When a contractor goes into default, creating the cost-to-complete estimate is a critical first step to recovery. One way to estimate the cost-to-complete the project is to utilize the latest pay application issued by the contractor.
In this post, we look at
- Where to begin to get a solid understanding of the status of the project
- How to use the pay application to establish a baseline on which to build the cost-to-complete estimate
- Calculating subcontractor costs-to-complete and what to consider when estimating the value of self-completed work
- The challenges presented by unidentified scope gaps and how to avoid them
- Other variables to consider
Fundamentals of Preparing an Accurate Cost-to-Complete Estimate
Before digging into the pay application information, there are some of fundamental items you need to understand to prepare an accurate cost-to-complete estimate:
- What is the scope of work?
- Who is doing what?
- What is missing from the scope?
- Are there any scope gaps or construction deficiencies?
- What additional costs should be included in your estimate?
- What are contingencies and how should you include them in your estimate?
- What are warranties and how can they affect your estimate?
With a basic understanding of the project status, the next step is to review the pay application. Here are some questions that you need to answer in order to use the pay application to populate the cost-to-complete estimate.
- Did the owner approve and paid the last pay application submitted?
- Did the status of the project correlate with the amount billed?
- Are payments to the existing subcontractors up to date?
- Are the existing subcontractors willing to finish the project?
- What is the balance of the contingency account?
- Is the owner aware of any scope gaps?
Cost-to-Complete Fundamentals
The baseline amount for the cost-to-complete estimate is the balance in the pay application including the retainage. One method to identifying that baseline is to familiarize yourself with the current subcontracts and understand the remaining scope of work for each subcontractor
Three steps can help get the information you need:
- Review a copy of each subcontract: The subcontract agreement will give you the original contract amount.
- Study the last pay application and Schedule of Values to understand the scope of work: The last pay application can give you an understanding of the approved change orders to date. The sum of the original contract and the approved change orders will give you the revised subcontract amount. Using the last pay application, you can see how much has been approved to date; you need to confirm with the owner and the surety what actually has been paid to date. (The fact that the pay application has been submitted and the owner has paid the contractor does not necessarily mean that the contractor has paid the subcontractors).
Example 1
3. Create a spreadsheet to track the original contract amount, the amended contract amount, amounts paid to date, retainage and unbilled balance.
Example 2
Once you have all that information you can get the contract balance by subtracting the revised subcontract amount and what has been paid to date from the original contract amount.
Be aware that the pay applications show the contract balance subtracting the revised contract amount from the approved to date. Refer to Example 1. The contract balance (Balance to finish) is the subtraction of the Adjusted Schedule of Values minus the Total completed and stored to date. In Example 2 the contract balance is the sum of the Earned Retainage plus the unbilled balance.
Once you have a list of all subcontractors, the prime assigned to each trade, and you know how much they have billed, and how much they have been paid you can estimate the accounts payable. The accounts payable includes:
- Subcontractors pending payments already billed
- Vendors pending payments
- Earned retainage to date
- Pending change orders
Please note that the pay application does not include any pending change orders; you need to get that information from each subcontractor.
Self-Performed Work Needs to be Accounted For
In some projects, the prime contractor might perform some of the work – such as earthwork, site utilities, finishes, landscaping, etc. – themselves, depending on their expertise. When calculating the costs incurred by the contractor that was self-performing the work, it is necessary to:
- Identify any scope of work performed by the prime contractor (the principal) This information may be found by reviewing the pay applications and schedule.
- Verify what work has been completed and what remains to be done. This can be done with a site visit to assess the existing conditions of the project and to make sure that the contractor did not front load the pay app.
- Assess the cost to complete of any pending work that was supposed to be self-performed by the prime contractor. This calculation is done by asking for a bid from existing subcontractors who could do the work or by using standard estimating methods to estimate the costs of remaining work. Usually subcontracting the work will be more expensive than if the work is self-performed.
This scope and related costs should be treated in the same manner as the subcontractors and included in the list.
Beware the Scope Gap
After you understand what remains in the scope of work, who is doing what, and what remains to paid, you have to ask: what is missing? This is how you identify scope gaps.
Scope gaps reflect work that has not yet been assigned to a subcontractor, vendor or prime contractor. In other words, scope gaps are the missing pieces of the puzzle. The easiest way to identify scope gaps is to review the project specifications, and compare each subcontract to the specifications, and look out for exclusions in each subcontract. Ideally, your subcontracts will cover each spec section in its entirety, without exclusions, but is not usually the case. One way to identify scope gaps is by making a list of the subcontracts, as previously addressed above and include the CSI code assigned to each trade.
Often there are scope gaps between subcontractors:
- One example might take place around the installation of the double detector check valve for the project. This is a common scope gap between the civil subcontractor and the plumber. Either of them can do the installation, but if you don’t check the contracts carefully neither of them might include in their work assuming that the other party will take care of it.
- Another scope gap might occur between the fire suppression subcontractor – the lead on the installation of the fire suppression system — and the low voltage subcontractor who is leading the installation of the fire alarm system. The fire alarm system needs to monitor the fire suppression system using tamper switches. Sometimes, during revision to the drawings, some tamper switches don’t show up in the drawings, and the low voltage subcontractor might oversee this scope, resulting in a scope gap.
Exclusions
One last thing, when reviewing new bids for work that remains to be completed, be sure to visit the last page of the proposals or at the bottom of the page. Look for and make note of those small letters that say: “Exclusions,” to understand truly what is not included in the subcontractor’s contract.
Consider this scenario:
- The owner has approved and paid the latest pay application.
- The status of the project correlates with the amount billed.
- The existing subcontractors are paid to date and willing to finish the work
In this case, with all the groundwork you have done to understand what remains to be completed, you can turn to the latest pay application to extract the following information:
- Unearned subcontract balances
- Unearned vendor balances
- General conditions balance
- Earned subcontractor retainage
- Current subcontractor payables (if any)
These details can go a long way to inform a strong cost-to-complete analysis. Given the complexity though of most projects, there is more to be done. The impact of the following variables should be calculated and incorporated into the cost-to-complete analysis, along with the amounts determined from the pay application
- Deficiency correction
- Contract requirements
- Contingencies
- Warranties
Learn More on Cost-to-Complete Estimates
We’ll explore these items and the role they play in cost-to-complete analysis in a future post.
If you have any questions or would like to learn more about how VERTEX can help with cost-to-complete analyses, please send an email to Gisel Hernandez, call 813.294.5068 or submit an inquiry.
