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  • Writer's pictureJohn Lowry

Rules-based Shared Data for Financial Control of Major Projects

This is one of the most compelling arguments for rules-based, shared cost and time data in construction contracts.

As Louis XIV’s department of works was recommended in 1683, as a result of what may have been the first government enquiry into the financial control of construction contracts:

In the name of God: re-establish good faith, give the quantities of the work and do not refuse a reasonable extra payment to the contractor who will fulfil his obligations’.

Over the past 40 years the construction sector moved away from rules-based, shared financial data to silo’d, fragmented data, on the spurious grounds of risk-aversion by siloing risk between partners in the construction enterprise. This change in culture was driven by government and private clients unwilling to resource contract management and wanting to isolate risk and blame, large contractors who perceived an advantage in owning and controlling financial data, and contract drafters who had never administered or managed a complex contract.

There is little understanding that managing risk is far more effective than contracting out of risk, particularly to parties that have no ability to manage assumed risk, and insufficient margin or capital to carry it if required.

It has led to distrust, disputes, loss, poor performance, slow innovation uptake compared to most other sectors, a mental health crisis, and an inability to attract top quality employees.

The solution is simple, but it’s not easy.

Because we have to turn away from a broken system that is embedded in culture and contract.

Financial Control of Construction Projects

Financial control means control of money changing hands. Since money almost always changes hands in the opposite direction from that in which goods or services are supplied, it can be considered as the control of who provides what and at what price.

This thought establishes rules-based, shared financial data (a priced BoQ) as the central vehicle for the financial control of a construction contract. The BoQ is the agreed statement of the prices which will be paid for work done by the Contractor for the Employer; it shares with the Drawings and the Specification the responsibility for defining what has been agreed shall be done.

Control is usually based on a forecast. The difficulty of controlling something is proportional to the difficulty of predicting its behaviour.

The points, finer and coarser, of the financial control of construction contracts revolve around the difficulty the Employer has in forecasting and defining to a Contractor precisely and immutably what he is required to do, and the difficulty the Contractor has in forecasting precisely what the work will cost.

To achieve effective control it is necessary to limit these difficulties as much as possible within the constraints of practicality. This means using as much precision as possible in defining the work to the Contractor and in enabling him to forecast its cost as precisely as possible. These are the essential functions of BoQ’s.

It is the essential function of a method of measurement to define the rules for how BoQ’s should be compiled so that they serve these two essential functions.

It is clear from this consideration that a BoQ works best if it is a model in words and numbers of the work in the contract.

The first purpose of a BoQ is to facilitate the estimating of the cost of work by a contractor when tendering. Considered as a model, it should therefore comprise a list of carefully described parameters on which the cost of the work to be done can be expected to depend. Clearly these parameters should include the quantities of the work to be done in the course of the main construction operations.

Carefully prepared BoQ’s are far more accurate than quantities prepared by contractors or subcontractor during a short tendering period. This implies that tendered prices with a BoQ contain considerably less “margin of error” over-measures and contingencies.

It allows contractors and subcontractors to concentrate their effort on method and pricing, rather than measuring the work, and hoping they have not made a material error.

The separation of design from construction in contracts and the appointment of contractors on the basis of the lowest tender are the two features of the system which makes it essential for a good set of parameters to be passed back to designers and and employers. Only then can they design and plan with the benefit of realistic knowledge of how their decisions will affect construction costs.

The less contractural pressures cause distortion of the form of the prices exchanged from the actual construction costs, the better this object is served. It is very much in the interests of Employers of the construction industry that the distortion of actual cost parameters should be minimised in priced BoQ's.

An Employers most important decision is whether to proceed to construction or not.

This decision, if it is not to be taken wrongly, must be based on an accurate forecast of contract price. Only if a designer has means of accurately predicting likely construction cost can such a forecast be achieved.

Programme and Timing

Because prices for items of materials and labour include an estimate of time to complete work activities, timing is an important aspect of pricing. Pricing of BoQ items include averages and judgements of the time it may take to complete an item of work. These averages are (or should be) transferred to a construction programme to determine the project timings and interactions with other contractors’ activities.

It is, therefore, critical that contractors can rely on a realistic construction program when pricing work.

The absence of cost parameters which are sensitive to methods and timing of construction has probably caused as much waste of capital as any other characteristic of the industry. However a carefully constructed and managed construction program can form the basis for an agreed sharing of the risk of changes and extensions to the planned programme of work.

A major aspect of financial control in construction contracts is the control of the prices paid for work that has been varied.

Whilst variations may not be wholly related to the quantities of items included in a BoQ, a priced BoQ does provide a basis for clients to be confident that the prices agreed in a BoQ bear a reasonable relationship with the original tendered price. (A quantity surveyor will typically review a priced bill of quantities to identify errors and “front-loading” to accelerate cash flow).

Other costs of variations, including delays, changes to workflow and disruption can be adjusted by including agreed extra costs of method and timing changes with a carefully crafted, managed and maintained construction programme.

That cost is difficult to predict must not be allowed to obscure the fact that a financial control depends on prediction. If the content and timing of the work cannot be predicted the conduct of the work cannot be planned. If the work cannot be planned its cost can only be recorded, not controlled.

Having no rules-based, shared parameters for pricing variations leads to effort being applied to the pursuit of payment instead of to the pursuit of construction efficiency. In a climate of uncertainty brain power is turned to maximising payment rather than to minimise cost.

Mitigation of this problem lies in adopting clear parameters of costs as the basis of prices in BoQ’s and construction programs. The employer would then pay for variations at prices which were clearly related to tender prices and the derivation of the adjusted price could be wholly systematic and uncontentious. This ideal may not always be achievable, but it is brought closer with more systematic, agreed methods for valuing variations, using open, shared cost and time data.

Cash Flow

From the cash flow point of view there are advantages in sticking to the principle of cost parameters. The closer the relationship between the pattern of the prices in a BoQ and the pattern of the construction costs, the closer the amount paid by the Contractor each month to its suppliers and sub-contractors. The Contractor’s cash balance position is stabilised, only accumulating profit or loss when his operations are costing less or more that was estimated.

This will become more important for all parties with the introduction of payment through payment trust accounts.

Since much of the Contractor’s turnover is that of materials, suppliers and sub-contractors with little added value, stability and predictability of cash flow has an importance often not appreciated by employers and engineers. Contractors are in business to achieve a return on their resources of management and working capital - a return which is seldom related closely to profit on turnover. Predictability of the amount of working capital required is a function of prompt and cost-related payment from the employer another benefit of using pricing parameters closely related to parameters of construction cost.

An employer’s interest is best served by a contractor who is able to base an accurate estimate on a reliable plan for constructing a clearly defined project, and who is able to carry out work with a continuing incentive to build efficiently and economically despite the assaults of those unforeseen circumstances which characterise construction work.

Confidence in being paid fully, promptly and fairly will lead to the prosperity of efficient contracts and to the demise of those whose success depends more on the vigour with which they pursue doubtful claims.

Adapted from the forward to the Institution of Civil Engineers (UK) standard method of measurement by Martin Barnes, the inventor of the Time / Cost / Quality triangle for project management. He is considered the father of modern project management.

[Ed: Edited for a more general construction industry context.]

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