Cost assurance to increase capital expenditure confidence
Companies are now feeling the impact of the COVID-19 crisis through every phase of the project lifecycle, as supply and demand shock cascade throughout the economy. While project delays and suspensions are causing disruption and uncertainty, there is also opportunity.
By Imran Akhtar, Director and David Sutherland, Project Director
Using this downtime proactively to review and verify costs and expenditure against existing contracts and commercial relationships will assist in maintaining capital discipline, build supply chain trust and position your project ready for re-start.
Based on our commercial performance research we know that:
- Only 35 percent of organisations “proactively identify cost risks and test their financial controls before entering into open book or cost-plus contracts.”
- Only 40 percent “agree that allowable costs and rules of assessment are clearly defined in their contracts.”
This presents an immediate concern that the majority of commercial terms and contracts are sufficiently ambiguous to allow for discrepancies. This creates a particular challenge for projects that are based on a target cost or cost-reimbursable commercial basis.
These ambiguous or ‘grey’ areas are where project costs can escalate unexpectedly.
Previous findings have highlighted:
- Duplicate invoices and instances of overpayment and underpayment
- Corrections as a result of payroll reviews
- Hours billed outside of contract terms
- Lump-sum costs claimed through reimbursable costs
- Disallowed costs e.g. insurance
- Accruals claimed against subcontractors in liquidation
- Costs charged to the wrong project
- Incorrect rates used for staff
- Plant not off-hired.
What is cost assurance?
Cost assurance provides an independent verification of cost that supports construction project governance. It is a collaborative process that reviews project costs in line with source documentation and appropriate evidence to provide a view on cost accuracy. It also reviews compliance against the contract to ensure that costs applied for to date are accurate and contractually allowable.
Cost assurance helps our clients understand where they may be exposed to overpaying, or in some instances underpaying their contractors. An effective approach will consider the key risk areas, analysis based on fact and how to resolve so projects are ready for a restart.
Review now to prepare for the future
Taking a three-staged approach to cost assurance during this downtime will help your company to identify areas of concern and collaboratively resolve with the supply chain.
Review: What are the key risk areas?
- Review your contracts
- Review contractor systems and processes
- Analyse costs and key metrics
Respond: Highlight issues and drive resolution
- Report and summarise findings
- Gather data, carry out validation activities
- Validate findings with the contractor(s)
- Plan process improvements and put in place a cost assurance plan
Monitor: Ongoing review of processes, systems and contract parameters
- Ongoing reporting of progress and implementation of improvement recommendations
- Use lessons learned to refine future cost assurance activity
Key areas for review given COVID-19 disruption
Given current events, we are actively encouraging our clients to agree with their supply chain:
- Additional audit and information requirements to increase cost transparency during the transition period and the peak of the outbreak
- How they will utilise government support initiatives alongside ongoing project payments to maintain their business and supply chains
- How supply chain liquidity and proof of payment will be evidenced (across all tiers)
We also recommend consideration of the following:
- Contractor owned major equipment: Is a suspension rental rate (standby rate) agreed?
- Do invoices/applications reflect the resources maintained during the suspension period?
- Is there a process in place to record supply chain activities that remain ongoing during suspension?
- How does the contract define actual costs and disallowable costs including definitions of indirect costs and overhead and profits?
- What are the contract provisions for ongoing storage costs?
- What is the cost provision for demobilisation and remobilisation?
- What is stipulated for rolling costs during suspension? This includes design deliverables connected to payments (payable against original design deliverables and lump sum if agreed that it’s not in suspension).
- How will interim payment against agreed resource plan and any ongoing suspension activities be managed?
Opportunities to make positive changes
Using the downtime to better understand how your contractors are set up to capture, manage and report on costs will play a vital role in improving project performance and profitability following a restart.
Based on a holistic approach that identifies risks, and provides recommendations on controls and systems to improve accuracy and efficiency, cost assurance allows project owners to increase their confidence in the management of project costs across their supply chain, with the ultimate opportunity to reduce the potential for claims.
Further resources
Please visit our COVID-19 response page for all of our resources relating to the impact of COVID-19 on the construction sector.