Types of organizations
Organizations are formed based on certain factors such as ease of formation, ability to raise capital, taxation, control of the business, and distribution of liability. Construction businesses are formed in different types of organizations. They can be a proprietorship, partnership, or corporations.
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When a project is large, several organizations may pool resources together to complete the project. The resources include expertise and funds. A consortium is a group of organizations working as one entity for the completion of the project. The owner of the project negotiates with the joint venture as if it were one organization.
The consortium is dissolved once the project has been completed. Each firm adds a special advantage to the joint venture. They may include financial resources, technical expertise or special knowledge1. Members of a consortium agree to a legal structure that suits the project.
Proprietorship is the simplest form of organization. It is a business entity that belongs to an individual. Capital is raised by the owner. The owner may use his other personal assets to secure loans from banks. Liability extends to the owner’s assets. If the business is unable to pay its creditors, the owner’s assets may be sold to pay the debt. Profits made by the organization are considered personal income to the owner. It is taxed as other forms of personal income. Risky businesses are usually not organized as a proprietorship.
Advantages and disadvantages
One of the advantages of a proprietorship is the ease of formation. There are few legal restrictions. Profits are part of the owner’s personal income.
Disadvantages include unlimited liability. There is reliance on capital from one individual. Construction businesses have a high risk of losses. Most proprietorship companies engage in small contracts that have a low risk of disputes.
Partnerships consist of general partners and limited partners. Any partnership must consist of a general partner. Capital is raised according to the agreed proportion. Profits and losses are also shared according to the agreed proportion. Limited partners can lose only the part of the money they used when investing in the company. The liability of the partnership does not extend to other assets owned by limited partners. For general partners, liability extends to their personal assets. If the organization is bankrupt, the personal assets of general partners may be sold to cover debts.
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Advantages and disadvantages
One of the advantages of partnerships over proprietorship is that they have the ability to raise more capital. Liability is distributed among the partners. In case of losses, the effect is lessened on individual partners depending on the proportion agreed upon. Knowledge and expertise are pooled together for better management. Limited partners have their personal assets secured.
One of the disadvantages is that a partner does not have full control of the organization. He/she has to consult with other partners to make decisions. Profits are shared. One is required to seek approval from other partners before engaging in any deal. Limited partners have no control over the business. The limited partnership is subject to more regulations by the state office issuing the charter2.
The action of one partner legally binds all other partners3. Limited partners are not allowed to use intangible assets such as intellectual property as their contribution to gain partnership. Their contribution should be in the form of cash, stocks, or other tangible assets.
A partnership is guided by a formula for evaluating the fluctuations in the value of the organization. General partners may assign themselves a salary package if they are involved in the management of the organization. The amount depends on the level of responsibility.
A corporation acts as a separate legal entity on behalf of the owners. Once issued with a charter document, it is allowed to issue stocks to the public. The size of ownership is recognized by the number of stocks that an individual owns. Share values assigned at the beginning of the initial public offer are not the actual value of the shares. The book value of shares is the actual value of the shares. The book value is obtained by dividing the net worth of the organization by the number of shares issued4.
The shares would be trading at a different value on the market. A value is determined by supply and demand. The numbers of shares stockholders are willing to sell at price buyers are willing to buy. The market price of shares rises in anticipation of profits or business growth. It falls when losses are anticipated or a firm does not have opportunities for growth.
Most construction organizations do not trade freely with the general public. They hold their shares closely. Any opportunity to trade shares is first offered to shareholders within the firm. It may be used to control share prices. The free share market is very volatile. Market prices rise and fall frequently. However, giant construction firms may trade in the public market because of the big number of their stocks.
An individual can gain control of a corporation by having a shareholding of 51% or more5. State authorities regulate the issuance of shares by corporations to protect the public from misrepresentation of share prices and financial reports.
In the UK, limited companies are required to file their annual financial records with the Registrar of Companies6. It is necessary to ensure that companies do not give a misrepresentation of the actual figures. They are also required to carry out an annual independent audit.
Advantages and disadvantages
Some of the advantages include ease of raising capital. Capital raised through shares does not have to be repaid. They do not incur interest. Shareholders can only lose up to the value of their shares. Their personal assets are protected from the risky construction business7. Corporations have a prolonged life.
One of the disadvantages is that it is difficult to form a corporation. It incurs higher legal fees. There are more restrictions set by the state regarding the formation of corporations. Corporations seeking to operate in multiple states meet further restrictions because they are considered foreign companies8. There is double taxation on profit through corporate tax for the company and income tax for shareholders.
Project cash flows
Cash flow refers to the inflow and outflow of cash. Cash inflow is money received by the constructor. It is also called revenue. Cash outflow is money spent by the contractor. Spreadsheets and other computer programs are used to test scenarios9. Scenarios refer to the net income that the contractor will remain with after completion of the project. The lower net income possible is known as the worst-case scenario. The higher net income possible is known as the best-case scenario.
The forecast of these scenarios uses factors previously noted with a high probability that the present may follow the same trend. The different business environments may change the impact of historical data on projections. Some of the external factors that may change the historical trend are macro-economic factors10.
Cash flow projection
Cash flow projection refers to giving a future account on how the cash will be received and spent. Most contractors spend cash before they start receiving payment. Contractors develop scheduling aids that show how money will be spent. The complexity of the project determines the complexity of the tools used to develop scheduling aids11.
In many public projects, contractors are required to develop an S-curve. The S-curve shows the level of completion and the amount of money spent up to that point. The S-curve is developed by first plotting bar charts of the project12. The bar charts are drawn according to the time schedule. The bar charts are assigned costs.
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The curve becomes steeper as more is spent within a short period and less steep when less is spent over time. At the beginning and at the end of construction less is incurred which makes the S-curve to be less steep. The middle part is steeper because more is spent over time.
Cash flow to the contractor
Cash flow to the contractor comes in the form of progress payments. The contractor is paid according to completion of work. The contractor is required to give an account of work completed periodically. The estimates are approved by the owner’s representative. The contractor drafts a bill which is forwarded to the owner. The owner makes payment as agreed depending on work completed. In some cases, the owner remains with some percentage of money until a certain percentage of work has been completed. It is known as retained payment. It encourages the contractor to complete the project to receive full payment13.
Borrowing by contractor
In most cases, the contractor needs a source of finance to complete projects before revenues are received. The constructor may need to borrow from banks in the form of an overdraft. They may also use credit cards. Overdrafts attract a higher rate of interest because contractors are considered to have a high default risk. On the other hand, owners are considered low risk borrowers. They are charged low interest rates14.
Borrowing by owner
Contractors should borrow less from banks to increase their profits. However, constructors are likely to pass over the cost of borrowing funds to the owner. Most contractors use a markup price to maintain the same level of profit. For mutual benefit, the owner may borrow from banks instead of the constructor. It reduces interest cost. As a result, the owner is charged less15.
Mobilization of cash (Front)
In some cases, constructors request early payments from the owner so as to avoid overdraft costs. It may happen when the owner has confidence in the contractor’s ability to complete the project. The contractor works with revenues from the owner instead of borrowing. For a contractor, the best case scenario is when the owner provides all the finances so that there is no need of an overdraft16.
There is a maximum amount that a contractor may be allowed to borrow as overdraft. The amount that exceeds the overdraft must be funded from other sources. Banks consider the number and value of projects that are held by the contractor. They also consider the number of construction firms that have requested for an overdraft17.
Adding revenues together with the overdraft, the contractor should have an amount that covers expenses and provides a safety margin18. A safety margin is an amount that covers expenses that may exceed projected costs. It covers the uncertainty associated with a cash flow forecast.
Overdrafts have the advantage of being cheaper than other sources. They are flexible and quickly arranged. In some cases, interest is only paid on money that has been withdrawn. It may also be issued without security19. Some of the disadvantages of an overdraft are that it may be repayable on demand. The conditions under which it is issued may change depending on bank policy or government economic policy. It is issued under varying conditions.
Comparison of payment schemes
The different sequences of receiving payments are evaluated to determine their profitability using the internal rate of return (IRR). IRR is the rate of interest that makes the difference between revenues and expenses net present values to be equal to zero20. There are no direct calculations to arrive at the IRR.
The sequence of cash flow is determined by the percentage the owner is retaining, delay in payment, and payment mobilization. The rate of return on the initial payment schedule is compared to the rate of return after mobilization of payment21.
Cost plus a fixed fee contract involves the owner paying for the entire cost of construction and an additional amount in the form of a lump sum or percentage of the cost. It provides the contractor with flexibility to accommodate changes made by the owner22. Other forms of the cost plus contracts provide a limit of the maximum amount that may be spent. Other forms provide a reward to the contractor for completing the work on schedule and the right standard efficiently.
In the U.S., construction companies are certified by two bodies for different aspects of standards and environmental concerns. The Leadership in Energy and Environmental Design (LEED) issues two types of certificates. The normal certificate of recognition is issued for meeting the required standards. It indicates approval. The plague certificate shows disapproval. Registered and certified construction companies are listed in an online directory23.
The Green Building Council (USGBC) issues certification depending on points achieved. It issues contractors with grades. The certification grades are gold, silver, and platinum. USGBC considers 5 aspects of construction. They include efficient utilization of water, sustainability of development, impact on energy and atmosphere, choice of materials and resources, and indoor environmental quality.
Cost control as a management tool
Cost control provides a way for detecting the possibility of cost overruns and preventing their occurrence. It also involves minimizing the impact of exceeding the projected cost. Project control data need to be collected when the project is still in progress at regular intervals. Comparison is made to determine a lag in the schedule or costs that exceed estimates. The data collected is also used in future projects to make comparisons about similar levels of work completion24.
Project control cost systems
Chart of cost accounts is a process that determines the level of details to be included in collecting data. During this process, cost control data and data for financial accounts are analyzed to create a relationship. A relationship which would allow cost control data to be used to develop financial accounts. Cost control data can also be derived from financial accounts. Sometimes cost control data is not useful in financial accounting.
The project cost plan is a process describing how to make comparison between project estimates and the planned costs. Cost data collection involves gathering data that can be used to minimize costs.
Project cost reporting is a process of identifying areas or activities that provide opportunities to reduce cost. Identifying areas where costs are deviating from the budgeted cost is necessary to enhance profitability25. Cost engineering is the process of assigning procedures that minimize costs.
Cost accounting is a process of assigning costs to small units within the whole project. Each control unit should consist of a task that can be easily identified in the field. The unit is assigned a code which is used to record costs. All costs that have the code will be known to have been incurred by the unit. It gives the management an easy work to identify where costs are incurred without going directly to the field26.
Cost coding systems
There are several ways of encoding costs so that they can be easily identified with a task. Some coding systems use departments as a way of breaking down into units. Some construction companies use construction processes to assign codes. American Road Builders Association has developed a coding system based on earthwork activities. MasterFormat has developed a coding system for accounts associated with building27.
The MasterFormat classification
The MasterFormat coding starts with two digits which identify a certain unit. Two digits are added for any addition detail. After 8 digits, 4 digits may be used to describe the cost and for what it was used for. The format reaches a 12-digit code but allows contractors to use additional digits to match their varying needs. Large projects may require more than 12 digits. Other projects find dates relevant which may be included in the code28.
Earned Value Method
Earned Value Method (EVM) examines the budget and the schedule in relation to the completed work. A project can be described as on schedule, behind schedule, or ahead of schedule. A project could have spent more than the budget, as the budget, or less than projected in the budget. EVM was developed from Cost and Schedule Control System (C/ SCSC). C/ SCSC had a reputation for effectiveness when it was used in the U.S. defense department29.
EVM is based on developing percentages of work completed and the expected cost and time they are supposed to have incurred30. The assessment is done periodically. The most preferred is on a monthly basis. The plotting of the earned values results in an S-curve.
Labor cost data
Labor cost data is used to determine wages and control costs. It is also used to maintain records for income taxation purposes. Labor cost data are collected by foremen. It is examined by other superior officers before it is processed in the head office payroll section.
A job log is used to collect data about labor and activities throughout the construction process31. Each contractor should have a document that provides all relevant information on the contractor’s responsibilities. A job log should provide details about historical events that were carried on the site. It gives an explanation why certain events occurred.
Supervisors have their own documents that show the activities they are involved in at the site. Time cards are used by foremen to document the labor hours for each worker. It provides information that can be used in the job cost control system32.
They are also known as indirect costs. These are costs that are used for support purposes. They include general and administrative costs. Administrative costs are incurred together for the whole project33. It is inappropriate to assign them to small units within the project. Home office overhead costs may be estimated by assigning a certain percentage of total expenses.
Indirect labor costs can be assigned to the appropriate accounts. The control unit that utilizes indirect labor can be identified in the field. Indirect labor costs should be estimated before work completion. Some contractors use a flat rate such as a percentage of total direct cost to cover indirect labor costs.
Overhead costs can also be calculated by assigning cost for each item. Home office overhead costs are estimated based on general and administrative costs expenditure for the previous year, contract volume for incoming year, and the markup34. Fixed overhead costs are usually estimated using a certain percentage of the total direct costs projected for the incoming year.
Atallah, Patricia. Building a successful construction company, Chicago: Kaplan AEC Education, 2006. Print.
Atkin, Brian, and J. Borgbrant. Performance improvement in construction management, Boca Raton: Taylor & Francis, 2009. Print.
Halpin, Daniel, and B. Senior. Construction management. 4th ed. Hoboken: John Wiley & Sons, 2010. Print.
Harris, Frank, and R. McCaffer. Modern construction management. 7th ed. Hoboken: Wiley- Blackwell, 2012. Print.
Lock, Dennis. Project management in construction, Burlington: Ashgate Publications, 2004.
McMenamin, Jim. Financial management: an introduction, New York: Routledge, 2013. Print.
Rounds, Jerald, and R. Segner. Construction supervision, Hoboken: John Wiley & Sons, 2011. Print.
Sears, Keoki, Glenn Sears, and Richard Clough. Construction project management: A practical guide to field construction management. 5th ed. New York: John Wiley & Sons, Inc., 2010. Print.
- See Halpin and Se Senior 80 on contribution to become a partner, Atkin and Borgbrant 116 contributions on joint ventures.
- See Halpin and Senior 83 on the Office of the Secretary of State.
- All partners must honor all contracts signed by a partner on behalf of the partnership.
- Atkin and Borgbrant 60 explain that it is intellectual capital.
- See Harris and McCaffer 417.
- See Harris and MacCaffer 430.
- On protecting personal assets, see Atallah 132.
- See Halpin and Senior 86
- See Halpin and Senior 195
- Macroeconomic factors include unemployment level, GDP, economic growth among others.
- See Halpin and Senior 196 on using scheduling aids.
- See Sears, Sears and Clough 271, Halpin and Senior 197, on allocating costs to bars on charts.
- For more explanations on incentives, see Halpin and Senior 197, Lock 145-148.
- See Halpin and Senior 198, Atallah 119. They describe a high risk of loss.
- See Halpin and Senior 198. The owner has a low chance of defaulting.
- See McMenamin 659 on the disadvantages of an overdraft.
- See Halpin and Senior 198. When there are many contractors requesting overdrafts, a contractor is likely to get less than requested.
- See Halpin and Senior 199. Safety margin may cover budget overruns.
- See Harris and MacCaffer 422 on unsecured overdrafts, advantages and disadvantages of overdrafts.
- See Halpin and Senior 202 on explanations about IRR.
- The option with the highest IRR is usually preferred.
- See Rounds and Segner 325 on the advantages and disadvantages of cost plus a fee approach.
- See Halpin and Senior 300, for more explanation on certification.
- See Halpin and Senior 301.
- See Sears, Sears and Clough 224, for a similar explanation on profitability.
- See Halpin and Senior 302 on dividing the project into units and coding for cost control.
- See Halpin and Senior 304 on a sample coding format.
- See Halpin and Senior 306. The code could be extended to match the contractor’s need.
- See Halpin and Senior 310 on the effectiveness of the C/ SCSC system.
- See Halpin and Senior 313 on examples of calculations.
- See Rounds and Segner 51, Harris and McCaffer 51, for explanations and sample job log.
- See Harris and MacCaffer 54.
- See Lock 138.
- See Halpin and Senior 320, Halpine and Senior 149 on using percentages in making estimates