of these project overhead costs are project administrative expenses, project office rent and utilities, project office supplies, project team’s salaries and bonuses, depreciation on project office equipments, taxes, bonds and insurances, the cost of rework, etc. While company overhead cost is all costs incurred by the construction firm in maintaining the business and supporting the production process, but are not related to a specific project. Office supplies, directors and company staff’s salaries and bonuses, depreciation on office equipments, company’s licenses, company’s advertising and marketing costs, training held by the company, etc are some of the example of this type. Unlike company overhead cost, the project overhead cost can be estimated in somewhat accuracy by checking and examining carefully all of the contract conditions and work’s specifications in a particular project. If the contractor or the Project Manager (with the help of a quantity surveyor) can do this estimation precisely, the project overhead costs can be determined in some accuracy, excluding the other unforeseen factors such as variations and force majeure. By doing this, hopefully the contractor’s team can manage their work and gain some profit accordingly.

While the company overhead cost is perhaps one of the main reason why there are so many contractors’ team cannot make a profit in their works. The company overhead costs will be charged into projects and usually it will effect to the project’s cash flow significantly. Here, it means that a project must bear two overhead costs; one from the project overhead costs itself and the other is from the company. Neglecting overhead costs can be a nightmare for Project Manager and his team because these costs constitute a significant portion of the total construction cost. What may be a profitable project can turn into a losser one.

 

Seng Hansen

Kenji Goh 6

Pricing Preliminaries

How to Priced Preliminaries? – Contractor’s Point of View

It is very difficult to price preliminaries. Besides, not all preliminaries items need to be priced, some are still unpriced. Another difficulty is that there is no specific rule or standard way to pricing preliminaries. Actually SMM2[1] also discusses about preliminaries item in section B of the book, but it only discusses the general description and regulations, not the specific way to measure and price this item.

 

In Bill of Quantities prepared by contractors, we usually find this item in Lump Sum unit. There is a risk in deciding this item to be priced in Lump Sum unit. If the actual project’s preliminaries is below the estimation stated in Bill of Quantities, then it will become the contractor’s profit. And the opposite principle applies. If the actual project’s preliminaries is higher than the estimation, then it will become the contractor’s loss. So as a quantity surveyor (regardless you are working for employers or contractors), we need to calculate this item efficiently so that it will give enough allowance for the costs, not too much or too low.

 

I think the best method to price preliminaries is to look the similar projects that have been done before. But this method needs contractor/estimator’s experience to decide and adjust the actual preliminaries cost of the executed projects with the current proposed project’s condition. Another method which is commonly used by contractors and estimators is by percentage of tender value, normally 5% up to 10%.

 

 

Major Problems in Pricing Preliminaries

Since preliminaries item is such a vast and unique item to be priced, there will be many problems in pricing it. Moreover, every project is unique and that means they will need preliminaries cost which differ one another. So we can say that the uniqueness of project is predominantly materialized in preliminaries cost.

 

 

Factors which influence the preliminaries item are:

1. Location of the proposed project

Where is the project’s location – is it inside the city area or outside, is it safe or not from stealing, etc.

1. Site conditions

What are the site’s conditions – is it winter or summer, do we need to clear the site before starting the work or not, how about the access to the site, etc.

1. Type of contract that is used

What is the type of the contract – is it a simple contract or a complex one, is it based on a negotiated or competitive tenders, etc.

1. The length of time in using resources

The length of time in using resources is very crucial. The contractor has to ensure that if there is a project’s delay and extension of time is granted, the additional cost incurred must be reimbursed. The cost of heavy equipment, the cost of the project team member and all other costs need to be priced according to the length of time they are on site. This must be included in preliminaries.

1. The market conditions

Will there be any inflation or not, will there be many projects or not, etc.

1. Contract particular

Understanding of contract particular – can contractors claim variation, how about the insurance clause, how about the period of retention, the advantages and disadvantages of the contract clauses, etc.

1. Availability of resources

Do contractors need to hire labour outside the city or just hire locals, do contractors need to import material or just use local materials, etc.

1. Local Authorities’ Obligation

Is there any obligation imposed by local authorities, is there any public undertakings, etc.

1. Obligation or Restriction Imposed by Employer

To what extent the employers want the contractors do their quality control, management of works, safety and security, maintenance, etc.

 

 

How Does It Affect to the Overall Contract Sum?

After we are talking what is preliminaries and how to priced it, now we come to the discussion about how does it affect to the overall contract sum? Normally, preliminaries will constitute about 5% up to 10% of the overall contract price. In this competitive business world, contractors need to do various efficiencies in their tender price so that their bids can compete with others. The employers usually will choose the best tender price after considering contractor’s qualifications. And the best price usually is the lowest tender price. Since the quantity of a project cannot be manipulated, contractors commonly do efficiency in their preliminaries cost. They will count only the items which they need with an eye to win the tender. And this action will bring us to a next question, will it be a risk if they underpricing the preliminaries?

 

 

Conclusion: Preliminaries as a Risk

In my opinion, preliminaries is a risk in contract sum estimation. And because it is a risk, so basically the decision to submit a tender price by contractors will be based on their experience in the field and discretion of contractor managerial board. Efficiency done by contractors in order to win the tender can be a boomerang for them if they miscalculate the items in preliminaries. If they are underpricing it, the project can be a complete failure and they must bear the loss. But if then they can manage it so that it is not underpriced, they can make a profit. And again, to submit a tender price is a managerial level’s decision. Eventhough the contractors knew that they will lose profit from it, some projects need to be executed due to other factors such as political, social or monumental aspect (to make their companies well known).

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[1] Standard Method of Measurement 2

 

Surat Dari Ayah

Dear_Don_Dear_Daughter_Lagu

Entire Contract 3

Entire Contract Application in Construction Contract: Cases

The application of entire contract in construction contract can be found in Contract Act 1950 section 53 illustration (a) reads as follows: A and B contract that A shall build a house for B at a fixed price. A’s promise to build the house must be performed before B’s promise to pay for it.

 

It depends on the express terms of the contract whether a contract is an entire contract or not. If there is payment procedure or any other clauses which expressly say that the contract is made based on entire contract, then both parties must perform it as it has been agreed. If the contract allows payment for completion of individual items of the work, then it is not an entire contract.

 

Below are some cases regarding to entire contract application in construction contract.

 

Appleby v Myers [1867] LR 2 CP 651

Appleby agreed to erect machinery on Myers’s premises for £459. When the erection was almost complete, an accidental fire destroyed the premises and the machinery. Appleby sued for £419 on a quantum meruit[1] basis. Blackburn J held; ‘The whole question depends upon the true construction of the contract between the parties … It sufficiently appears that the work which the plaintiffs agreed to perform could not be performed unless the defendant’s premises continued in a fit state to enable the plaintiffs to perform the work on them; and … if by any default on the part of the defendant, his premises were rendered unfit to receive the work, the plaintiffs would have had the option to sue the defendant for this default, or to treat the contract as rescinded, and sue on a quantum meruit. But … where, as in the present case, the premises are destroyed without fault on either side, it is a misfortune equally affecting both parties; excusing both from further performances of the contract, but giving a cause of action to neither.’

Conclusion: Since it was an entire contract, the action taken by Appleby to sue for a sum of money failed as the obligation to pay did not arise until completion of the work and the contract was frustrated without fault on either party before that date.

 

Sumpter v Hedges [1898] Digest 161

Sumpter contracted to build two houses and stables for Hedges for £565. He did work valued at £333 and stop because he had no more money. He had already been paid part. Hedges finished the building, using materials which Sumpter had left behind. Sumpter sued for the outstanding money. Bruce Judge held that since Sumpter had abandoned the contract and Hedges had no choice but to accept the half completed house, Sumpter get nothing for the work. However, Hedges had a choice relating to Sumpter’s materials; Hedges must pay for using them.

Conclusion: In an entire contract, if a party abandons performance of the contract, he cannot recover payment for the partially work done.

 

Hoenig v Isaacs [1952] EWCA Civ 6

Mr. Isaacs was meant to decorate and furnish Mr. Hoenig’s flat for £750. When the work was done, there were problems with a bookcase and wardrobe, which would cost £55 to fix. Mr. Hoenig refused to pay the £350 outstanding. The court found that the defendant paid £150 on 12th April, 1950, and another £150 on the 19th April, 1950. On 8th August, 1950, the plaintiffs said that they had carried out the work in absolute compliance with the contract and demanded payment of the balance of £450. On the 30th August, 1950, the defendant paid £100, but said that there were defects and omissions in the work and that he would call in someone else to make them good and deduct the cost from the plaintiffs’ bill. He did not do this but entered into occupation of the flat and used the furniture. The plaintiffs then brought this action for the balance of £350. They denied that there were any defects at all. The Official Referee found that there were defects in three of the items of furniture and that the cost of remedying them was £55. He deducted that sum from the £350 and gave judgment for the plaintiffs for £294.

Conclusion: The doctrine of substantial performance was applied and therefore Mr. Isaacs was entitled payment, reduced by damages of the defects.

 

Ming & Co v Leong Ping Ching [1964] 30 MLJ 312

A contract for the construction of an extension to a maternity home in Kuala Lumpur at a price of $28,500 was concluded by an exchange of correspondence. Following disputes about the time being taken to complete the work, although no completion date was agreed, the defendant owner alleged that the contractors had abandoned the contract and that she was entitled to complete the work.  The plaintiff contractors claimed that they were entitled to a quantum meruit of $11,119 of which $9,000 had been paid. The defence was that this was an entire contract and, on the authority of Sumpter v Hedges 1898, Digest 161, the plaintiffs could not sue on a contract which they had abandoned. Gill J held; ‘The answer to that is that in the first place the plaintiffs did not abandon the work, and, in the second place, this was not an entire contract. An entire contract is one in which the entire completion of the work by the contractor is a condition precedent to payment.  To my mind, a contract in respect of which progress payments are made from time to time is not an entire or lump sum contract’. The quantum meruit of $11,119 was allowed, less the $9,000 already paid to the contractors.

Conclusion: The contractor won the case under quantum meruit principle since the contractor did not abandon the work and the owner had paid some amount of money to the contractor, and therefore it was not an entire contract.

 

Kunchi Raman, KP v Goh Bros Sdn Bhd [1978] 1 MLJ 89

The plaintiff, K.P. Kunchi Raman, entered into a labour-only contract with the defendant for the laying of water pipes between Mak Mandin and Prai, and Mak Mandin and Jalan Raja, Butterworth, including the reinstatement of a cycle track. The contractor claimed $11,656 as the balance payable to him under the contract. The defendant counter claimed for the repayment of $55,024 for unsatisfactory work already completed, and failure to complete all items of contract work, amounting to failure to complete the contract.

Gunn Chit Tuan J in the High Court held that the contract was an entire contract, but that the doctrine of substantial performance[2] should be applied’ …. considering the nature of the defects, the cost of rectifying them and the balance of the work undone.  I was inclined to the view and found that in all the circumstances of this case the plaintiff had substantially completed the contract. For that reason I held that the defendant was not entitled to repayment of the said sum of $55,024 paid to the plaintiff who was entitled to claim for any balance due to him for work done’. This would have resulted in the plaintiff’s claim succeeding and the defendant obtaining nothing. However, the defendant was entitled to damages for the defective work and for completing the contract, and since this entitlement exceed the plaintiff’s claim, following Hanak v Green 1958, the defendant was entitled to judgement for $6,047.

Conclusion: It was an entire contract and since the doctrine of substantial performance was applied, the contractor must pay sum amount of money to the owner for defective work.

 

From the cases discuss above, we can take some important points:

1. In an entire contract, if the contractor abandons performance of the contract, he cannot recover payment for the partially work done.
2. If the contractor has done some part of the work and there is not an entire contract, then he may claim some amount of money under quantum meruit principle.
3. If the contractor has done some part of the work and there is an entire contract, then he may claim some amount of money under the doctrine of substantial performance, or if it is proven that the breach of the contract is on the employer’s fault.
4. A contract in respect of which progress payments are made from time to time is not an entire contract.

 

 

 

Conclusion

Entire contract is one kind of contract which tends to benefit the employers rather than for both parties. With the development of construction contracts and judicial judgments, the use of entire contract is modified by the doctrine of substantial performance which gives fairer rights to both parties.

 

I suggest to the contractors who would like to enter such contract only in the conditions as follows:

1. The project type is simple, does not involves many other parties such as subcontractors
2. The project duration is short
3. The contractors already have the experience to do the similar projects
4. The employers are credible enough

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[1] Quantum meruit (Latin: as much as he deserved) A legal principle that enables the provider of goods or services to recover fees for the provision of those goods or services.

[2] The doctrine of substantial performance: A party who substantially performed his obligations can now recover the contract price, reduced by damages awarded to the other party in respect of the defects.

Preliminaries: What Are They?

In construction industry, we know that there are fixed costs and estimated costs. Fixed costs are the costs which we can calculate and price them, this includes materials, labour, plants and equipments cost. Sometimes contractors called it as direct costs. While estimated costs are the costs which due to their unpredictability and uniqueness, we cannot calculate and price them precisely. Preliminaries is one of the latter’s example. Preliminaries in construction industry can be defined as requirements/components/facilities which are need to be provided prior to commencement of actual implementation of physical work. But this is the general definition of preliminaries.

 

Now, what items which are constituted the preliminaries? Following are the items that normally will be considered by the contractors for many projects as preliminaries:

No	Items	No	Items
1	Site Supervision – Site Agent, etc	13	Protection and casing of finished work
2	Toilets	14	Safety Measures
3	Code of welfare conditions	15	Telephone
4	Temporary roads	16	Temporary compounds
5	Temporary fencing, hoardings, screens, gantries and walk-away	17	Notices and fees to local Authorities and Public Undertakings
6	Setting out	18	Attendance on clerk of works
7	Watching and lighting	19	Temporary Power and Site Lighting
8	Insurances	20	Travelling time fares
9	Additional overtime	21	Transportation to site
10	Maintenance of the public and private roads	22	Temporary offices, storage sheds, man store
11	Weather protection and precautions	23	Cleaning out Buildings
12	Testing materials	24	Temporary water on site

 

Preliminaries & Contingency: The Differences

The definition of preliminaries is different with contingencies. Contingency is an estimated allowance for the cost of unknowns or changes. It also includes escalation and estimating error. So basically it is an anticipated allowance for any cost which may be incurred during the construction process. It can vary in amount depend on the project size and type. While preliminaries are estimated allowance for the cost of things which are known but we cannot priced them precisely due to their uniqueness and vastness.

 

 

Preliminaries & Overhead: The Differences

Overhead is defined as indirect expenses that cannot be charged to individual costs or bid items. Overhead covers items such as directors, secretariat, marketing, equipment not only for project necessity but also for headquarters necessity. Usually the overhead is expressed as a percentage and added to tender cost. Since it cannot be charged as an individual cost, we cannot find this item in Bill of Quantities. While preliminaries as a cost can be find in Bill of Quantities.

Entire Contract 2

Advantages & Disadvantage of Using Entire Contract

In my opinion, the use of entire contract tends to benefit the employer rather than for both parties. In the employer’s point of view, this kind of contract can be very beneficial for him. First of all, the employers can avoid paying contractors for their partly performed works. They also can use their allocated money for some other works first. Moreover, if there is a breach of contract, they may not pay the contractors for their uncompleted works, while they still can benefit from the performed works done by the contractors. The only disadvantage is that not all contractors want to deal with this kind of contract. Contractors willing to involve in this kind of contract are usually experience contractors.

 

The Doctrine of Substantial Performance

When a discharge of an entire contract occurs, the older reported cases such as Appleby v Myers [1867] and Whitaker v Dunn [1887] require complete performance by contractors as a condition precedent to his right of payment under an entire contract. If the contractors do not complete their work at the time of contract termination, then they cannot be able to claim their rights for services that they have done.

However the common law has since been modified by later judicial pronouncements which seem to be fairer to both parties. The doctrine of substantial performance is now been applied. It is said that a contractor who has substantially performed his obligations of the contract may claim on the contract for the agreed sum, though he remains liable in damages for his partial failure to fulfill his contractual obligations.

Therefore, substantial performance is an alternative principle to entire contract. This principle is relevant when a contractor’s performance is in some way deficient, through no willful act by the contractor, yet is so nearly equivalent that it would be unreasonable for the owner to deny the agreed upon payment. If a contractor successfully demonstrates substantial performance, the owner remains obligated to fulfill payment, less any damages suffered as a result of the deficiencies in workmanship by the contractor.

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