Cost assurance techniques for projects guaranteed to increase confidence in capital expenditure
Embedding a discipline within the project organisation to look at how well all the categories of costs and expenditure are being managed is a given.
In our experience, for the owner or operator with the foresight to stand back from their day to day running of projects to put an additional layer of assurance onto the commercial engagement and management of their supply chain, the benefit can be significant.
It is to address this need that we strongly advocate an external cost assurance process.
Is there really a need?
In a commercial performance study we conducted in 2017, only 35 percent of respondents stated that their organisation “proactively identified cost risks and tested their financial controls prior to entering into open book or cost-plus contracts.” Only 40 percent of respondents “agreed that allowable costs and rules of assessment are clearly defined in their contracts” leading to the conclusion that the majority of commercial terms and contracts are sufficiently ambiguous to allow for discrepancies. These ambiguous or ‘grey’ areas are where project costs can escalate unexpectedly.
In a commercial performance study we conducted in 2016/17 only 35 percent of respondents stated that their organisation “proactively identifies cost risks and tests financial controls prior to entering into open book or cost-plus contracts.” Only 40 percent of respondents “agreed that allowable costs and rules of assessment are clearly defined in their contracts."
Where to look
As an example and simply put, the more times an invoice for an unallowable cost goes unquestioned and approved, the more its payment is expected by the supply chain. Thus an 'unallowable' cost quickly becomes an 'allowable' one. “During one cost assurance analysis, we discovered a contractor had been charging the client for an insurance premium that was unallowable,” says Director Gonzalo Rosa, based in Calgary, Canada. “But no one had questioned it; and because it had been regularly approved, everyone just assumed it was part of the contract.”
Unnecessary duplication is another factor that needlessly pushes up project costs. “In a recent assurance exercise we completed for a client, we reviewed a contractor's invoices and noted duplicate entries. Our prior review of the contractor’s system noted this to be a risk as they managed cost in a very manual way, not fully utilizing the systems they had around them to maximize efficiency,” says David Sutherland, Associate Director, based in Houston, USA. “Essentially, these were costs that were being claimed twice over a matter of months, amounting to significant sums to be credited back to the client.” Meanwhile, Imran Akhtar of our UK infrastructure practice notes that over the last couple of years his team has discovered ’disallowable’ costs or instances of overpayments that have returned around £10 million to clients.
Proactive cost assurance as a function shouldn't be a “nice to have”, Akhtar argues, “It should be, more than ever, an intrinsic part of any capital project”. It requires a dedicated team who zones in and expertly review areas of opportunity to save costs by reducing spend in terms of quantity of material take off, in considering aggregation of spend and checking compliance with the commercial terms set up in the contracting phase of a major project. “We have first-hand experience of how a ‘smart’ analysis of spend can provide unique and valuable insight” says Akhtar.
Cost assurance is more than a compliance function
While it can certainly pay for a project owner to operate a robust cost assurance process, there are usually two barriers to its adoption:
- First, cost assurance is seen as a compliance function more akin to good financial governance rather than a targeted business initiative to better understand the cost and commercial landscape, help strengthen controls and reduce the risk of supply chain over payments.
- Secondly, and linked to the first barrier, is the belief that cost assurance can only be done in-house as part of a business’s commercial function.
To maximise the benefit of cost assurance, a team needs a broad range of experience combining financial, commercial, data management, contract management and contract administration skill sets. Quite often in-house teams don't have either the range of experience or the time. The fact is that an internal team will normally only carry out a small, focused verification exercise; whereas true cost assurance is more — much more — than simply checking invoices or ‘ticking a box’.
It's a holistic approach that identifies risks, and provides recommendations on controls and systems to improve accuracy and efficiency. It will ultimately allow the project owner to increase their own confidence in the management of project costs across their supply chain.
Working with an independent commercial partner whose day job it is to deliver cost assurance can make all the difference. “We take the time to understand the nature of the project before we perform a comprehensive systems review. You have to make the time to do this in order to understand where risks might be,” says Akhtar. “Only once we have an understanding do we form our testing approach, which is a combination of reviewing source evidence (invoices, goods received notes, subcontractor contracts, etc.) and the cost data in an intelligent way.”
Automation is key to assisting the experts
“We have also invested in technology which in-house cost assurance teams might not have access to, and that has vastly improved the logistics of cost assurance, making the process more streamlined and cost-effective.
“Previously, a company would have had to put a huge amount of effort and manpower into reviewing all of its costs,” says Rosa. “That's changed in the last five to ten years because computer software means much of the routine work is now able to be automated. This has made the exercise a lot more efficient, and it's increased the benefit-to-cost ratio we can demonstrate to clients.” For example, duplicate testing and semantics testing is able to be completed using specialist software, which allows thousands of lines of cost data to be assessed quickly and accurately.
Akhtar notes: “Our cost assurance team also use smart techniques and tools, such as data visualisation and trend / pattern analysis, to bring the process to life and show results in an interactive and informative way — something that can't be done as easily with a written report. Ultimately, this new technology means findings can be presented in a way that is easier to digest.”
Yet, while the latest technical innovations are a key part of any good cost assurance offering, there's no substitute for human experience. Software can manipulate data, but the knowledge of how to interpret and present findings is part of a team’s professional judgement and opinion.
Professional scepticism, judgement and ethical conduct is critical across the cost assurance process. Sutherland, for example, has worked on numerous major capital projects, so he knows exactly how they operate and the risks they present. “I've lived the kinds of issues that oil and gas companies face every day,” he says. “A cost assurance team, like ours, requires a combination of diverse skills from all different types of backgrounds, supported by subject matter experts, like cost engineers, commercial specialists, quantity surveyors and project managers. That range of knowledge — not just of cost assurance, but of how the industry works and the political and commercial relationships and tensions that can develop between a business and its supply chain — allows the team to dig deeper and provide true value.”
Software can manipulate data, but the knowledge of how to interpret and present findings is part of a team’s professional judgement and opinion. Professional scepticism, judgement and ethical conduct is critical across the cost assurance process.
Cost assurance – what you need to know
Think 'cost assurance' at the start of every project
That way you'll cultivate a reputation as a project owner that is looking to manage cost in the most optimal way. It's an ethos that contractors will respect — and expect.
Take time with the contractual relationship
Clearly define the parameters and definitions down to the allowable costs and rules of assessment in all of your contracts.
Good communication is vital — on all sides — so that everyone involved in project-related costs understands their roles and responsibilities, and what is expected of them.
Consider an incentive mechanism to promote positive behaviours
Consider introducing key performance indicators linked to additional reward in the contract to help promote the right behaviours around cost management; performance; and also cooperation with the broader cost assurance process.
Data as an asset
Data can be as valuable as the built asset. The project owner should take time upfront to consider what information they need and why, and collaboratively engage with the supply chain to communicate expectations.
Trust — but verify
You have built up a relationship with your contractors and you trust them, which is important. It is, however, equally important that you verify the information they give you. If a trust/verification process is already in place, it's easier to fix a good working relationship should it become strained.
Give due consideration to an independent cost assurance role
Often, external stakeholders insist that cost assurance be conducted by an independent party. The project owner should consider this and act accordingly. Ultimately a diversely skilled and focussed team is the key to getting it right.