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Construction projects – part 5 - Indirect costs



Risk allowance

You cannot carry out any project in the absence of risk.
Risk will arise from many avenues.

  • Delays can arise from bad weather
  • Poor estimation of task durations and material requirements
  • Poor employee training / skills / performance in general
  • Defaults on payments affecting cash flow
  • Equipment failures and other technical problems
  • Increased costs of materials on a fixed price contract
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In this sense the contractor adds an amount to cover these ‘unforeseen’ circumstances in the costs.
This is a form of insurance for the contractor which the client actually pays for. Good planning will help to prevent many of these or at least reduce their likelihood.

For larger contracts a more formal approach can be taken when looking at weather problems.

Areas of risk clearly do not always occur. This does not mean you should lower your costs for the next project by ignoring them.

When you calculate how much you should add for risk issues there are a few things to consider.

For example, you will be bidding for a contract and as such you are not in a position to say:
‘This might happen, and that might happen and therefore we are adding cost ‘X’ to cover this’.

The risk cost can be added to individual tasks or as percentage of the total direct costs.
There are advantages and disadvantages to both methods.

Bear in mind that some of the risks you may be considering can be covered with insurance policies.
These are best discussed with your insurance broker.

You may decide that your risks can be covered by adding say, 3 to 5 % to the direct costs.
Adding an amount to each individual task is less easy and may be difficult to estimate and justify in the costing.
You could extend the duration of a task on the assumption that weather may cause delays.
If you do this you may extend the project timelines which may affect the winning of the contract.

Company costs

All companies have costs that will be incurred whether you have any business or not.
These costs should be shared between the projects.
In the main, the larger projects or more complex ones should bear the brunt of the costs.

The leaner and more efficiently a contractor runs the company the lower will be costs and the bids that much more competitive.

Salaries

These apply to the full time staff, for example, secretaries, any permanent supervisors etc.
The costs include company cars, taxes and any other benefits for permanent staff etc.

Property

This covers the renting or purchasing of buildings that are required by the business but not directly related to any particular project.
The long term cost of leased property should be spread over the life of the lease as an annual cost.
Any purchased property should be depreciated over the estimated life time of the item.

Naturally, additional costs in running and maintaining the properties must be included, for example, electricity and telephone systems.

Vehicles

Vehicle purchase is accompanied by running costs of fuel, regular maintenance, repairs and insurance.
In a similar fashion to property vehicle replacement is allowed for by an annual cost of depreciation.

Loan interest

There may be times in a project when you will need to raise money through a loan.
This might be:

  • At the start of a project to get it off the ground
  • If cash flow planning has been poor and you need to spend money on materials or equipment
  • If there are delays in client payments at agreed intervals

Interests on loans can be high which in turn can eat into any forecast profit margins.

The total company costs are calculated over 12 months and then converted to a monthly average.

We can then assess the company turnover.
So for example if we have:

Company turnover = £140,000 Company costs = £14,000 which is 10% of the turnover.

Hence, the company costs can be recovered by adding 10% to all projects undertaken.
This can be hard to calculate for smaller companies and another method involves adding an amount to each project.

If we have 4 projects in a month their relative values could be:

Project ‘A’ = 5
Project ‘B’ = 4
Project ‘C’ = 2.5
Project ‘D’ = 2.5

Total = 14

Hence, the relative amount for Project ‘A’ = 5 / 14
If the monthly company cost = £1400
The amount attributable to Project ‘A’ each month would be £1400 x 5 / 14 = £500.

If Project ‘A’ lasts for 6 months you can attribute a total of 6 x £500 = £3000.
This method only works well if you can forecast the projects and their durations accurately otherwise you will lose money.

Non - PRINCE2 information