Professional Documents
Culture Documents
Professional ™
Project Management
Finance and Business
Contents
Introduction ................................................................................................................................................. 1
Every effort has been made to ensure that all information is current and correct. However, laws and
regulations are constantly changing. Therefore, this program is distributed with the understanding that the
publisher and authors are not offering legal or professional services.
We would like to thank the following dedicated subject matter experts (SMEs) who shared their time,
experience and insights during the development of the IFMA FMP Credential Program.
In 2009, the International Facility Management Association (IFMA) conducted a global job task analysis
(GJTA) to identify the tasks and knowledge that are important for competent performance by facility
managers across the world. As part of that effort, IFMA identified finance and business as a competency
area, described the role of the facility manager as related to finance and business, and identified key tasks,
knowledge statements and competencies that support finance and business.
This course focuses on the area of finance and business. Combine this print
manual with the online study tools (including quizzes, case studies,
Flashcards, progress reports and more) to help you apply and retain the FMP
concepts. Successfully complete all four FMP courses and final assessments,
submit your FMP application to IFMA for approval and receive your
credential.
A facility manager’s role in each of these areas is, of course, shaped by the
policies, practices and norms of the organizational environment.
In this Finance and Business course, the goal is to present essential concepts
underpinning finance and business appropriate for facility managers. The
information provided is intended to be reasonably self-contained so a facility
manager with little or only a modest background in finance and business can
understand its contents.
This course aims to provide proficiency and guidance. As you read through
the course, reflect on the culture of your organization and consider how this
information applies.
Note on term The term “entire organization” is used throughout this course to apply to the
“entire facility management organization’s parent or client organization (corporation,
organization” government body, nonprofit, etc.).
Some facility managers may find the idea of finance and business intimidating
and cringe at the mere thought of dealing with numbers. But the reality is, in
any organization, the duties and responsibilities of the facility manager are far-
reaching, and almost all facility management decisions have financial and
business implications. Financial decisions in an organization are not limited to
the chief operating officer, the chief financial officer, the finance director, or
other finance specialists.
The good news is that becoming finance- and business-aware need not be
daunting. This chapter provides the foundation and explains basic finance
terminology and essential accounting concepts for facility managers. With this
information we will proceed to explore additional core finance and business
topics in facility management through subsequent chapters.
The terms are presented in alphabetical order, and the list is not intended to be
all-inclusive. Think of the list as a baseline reference of common terms found
throughout this Finance and Business course. Also, keep in mind that these
terms may be defined slightly differently across organizations. Here we simply
lay the foundation for the in-depth content that lies ahead.
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term Definition
Accounting A monetary reporting system used to inform interested parties about a firm’s
business transactions.
Accrual basis Revenues recorded when earned and expenses recorded when incurred.
accounting
Amortization The systematic reduction of a lump-sum amount; the expense applies to intangible
assets (such as patents, franchises, leaseholds and goodwill) in the same way
depreciation applies to physical assets.
Asset Something that retains value for a period of time after purchase such as a building or
a piece of equipment.
Balance sheet A “snap shot” of a firm’s financial position at a specific point in time.
Budget A formal, numerical expression of how an organization expects to operate for a
defined period of time. Identifies the resources and commitments needed to satisfy
the identified goals over a period as well as the sources of the funding to provide
those resources.
Capital asset A depreciable item whose cost is significant to the company and whose expected life
is longer than one accounting period and often much longer.
Capital budget Shows financial impacts resulting from major, long-term, non-routine expenditures for
items like property, plant and equipment.
Cash flow Net cash before financing, including acquisitions.
Chart of Numerical list of all standard items that an accounting system tracks: assets,
accounts liabilities, net assets, revenues, expenses.
Closing fiscal Process of transferring account balances from sub-ledgers to trial balance account at
period the end of an accounting period; typically associated with income statement
accounts.
Cost The price paid for acquisition, maintenance, production or use of materials or
services.
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term Definition
Cost-benefit ratio Ratio in which the net present value of an investment or project is divided by the
investment’s or project’s initial cost; a ratio of greater than one indicates that the
investment or project is viable.
Cost center An organizational unit in which budgetary funding is used to sustain operations.
Cost of operation The total costs associated with the daily operation of a facility. It includes all
maintenance and repair costs (both fixed and variable), administrative costs
(clerical, time-keeping, general supervision), labor costs, janitorial, housekeeping
and other cleaning costs, utility costs and indirect costs (e.g., all costs associated
with roadways and grounds). Could also include the amortized or depreciation
costs of capital assets.
Cost of The cost to the owner of owning the building, servicing the existing debt, and
ownership receiving a return on equity. This also includes the cost of capital improvements,
maintenance and repair, operations, and disposal.
Credit Positive cash entries in a bank account; an amount due to be paid to, or already
residing in, an account. The opposite of debit.
Creditor A lender of money or one to whom funds are owed.
Currency The net rate at which the organization converts revenues and expenses from one
conversion factor currency into another. Often an internally agreed rate set at the start of the budget
year so as to remove the effect of currency fluctuations from operational budgets;
almost never the same as the nominal exchange rate.
Debit An amount due to be paid from, or already paid from, an account. The opposite of
credit.
Debtor An individual, company or other organization that owes debt to another individual,
company or organization (the creditor). Almost always compensates a creditor with
a certain amount of interest, representing the time value of money.
Depreciation A noncash charge against assets, such as cost of property, plant and equipment
over the asset’s useful life. An expense associated with spreading (allocating) the
cost of a physical asset over its useful life.
Discount rate The rate at which future cash flows are discounted because of the time value of
money; the interest rate used to compute a present value amount.
Double-entry An accounting system in which each transaction is recorded in at least two places:
accounting a debit to one account and a credit to another account. Also known as dual-entry
accounting.
Earnings before A measure of an organization’s earning power from ongoing operations, equal to
interest and earnings before deduction of interest payments and income taxes.
taxes (EBIT)
Earnings before An approximate measure of an organization’s operating cash flow based on data
interest, tax, from the organization’s income statement. Calculated by looking at earnings
depreciation and before the deduction of interest expenses, taxes, depreciation and amortization.
amortization
(EBITDA)
Equity The residual ownership interest in an organization’s assets after deducting all of its
liabilities. Can also be the issued shared capital of the organization.
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term Definition
Equivalent annual The cost per year of owning and operating an asset over its entire life span. This
cost (EAC) measure facilitates comparisons of the cost-effectiveness of various assets.
Expenses Money outflow that represents goods and services consumed in the course of
business operations.
Feasibility study Study of a planned scheme or development, the practicality of its achievement,
and its projected financial outcome.
Financial Relates to the preparation of financial statements for the organization as a
accounting whole. May be used by owners and other internal parties but primarily intended
for external parties such as creditors, investors, government agencies, unions
and suppliers. Information is developed according to specific accounting
standards.
Financial The primary financial reporting standards-setting body in the United States; an
Accounting independent, nonprofit group under the authority of the U.S. Securities and
Standards Board Exchange Commission (SEC).
(FASB)
Financial leverage Refers to the use of borrowed money in acquiring an asset.
Financial ratios Analytical tools examining the relationship of one quantity to another. Used to
show underlying financial conditions and to help judge the financial health of an
organization.
Financial reporting The process of presenting information about an entity’s financial position,
operating performance, and cash flow for a specified period.
Financial Documents (e.g., balance sheet, income statement, statement of cash flows,
statements statement of retained earnings) that report financial information about an
organization.
Fixed asset An asset, such as property, plant or equipment, that has a long life and cannot
be expensed in a single year or cannot be easily converted into cash.
Fixed costs Costs that remain unchanged in total for a given time period, despite wide
changes in the related level of total activity, for example, a licensing fee or taxes.
Fixed expenses Expenses over which a company has little control.
Generally accepted In the United States, rules, procedures and conventions used to help govern an
accounting organization’s accounting operations and the preparation of financial statements.
principles (GAAP)
Income statement Accounting document that represents the company’s revenue and expense
transactions for the reporting period.
Incremental A budget method that extrapolates from historical data; next year’s budget is
budgeting constructed by starting with the current year’s budget as a baseline and then
adjusting each line item for expected changes.
Insurance A system to protect persons, groups or businesses against large financial loss by
transferring the risks to an insurance company or other large group who agrees
to share the financial losses in exchange for premium payments.
Intangible assets Assets that have no physical substance. Intellectual property (items such as
patents, trademarks, copyrights, business methodologies), goodwill and brand
recognition are all common intangible assets.
Exhibit 1-1: Common Financial Terms for Facility Managers (continued on following pages)
Term Definition
Internal rate of return The interest rate at which lifetime dollar savings equal lifetime dollar
(IRR) costs, after the time value of money is taken into account. This rate is
then compared to the minimum acceptable corporate rate of return to
determine if the investment is desirable. This is one of the most
important tools for facility managers because it is used frequently to
compare competing investment proposals.
International Financial A set of international accounting and reporting guidelines and rules that
Reporting Standards organizations can follow when compiling financial statements.
(IFRS)
Journal A daily, chronological record of business transactions.
Journal entry An entry to the journal, recording a financial transaction (as a debit and
then as a credit) by date. Journal entries are eventually posted to a
ledger.
Lease A contract between the owner of real property (lessor) and another party
(lessee) for the possession and use of the property for a specified term in
return for rent or other valuable consideration.
Ledger Accounting book of final entry, recording journal transactions under
separate accounts. Sub-ledgers provide more detailed information about
individual accounts.
Liabilities Debts a business incurs that are expected to result in future negative
cash flows to the firm (for example, salaries and tax liabilities). Can also
include an assessment of net risk items (e.g., bad debts).
License Distinguished from a lease, a license is the degree of real property
interest the signer has in a property. A lease provides a higher level of
legal interest in a property than a license.
Life cycle The useable life span of a product, process, facility, tool, system,
technology, natural resource and the like. It is based on the presumption
that all things go through a continuous cycle beginning with creation, use
and disposal, and then ideally start all over again.
Life-cycle costing Process of determining (in present-value terms) all costs incident to the
planning, design, construction, operation and maintenance, and
disposition of a structure over time.
Liquid assets Cash or assets that can be immediately converted to cash (or are easily
convertible to cash).
Management Relates to the provision of accounting information for an organization’s
accounting internal users, designed to support the information needs of managers.
Unlike financial accounting, management accounting is not bound by any
specific accounting standards. Also referred to as managerial
accounting.
Net present value The monetary value today that an investment project earns after yielding
(NPV) the desired rate of return for each period during the life of the investment.
Operating budget A short-term budget projecting all estimated income and expenses
during a given period (usually one year). Excludes capital expenditures
because they are long-term costs.
Term Definition
Opportunity costs Represent “lost” opportunities (measured in monetary units) that could
have accrued to the entity by pursuing an alternate course of action.
Payback period Refers to the length of time it will take to recoup the initial investment
cost. In other words, how long it takes to earn back the funds you spent
on a project.
Period Time interval covered by a financial statement; usually one year for
external statements but often less (month or quarter) for internal
statements.
Present value (PV) This method is used to compare costs; all cash flows are converted to
their present value or the value of past and future dollars corresponding
to today’s value.
Profitability index The ratio of the present value of the cash inflows to the initial investment
(PI) cost.
Pro forma statement A financial statement prepared as a projection of the future. Attempts to
present a reasonably accurate idea of a financial situation if present
trends continue or certain assumptions hold true.
Property loss The loss in the book (balance sheet) capital value of an asset due to
changes in market conditions, requiring a write-down in the asset values
and thus a reduction in the value of the balancing equity value.
Property tax A tax levied against owner, leasor or occupier of any property based on an
assessment of the value of the property, its public infrastructure
requirements, or some other determining factor.
Revenues Cash or properties received in exchange for goods or services.
Statement of cash A financial statement used to show cash levels across the operating period
flows so as to ensure that predicted liabilities due to be paid at any given time do
not exceed the ability to pay.
Statement of A financial statement that starts with the balances from the end of the
shareholders’ equity prior period and shows changes due to net income (loss) and dividends
for the period or any new issuances or repurchases of stock.
Time value of A dollar in hand is worth more than a dollar to be received in the future
money principle because it can either be consumed immediately or put to work to earn a
return.
Trial balance Total of all debits and credits; if debits do not equal credits, an error has
occurred (e.g., mistake in entry, omission, double posting).
Variable costs Costs that change in total in proportion to changes in the related level of
total activity. For example, fuel costs depend on mileage driven.
Variable expenses Expenses that fluctuate and may be influenced by factors such as
occupancy levels.
Working capital The funds required to service the worst cash flow position plus any
contingency provision deemed necessary.
Zero-based A budget method in which the continued existence of items must be
budgeting justified both financially and operationally before they are included in the
new budget.
Collectively, these goals are important not only in ensuring efficiency and
stewardship over the organization’s resources but also in satisfying legal and
regulatory requirements.
Financial Recall how these two terms were defined in the primer of financial terms:
accounting and
management • Financial accounting: Relates to the preparation of financial statements
for the organization as a whole. May be used by owners and other internal
accounting
parties but primarily intended for external parties such as creditors,
investors, government agencies, unions and suppliers. Information is
developed according to specific accounting standards.
Provides data for external users. Provides data for internal users.
Provides objective and verifiable financial Includes financial and nonfinancial
information; emphasis on precision of information; may also include subjective
information. information; accuracy is important but the
emphasis is on relevance and timeliness of
information.
Must follow externally imposed rules. Not bound by any mandatory rules.
Reflects aggregate, summarized data for the Reflects parts of an organization (measures
entire organization. and reports internally about products and
services, departments, managers, employees
and customers) as well as the whole
organization.
Provides a historical orientation; records and Records and reports on events that have
reports on events that have already occurred. already happened but emphasizes providing
information about future events.
There are bound to be some variances in the actual accounting systems and
specific financial and management accounting practices across
organizations. Organizational specifics (e.g., size, sophistication, industry,
public, private and other characteristics) will dictate the accounts and
detailed records kept.
Management
Description FM Examples
Activity
Planning Identifying alternatives, • Reviewing current water
selecting a course of consumption reports and water bills
action, and specifying for a commercial building
how the actions will be • Setting objectives and identifying
achieved methods to increase profits by
improving water efficiency
• Securing necessary organizational
approvals and funding
Management
Description FM Examples
Activity
Directing Mobilizing and motivating • Assigning related tasks to FM staff
people to carry out plans • Retraining FM staff in procedures as
and execute operations necessary
• Installing aerators for sinks and showers
to provide immediate reductions
• Initiating programs to collect rainwater and
runoff for irrigation systems
• Educating customers, users and building
visitors about water resource
management efforts
Controlling Controlling operations to • Monitoring water efficiency operations and
ensure that plans are programs to ensure that they are being
carried out and carried out as intended
appropriately modified as • Monitoring program costs
circumstances change
• Reviewing performance reports and
comparing actual performance and any
ongoing savings in water bills with old
expenditures, planned reductions and
expected savings
• Soliciting feedback from FM staff,
customers and users about the water
efficiency initiatives
• Taking corrective actions as warranted to
improve plan execution and/or control
costs
Decision making Making a variety of • Identifying alternatives and choosing
management decisions among competing objectives and methods
throughout planning, to carry out water efficiency plans
directing and controlling • Reviewing related expenditures and
activities savings throughout the initiative
• Making small and large decisions that
affect FM staff, customers, users and
building visitors
• Answering questions, helping to solve
problems and arbitrating any disputes
As Exhibit 1-3 notes, planning, directing and controlling all involve decision
making. And, in practice, these management activities are more cyclical than
linear. For example, in daily operations, a facility manager’s management
activities are likely to flow from planning through directing and controlling
and back to planning again for a wide variety of tasks.
Planning Directing
Text
Formulating plans Implementing plans
Decision
Making
Controlling
Measuring performance
and comparing actual to
planned performance
International Globally, many countries require, or promote the use of, the International
Financial Reporting Financial Reporting Standards (IFRS). The primer of terms at the beginning of
Standards (IFRS)
this chapter defines IFRS as a set of international accounting and reporting
guidelines and rules that organizations can follow when compiling financial
statements. These international accounting standards are established and
maintained by the International Accounting Standards Board (IASB), an
independent private-sector body formed from the accountancy bodies of
numerous countries.
Generally accepted The accounting profession in the United States has attempted to develop a set
accounting of standards that are generally accepted and universally practiced. The primer
principles (GAAP)
of terms defined generally accepted accounting principles (GAAP) as rules,
procedures and conventions used to help govern an organization’s accounting
operations and the preparation of financial statements. In the United States,
GAAP is sanctioned by the Financial Accounting Standards Board (FASB), an
independent self-regulating body. All organizations operating in the United
States are expected to follow GAAP (and FASB standards) in accounting for
transactions and in representing their results in financial statements.
GAAP encompasses both broad guidelines and specific procedures. But a key
aspect of GAAP is an emphasis on “general.” GAAP accommodates variation
in applied accounting methods as long as the methods generally adhere to the
following basic principles:
Chart of accounts A chart of accounts is a numbered list of all standard items that an accounting
system tracks. It captures organizational revenues and expenses in a
systematic manner. Capturing all financial information through this
consolidated system:
• Enables the organization to make sound financial decisions.
• Provides critical data for the preparation of financial reports.
• Allows for accurate financial comparisons.
• Facilitates an organization’s ability to respond to requests for financial
data from regulatory agencies, lending institutions and others.
Coding can also be used to track costs across projects and matrix work units
(e.g., horizontally as well as vertically within business units).
Account categories
A chart of accounts typically covers five categories of financial information:
assets, liabilities, net assets (owner’s equity or capital), revenues and
expenses. These categories are listed in the order in which they customarily
appear in the financial statements.
• Assets. An asset is something that retains value for a period of time after
purchase such as a building or a piece of equipment. Assets are what an
organization owns. Assets may be physical; they may also be financial or
intangible resources. Examples of assets include cash on hand, accounts
receivable (uncollected monies), inventory (products and publications),
equipment (furniture, computers and other office equipment), real estate
(property and buildings) and investments.
• Liabilities. Liabilities are the debts a business incurs that are expected to
result in future negative cash flows to the firm (for example, salaries and
tax liabilities). Liabilities can also include an assessment of net risk items
(e.g., bad debts).
• Expenses. Expenses are money outflow that represents goods and services
consumed in the course of business operations. Expenses are the costs of
assets used up and the liabilities incurred for the purpose of operating the
organization.
There are numerous software programs with useful templates and fields that
may be used to construct a chart of accounts.
Most organizations use computers for accounting (rather than manual recording).
Whether done by computer or manually, a ledger compiles accounting records.
Types of journals
The simplest journal type is the general journal, a chronological listing of
transactions and other events expressed in terms of debits and credits to
particular accounts. Some organization use special journals in addition to the
general journal. Special journals summarize transactions with common
characteristics such as (but not limited to) the following examples.
• Cash disbursement journal—provides a chronological record of all checks
that are written according to the categories used in the chart of accounts.
• Cash receipts journal—gives a chronological record of all deposits that are
made according to the categories used in the chart of accounts.
Some financial accounting software packages will track all bills as accounts
payable and all revenue as accounts receivable. This type of software
eliminates the need for the cash disbursement and cash receipts journals.
Journal entries may or may not include monetary designations. When journal
entries show transactions within the same country, monetary designations are
often omitted. However, monetary designations specifying currency assume
particular importance in situations involving cross-border transactions and
multinational organizations. The euro (€) is the currency shown in Exhibit 1-6
below and in Exhibits 1-7 and 1-8 in the next section.
Exhibit 1-6 shows an example of a general journal with sample entries for the
following transactions.
• February 1: €20,000 water efficiency equipment purchased on account
from Aqua Monitoring Systems Company
• February 2: €180 invoice received from Copy Max for brochures
promoting water conservation and explaining the facility management
water efficiency program
• February 11: €2,400 credit for merchandise return to Aqua Monitoring
Systems Company
Exhibit 1-6: General Journal with Sample Entries (No References Shown)
Date Amount
Account Title and Explanation Reference
20XX Debit Credit
February 1 Equipment €20,000
Accounts payable €20,000
(Purchased on water efficiency
equipment account from Aqua
Monitoring Systems Company)
February 2 Printing €180
Accounts payable €180
(Received invoice from Copy Max for
water efficiency brochures)
February 11 Accounts payable €2,400
Merchandise returns €2,400
(Returned equipment to Aqua
Monitoring Systems Company)
The first column of the general journal shows the date of the transaction. The
second column shows the account debited or credited (see columns four and
five), including a brief explanation. The third column shows a reference to the
specific account; this column is completed at the time the accounts are posted.
When journal entries are posted to the individual accounts in the general
ledger, a reference is made to the account number to indicate that the entries
were transferred.
Double-entry As we have seen, an account is simply a record of transactions that fit within a
accounting specific category. Double-entry (or dual-entry) accounting is a system in
which each transaction is recorded in at least two places: a debit to one
account and a credit to another account.
In the financial terminology primer earlier in this chapter, debit and credit
were defined as follows.
• Debit is an amount due to be paid from, or already paid from, an account.
Debit is the opposite of credit. In double-entry accounting, debits are
shown as the left-hand side of a journal entry or an account record, where
debts and expenses are recorded. Debit is commonly abbreviated as “Dr.”
In Exhibit 1-7, we see a posting of journal entries for the water efficiency
equipment.
February 1 €20,000
The equipment account debit increases.
February 11 €2,400
The merchandise return account credit increases.
February 2 €180
The printing account debit increases.
This double-entry accounting format showing both the debit and credit sides
of the account is sometimes called a T-account because the left- and right-
side format looks like the letter T.
In the journal postings in Exhibit 1-7, the “No.” notations of 1800, 2000,
2300 and 7900 refer to the ledger accounts to which the respective items
are posted. Every organization selects its own numbering system for its
ledger accounts. In this example, the “No. 2000” is associated with
accounts payable. At the time of posting, these are the numbers that are
entered as references in the general journal.
Date Amount
Account Title and Explanation Reference
20XX Debit Credit
February 1 Equipment 1800 €20,000
Accounts payable 2000 €20,000
(Purchased on water efficiency
equipment account from Aqua
Monitoring Systems Company)
February 2 Printing 7900 €180
Accounts payable 2000 €180
(Received invoice from Copy Max for
water efficiency brochures)
February 11 Accounts payable 2000 €2,400
Merchandise returns 2300 €2,400
(Returned equipment to Aqua
Monitoring Systems Company)
In a manual accounting system, summary totals from all journals are entered
in the general ledger once a month. A year-to-date balance can then be
maintained for each account. In a computerized accounting system, account
data is typically entered only once. The software then automatically tracks the
account number wherever it appears and updates the general ledger. Most
software packages also include a general ledger that shows every transaction
included in the balance for each account.
Note that the first three steps (analyze, journalize and post transactions to
general ledger) are performed as transactions occur, throughout the
accounting period. Therefore, the discussion of these steps reinforces the
accounting concepts just presented. The remaining steps are performed at
the end of the accounting period.
Analyze
Journalize
Adjust entries
• Adjust entries. In this step, accounts are adjusted for internal transactions,
like the use of prepaid rent or unearned revenue.
• Prepare adjusted trial balance. The adjusted trial balance is the trial
balance after all adjusted entries have been made, reflecting the proper
balance of each account.
• Close accounts and prepare post-close trial balance. This step in the
accounting cycle closes accounts in preparation for the next accounting
period. Temporary or nominal accounts are closed, while permanent or
real accounts carry their balances into the next period.
The post-close trial balance is prepared after closing to show that debits
and credits of the real accounts (assets, liabilities and shareholders’
equity) are equal.
All accounting systems use some variation of these steps to record and verify
transactions. When the steps in the accounting cycle are completed, the
sequence starts over again (in the next accounting period).
Historical cost Most assets and liabilities are reported on financial statements at the levels at
which they were acquired or incurred rather than at fair market value. Historical
cost is the amount paid to acquire an asset, or, for noncash exchanges, it is the
estimated value of the noncash asset or liability exchanged. Historical cost is the
most commonly used valuation method. Depreciation, amortization or other
allocations reduce the book value (the residual asset value shown in the balance
sheet) of the depreciated asset to the organization. The depreciation itself is
shown in the organization’s profit and loss (P&L) statement. Property, plant and
equipment and intangible assets are generally reported at historical cost less
accumulated depreciation or amortization, where appropriate.
Revenue Accrual basis accounting is defined as revenues recorded when earned and
recognition expenses recorded when incurred. The revenue recognition principle is a
cornerstone of accrual accounting. Revenue recognition helps to determine
the accounting period in which revenues and expenses are recognized.
According to the principle, revenues are recognized when they are realized
or realizable and when they are earned.
• “Recognized” means that revenue has been recorded as a journal entry.
• “Realized” means that assets such as goods or services have been
exchanged for cash or claims to cash (e.g., an invoice for an account
receivable).
In other words, with the accrual method, income and expenses are recorded as
they occur, regardless of whether or not cash has actually changed hands.
Revenue is recorded when it is earned, regardless of when it is actually
collected. In addition, all expenses are recorded when they are recognized and
not when the cash is actually paid.
Deciding if these recognition conditions have been met can be complex. For
most goods, revenue is recognized at the point of sale because the actual sales
price can be verified. The period in which the sale is recorded is used in
accrual accounting as the point at which the revenue is recognized as earned.
For most revenue, the time of sale is the point at which all of the qualities
listed above are met. Some exceptions exist for recognition (e.g., long-term
construction projects). But these are the concern of financial accountants, not
facility managers, and therefore are beyond the scope of this discussion.
Full disclosure Full disclosure and proper accounting complement each other. Financial
statements should include only items that fit within the element definitions and
that are measurable, reliable and relevant. If, for example, information is
aggregated at too high a level or is overly detailed, its usefulness can be reduced.
The full disclosure principle recognizes that statement preparers must make
compromises between levels of detail sufficient to help users with their
decisions while condensing that information enough to keep it understandable.
Supplementary information may be presented outside the main body of the
statements—for example, in footnotes to the financial statements.
You may encounter other accounting principles for financial statements. But
again, these accounting standards and conventions are primarily the direct
concern of the organization’s financial accountants and, for the most part,
beyond a facility manager’s responsibility. As warranted, you may find it
helpful to learn more about them.
Match the following accounting system components with their record-keeping function.
5. True or false? According to the rules of debit and credit, increases in assets are recorded on the debit
(left) side of the account.
( ) a. True
( ) b. False
6. The process that copies amounts from the journal to the ledger is
( ) a. recording transactions.
( ) b. journalizing.
( ) c. posting.
( ) d. preparing a trial balance.
Topics in this chapter explore the essential concepts of finance and business
that facility managers need to know to be intelligent consumers of financial
information—how to develop and maintain budgets, judge the financial merits
of different investment opportunities, and determine which operations are
profit generators and which are not.
The information will not make you a financial expert or qualify you to become
a financial analyst, controller or CFO. But it will better prepare you to plan, to
use financial concepts, and to manage resources in making good FM business
decisions that add value to your organization.
The good news is that FM budgeting doesn’t have to be that way. Yes,
budgeting typically requires lots of hours, and it can be intense. There’s no
magic wand that can change those aspects. But good budgets are worth the
time and effort. The following discussion is intended to provide budgeting
concepts that are easy to understand and implement, contribute to sound
budgets and help to reduce the time required.
The importance How do you prepare for an out-of-town business trip? Most likely you
of budgeting pack a briefcase, your mobile phone and perhaps a laptop along with a
travel bag of clothes and personal articles. Basically, you think about
whatever you need for the trip and then try to plan accordingly. Of
course, you would take money or a credit card to cover anticipated
expenses. For most business travel, these are the essentials that help to
facilitate the trip.
Budgets are important for management planning. In that respect, they are
similar to strategic plans and forecasting.
Forecasts can and often do change. They are typically updated as new
information indicates a change in conditions.
Forecasting involves planning but lacks the high level of control and
accountability that budgets have. Variances in forecasts do not undergo the
same scrutiny as they do in budgets (where they are analyzed and
explained). Budgets imply that management accepts responsibility and
commits to meet the budgeted objectives (whereas the forecaster is not
directly responsible for forecasted outcomes).
• Allows for fine-tuning the strategic plan. Strategic plans are stated
in fairly broad terms and based on the best information available.
Budgets assign responsibilities for expenditures to functional areas
and managers. The detailed planning that characterizes budgets uses
Budget
Description Advantages and Disadvantages
Approach
Authoritative Senior management sets everything Advantages:
from strategic goals down to the • Budget goals reflect strategic
individual items of the budget for each objectives.
department and expects lower • Better control over decisions.
managers and employees affected by
the budgets to fulfill these goals. Also Disadvantages:
known as a top-down budget. • Dictates instead of communicates.
• Senior management may be out of
touch with departmental operations
and set unrealistic or unattainable
goals.
• Can result in employees feeling
resentful and/or unmotivated.
Example: Senior management gives FM a limit of C$200K for general landscape maintenance
activities for the upcoming year. The facility manager must develop the operating budget with C$200K
as the landscape maintenance expense target.
Participative Managers at all levels and certain key Advantages:
employees cooperate to set budgets • Expertise leads to informed budget
for their areas. Top management decisions.
usually retains final approval. Also • Can result in employees feeling
known as a bottom-up or self-imposed involved and empowered.
budget.
Disadvantages:
• Strategic goals do not receive
priority in the budgetary process.
• Easy or abdicated approval can lead
to loose budgets and budget
padding (where managers have
incentive to underestimate revenues
or overestimate costs).
Example: A facility manager develops a department operating budget with input from purchasing,
human resources and administration. Upon completion, the budget is sent to senior financial
management for review and approval.
Combined The ideal process combines the Advantages:
features of authoritative and • Strategic goals are communicated
participative budgeting and falls top-down and implemented bottom-
somewhere between these methods. up.
Also known as an iterative budget. • Personal control leads to
Characterized by two-way acceptance, which leads to greater
communication: personal commitment.
• Senior management understands Disadvantages:
participants’ difficulties/needs.
• Control retained and expertise
• Participants understand
management’s dilemmas. gained at the cost of a slightly longer
process.
Example: Senior management provides FM (and all other department heads) with a clear
understanding of strategic goals. A facility manager works in her team to develop an operating budget
that incorporates FM tactical goals aligned to the larger strategic goals. Senior management reviews
the FM budget, and once any adjustments are negotiated, the budget is approved.
It’s important to realize that the elements behind the questions and
assumptions are dynamic. Employment costs and conditions change, the
supply of and demand for facility management services varies, laws that
affect business and employment change, and a myriad of other factors can
shift up or down. To develop reasonable budget assumptions, facility
managers need to stay current with what is going on. In the end, the
assumptions are educated guesses about the future.
Types of Operating and capital budgets are two types of budgets that are extremely
budgets important in FM. From a broad perspective, operating budgets are
considered short-term, as they typically project only one year at a time. By
comparison, a capital budget is long-term and may project two, five or
sometimes ten years into the future. Operating budgets and capital budgets
have several other distinguishing characteristics.
Operating budget Formally defined, an operating budget is a short-term budget projecting all
estimated income and expenses during a given period (usually one year). It
excludes capital expenditures because they are long-term costs. Operating
budgets are also called operational budgets or operational expenditures.
True to its name, an operating budget consists of funds that are used to support
daily operations. Customarily, an operating budget estimates revenue (income)
and expense items on a monthly basis and includes projections for a one-year
period. Specific items contained in an operating budget may vary, but typical
categories are shown in Exhibit 2-2.
Developing an annual work plan (as a precursor to the operating budget) can
result in a helpful tool to plan and organize expense information about
projects, operations, maintenance and other costs and expenditures for the
projected period. The annual work plan (AWP) covers short-term needs, is
very specific and based on solid projections.
Exhibit 2-3: Common Cost Categories in Annual Facility Management Work Plan
Keep in mind, this work plan excerpt is just an example of possible categories. It is
not intended to be a ready-made template. Categories and how they are populated is
a function of what is appropriate for an organization. Of course, there are myriad
possibilities that could exist due to the types and complexities of facilities. The line
items shown here are included simply as likely categories of general and
administrative costs but not meant to be all-encompassing or complete.
In this sample, there are no entries in the fields. The “Amount” headers should
specify the currency being used. Whatever remarks might be helpful to clarify the
costs or expenses can be included in the “Comments” column. For example,
regarding “Personnel,” if the facility manager is planning to hire one new FTE
maintenance person, the comment might be: “Includes one new hire FTE
maintenance.”
Next, we see how this annual work plan excerpt could be translated into an
operating budget. Exhibit 2-5 on the next page shows a sample excerpt of a
hypothetical operating budget for general and administrative costs for the
calendar month of April. Actual expenses are shown in comparison to budget;
variances are also included.
Expense Forecast
Fiscal Year Expended Budget Expense Change Current
This Outturn
Cost Categories Budget Year-to- Year-to- Variance This Month Year on Year-End
Month Against
Amount Date Date (Month 8) Year Forecast
Last Year Budget
Salaries 250,000.00 187,500.00 166,666.67 –20,833.33 22,315.00 18,475.22 3,839.78 270,833.33 –20,833.33
Employer’s taxes 25,000.00 18,750.00 16,666.67 –2,083.33 2,231.50 1,847.52 383.98 27,083.33 –2,083.33
Employment insurances 81,250.00 60,937.50 54,166.67 –6,770.83 7,252.38 6,004.45 1,247.93 88,020.83 –6,770.83
Pension payments 10,000.00 7,500.00 6,666.67 –833.33 892.60 739.01 153.59 10,833.33 –833.33
Health-care insurances 62,500.00 46,875.00 41,666.67 –5,208.33 5,578.75 4,618.81 959.95 67,708.33 –5,208.33
Other benefits 25,000.00 8,762.25 16,666.67 7,904.42 250.00 1,000.00 –750.00 17,095.58 7,904.42
Total 453,750.00 330,324.75 302,500.00 –27,824.75 38,520.23 32,685.00 5,835.22 481,574.75 –27,824.75
Capital budget A capital budget shows financial impacts resulting from major, long-term,
non-routine expenditures for items like property, plant and equipment.
Organizations may set capital thresholds (cutoff levels) that establish the
sphere of influence that finance and operational managers each have for
capital projects. For example, finance may delegate more authority and
responsibility to a facility manager for capital requirements below $50K.
That finance department then takes ownership for any expenditure above
$50K. Facility managers (and all other department managers) must
understand organizational rules, policies and procedures for capital budgeting
set by finance management, and they must unconditionally observe the
protocol.
Does the project support Will this project yield an average return
organizational business objectives and on investment?
reflect the priority of those objectives?
Will this project modernize work
What are the boundaries for the processes and result in cost savings?
project (e.g., what the project will do
Is this project needed to ensure the
and what it will not do)?
organization’s financial integrity?
Is the funding needed to complete an
Is this project necessary to comply with
ongoing project?
legal/regulatory requirements?
Does this project involve maintenance
What are the financial risks associated
or replacement of worn-out
with this project?
equipment?
Will this project yield a high expected
return on investment?
Additional Several important operating and capital budgeting principles have been
budgeting presented. The following overview of some additional budgeting concepts can
concepts help facility managers to better coordinate efforts with upper management and
promote their departments in terms that finance- and business-oriented senior
management will understand.
Estimating revenue A budget must account for revenue and expense projections.
and expense
projections
Revenue projections
Most facility managers do not have any revenue projections—unless they have
retail space they are leasing on a regular basis; are leasing property owned by
their company, such as a building, or space to a third party; are subleasing
property, a building or space to a third party where the facility has a lease with
a landlord; or the facility manager will realize monies from the sale of a
facility. There are some FM departments that have a chargeback requirement
to their internal customers where the facility manager would realize revenue
from the work provided to internal customers.
Expense projections
Expense projections should consider all the costs required to achieve the
organization’s objectives—capital expenses (for example, equipment) and
general administrative expenses.
Fixed/variable Fixed/variable budgeting separates costs according to how they relate to other
budgeting areas of an organization’s business.
Fixed costs
Fixed costs are costs that remain unchanged in total for a given time period,
despite wide changes in the related level of total activity, for example, a
licensing fee or taxes.
The organization is committed to fixed costs for the whole of the accounting
period, and (in general) such costs cannot be reduced or deferred without
incurring some significant additional risk, business impact or cost of change.
Although fixed costs remain stable and do not change up or down for the time
period, they can and often do change between budget cycles. Taxes, for
example, can go up or down but are not activity-driven.
Variable costs
Variable costs are at the other end of the spectrum. Variable costs change in
total in proportion to changes in the related level of total activity. For example,
fuel costs depend on mileage driven. Variable costs are cost elements that can
be changed in the short term with few constraints. (Albeit often there is still
some business impact.)
As the name implies, variable costs are not stable—they vary directly with
changes to activity in a budget (such as assets and expenses). If a budget
activity increases, so will variable costs (and vice versa). A couple of other
examples of variable costs are the costs of mail services or printing—expenses
that vary based on usage.
Budget periods Organizations must prepare budgets for a set time period. A budget is
typically established for the one-year period that corresponds to the fiscal
year of the organization (although the organization’s fiscal year may not be
the same as the government’s tax year).
Annual budgets are often broken down into quarterly and monthly time
periods, allowing managers regular opportunities to compare actual data with
budgeted data. This process can highlight any problems and allows managers
to remedy the problems more quickly.
Budget methods There are several different budgeting methods an organization may use.
Budget methods a facility manager may encounter may include any one of the
following.
Incremental budgeting
Incremental budgeting is a budget method that extrapolates from historical
data. Next year’s budget is constructed by starting with the current year’s
budget as a baseline and then adjusting each line item for expected changes.
In incremental budgeting, a manager starts with last year’s budget and adds to
it (or subtracts from it) according to anticipated needs. Of the various
budgeting methods, incremental budgets generally are easier to complete and
involve less work. An advantage of the method is that history, experience and
future expectations are used to develop the budget. The main drawback to
incremental budgeting is that such budgets tend to only increase in size over
the years. Managers may simply use the figures from the past budget period
and increase them by a set percentage rather than devoting appropriate time to
research the realities of the current and future environment. A sense of
entitlement may also arise with the use of an incremental budget.
Zero-based budgeting
Zero-based budgeting is a budget method in which the continued existence of
items must be justified both financially and operationally before they are
included in the new budget.
.
Most budgeting methods incorporate some review of historical data. Zero-
based budgeting incorporates a unique perspective regarding historical
records. Zero-based budgets help to avoid situations in which ineffective
activities continue to exist simply because they were in the prior budget.
While the traditional incremental budget focuses on changes to the past
budget, the zero-based budget focuses on a critical review of every assumption
and cost justification for all proposed expenditures.
Senior management reviews these lists and cuts items that lack justification
or are less critical. In the process, questions are asked, such as, “Should the
activity be performed and if it isn’t, what will happen?” or “Are there
substitute methods of providing this function such as outsourcing?” Senior
managers may also use benchmark figures and cost-benefit analysis to help
decide what to cut. Only those items approved appear on the budget. Once
the justification is made, the budget must be based on the most accurate
information available—hopefully, historic.
The primary strength of the zero-based budget is that it forces review of all
elements of a business. A facility manager would have to perform an in-depth
analysis of each line item—considering objectives, exploring alternatives and
justifying requests.
Activity-based budgeting
True to its name, an activity-based budget (ABB) focuses on activities. ABB
includes the use of activity-based costs to make a clear connection between
resource consumption and output. This allows managers to better understand
how resource demands are affected by changes in activity.
Assuming that two or more activities share spaces or buildings, ABB must
naturally be complemented by some type of chargeback system to the activity.
(Chargebacks are discussed in Topic 7.)
General Many factors characterize an FM budget, but no single factor can lead to a
budgeting successful operating or capital budget. FM is a major consumer of
guidance organizational resources. As such, the reality is that FM budgets are subject
to closer scrutiny than those of most other departments. Facility managers
do not need to be budget experts, but the high-level visibility of their
Finance and business personnel who review and approve FM budgets are
often unfamiliar with department practices and principles. Given that, the
budget process provides a facility manager with the opportunity to educate
those individuals about what FM does to accomplish the following:
The overall goal of the budget process is to produce accurate and detailed
financial projections and provide for fiscal accountability—a
straightforward goal but not an easy one. As we have read throughout the
budgeting content presented here, organizations will vary in how they
gather information and implement, monitor and adjust activities. But a
proactive FM budget process facilitates the preparation of both operating
and capital budgets. Exhibit 2-7 offers some general guidelines
appropriate for facility management across all types of organizations.
• Know the organization’s strategic plan, core • Design the FM budget process to
business and operational objectives. Make be consistent and easy to
budget decisions that align FM to them. understand. Clarify everyone’s roles
Demonstrate that alignment to external in the budget process.
reviewers and stakeholders. • If time permits, draft a preliminary
• Understand the organization’s budgeting budget that estimates revenues and
process—the guidelines you need to follow, expenses. If they are not within
the timing of the process, and how the senior management parameters,
organization will use the budgets. look for ways to make adjustments.
• Understand all line items in the budgets FM • Once a budget is implemented,
contributes to. If you don’t know what regularly monitor expenses against
something means or how the number is budget levels to track progress
derived, ask questions to find out. toward budget goals.
• Foster buy-in from decision makers. • If budget problems arise, be
Understand the concerns of the people prepared to correct them through
making decisions about the FM budget. Be formal plans of action and to offset
sure to address those concerns in the negative budget variances.
department budgets. • Have ongoing discussions with
• Establish rapport with finance staff involved those involved in FM budgeting.
in the budgeting process. Regularly The better the communications and
communicate and coordinate FM planning, the increased chance of
requirements. Ask questions about points handling and responding to
you don’t understand. As appropriate, seek unplanned contingencies.
advice about the assumptions being made • Have several contingency projects
in the FM budgeting. and activities identified should
• If other FM personnel are to participate in spending levels be lower than
the budget process, make sure that anticipated.
everyone involved understands elementary
accounting principles.
Budget Monitoring expenses against budget levels is a core management activity for a
monitoring facility manager. “Periodic review” is a term often used interchangeably with
budget monitoring.
a monthly basis; there may be an additional reporting lag before the information
is available for a facility manager’s review. Weekly checks can help to ensure
that there are no surprises when monthly budget reports become available.
Monthly analysis Monthly analysis provides expenditures for that month and helps to assess short-
term spending patterns, timing of billing and payments, and like activities.
Monthly combined This combination facilitates comparisons of current monthly and year-to-date
with year-over-year expenses with both the authorized budget and previous spending. The
and year-to-date
combination helps to identify trends and variances.
analysis
Quarterly analysis Quarterly analysis typically coincides with the organization’s fiscal calendar.
Many organizations monitor their targets on a quarterly basis and report to the
stock market and/or shareholders on that performance, so it is key from a
“whole organization” perspective and from a target/results basis.
• Variances identified by quarterly cost reviews can be used to fine-tune
budgets and reallocate funds as necessary.
• As quarterly analysis at the end of the second or third quarter is usually
tied to organizational profit and loss statements (discussed in subsequent
content on financial statements), a facility manager can use the analysis
results to ensure that the department’s budgeting and spending approach is
consistent with the organization as a whole.
Midyear analysis Actual expenditures for the first six months can be compared with budget and
projections for the second six months. This is also the point at which some
organizations start to plan budgets for the next fiscal year.
Annual analysis Year-end budget reports can provide further insights about how efficient the
department is and where improvements may be needed. Valuable comparisons
can be made, such as:
• Percentage of maintenance and repair versus new work.
• Trends in maintenance and repair versus new work.
• Unit costs compared to benchmarks (such as the IFMA benchmarks for
facility costs).
Data analysis and statistical analysis software has greatly increased the
amount of data and information that budget analysis can compile.
Spreadsheets, databases and financial analysis software can produce accurate,
up-to-date information for review. In addition, many organizations incorporate
enterprise resource planning (ERP) programs into their budgeting process.
ERP programs have the ability to consolidate all of an organization’s
operating information into a single computer system. For example, a facility
manager and finance personnel could use ERP data to estimate and then track
the effects that an FM budget alteration has on other parts of an organization.
Budget Budget closeout coincides with the end of the fiscal year. As with many
closeout aspects of budgeting, budget closeout can be simple or complex. Some
organizations may have formal authorization requests to close; others may
have a more informal closeout process, signaled when all administrative
actions have been completed and expenses have been posted to accounts.
Simple or complex, the process typically requires coordination between the
facility manager and the finance department.
Legal and financial requirements and even simple tasks may differ across
organizations. For example, in most government sectors, there is a rigorous
closeout of purchase orders. With few exceptions, the government closes out
its books at the end of every fiscal year since the authority to obligate those
funds normally expires at the end of that year. Expenses are simply accounted
for based on the obligation incurred during the fiscal year in which the funds
were appropriated. Customarily, this is followed by a financial audit. FM must
follow the rules prescribed by the organization and its environment.
In the private sector, accruals are a part of the year-end closeout process. An
accrual refers to either accrued revenues (which are earned revenues yet to be
received as cash or recorded) or accrued expenses (which are incurred but
unpaid expenses yet to be recorded).
There are two ways to account for receiving cash or paying expenses.
• Cash basis (or cash basis accounting) accounts for cash when it is
received or spent. Items promised to be paid or received, such as accounts
payable and receivable, are ignored.
Example: When a work order has been issued and the work has been
carried out but not yet invoiced, the work order value may be used to
calculate the accrual.
Budget closeout ultimately reveals how well a facility manager has managed
the budget. Whether it is one percent or less, within five percent, or some
other percent, the number is an indicator of performance—good or bad.
State or cross- There is general international acceptance that standards are a proven business
border facilitator and standardization increases consumer confidence, lowers costs
benchmarking and otherwise supports the growth of economies.
and budgeting
The European Committee for Standardization (CEN) is such a business
facilitator in Europe. Through its services, CEN provides a platform for the
development of European Standards and other technical specifications that
become the national standards in each of its member countries. CEN along
with its American counterpart, ANSI (the American National Standards
Institute), are both member organizations of ISO (the International
Organization for Standardization).
CEN has developed several European Standards for real estate and facility
management. These standards are of key importance to many of the European
Union member countries who have traditionally worked to their own
standards. In a globalized world, CEN standards strive to promote conformity,
provide a transparent basis for management, and support the communication
of information. All of these outcomes have the potential to reduce the
challenges of real estate and facility management across states and borders and
help organizations make better decisions.
CEN’s benchmarking standard identifies many factors that can impact finance
or business in state or cross-border benchmarking such as (but not limited to):
• National rules and regulations.
• Currency exchange rates.
• Taxation and value-added tax.
• Accounting rules.
• Rental basis and service charges.
• Labor costs.
• Level of outsourcing.
• Subletting.
• Spare capacity (temporarily/short-term vacant space).
• Effect of internal recharging.
The impact of these factors (and others) cannot be ignored but must be
understood when deciding whether to use benchmarking or which factors to
benchmark.
Since SOX applies to organizations trading in or with the United States (no
matter where they are based), it is also applicable to facility managers
Financial Organizations may prepare two sets of financial statements—one for internal
statement purposes and a second set for external disclosure. Publically traded companies
categories have an additional requirement for their external financial statements—they
are required to produce external audited financial statements.
Internal financial Internal financial statements are produced on a regular basis (usually monthly)
statements and made available to senior management, staff management and others with
operating or oversight responsibilities. Internal statements serve as essential
reporting mechanisms and management tools. They may present information
about the organization as a whole, or they may report on data for each department
or units within departments.
External financial Publically traded companies are required by law to produce external financial
statements statements that are prepared in accordance with accounting standards—IFRS or
GAAP and FASB. The terminology in external financial statements is precisely
defined by the applicable accounting standards. Full disclosure (mandated by
regulatory bodies such as the Securities and Exchange Commission in the United
States) requires that external financial statements be made available to regulatory
bodies, banks, lending institutions, the public and other interested parties. Even
though companies that are not publically traded do not have a similar mandatory
requirement, they still typically produce external financial statements for their
private owners, banks and lenders.
Audited financial Audited financial statements are prepared and certified by an auditor. The
statements credentials of the auditor may vary. In the United States, an independent
certified public accountant (CPA) is the auditor; in the United Kingdom, a
chartered accountant serves as the auditor.
During the audit process, the organization is responsible for providing source
documents for its financial statements to the auditor. Source documentation
includes a wide range of financial documents, such as accounts payable and
accounts receivable information, expense reports and budgets. The audit
includes a rigorous review of the organizations’ financials as well as the
additional documents; the auditor examines, evaluates and cross-references
them. The outcome is a professionally prepared set of audited financial
statements that the organization can then present to interested parties. In the
United States, for example, the auditor certifies that the financial statements
meet the requirements of the GAAP.
An unqualified opinion:
• States that the financial statements are presented fairly.
• Provides the highest level of assurance an auditor can supply regarding the
accuracy of the financial statements.
• Indicates that the auditor is satisfied with the financial statements as a
whole.
A qualified opinion:
• Suggests that there is a material problem with one or more aspects of the
financial statements.
• Flags an issue that the auditor has reservations about (such as a minor
departure from IFRS, GAAP, or the Sarbanes-Oxley Act.)
Exhibit 2-9 on the next page provides the general order and process used to
generate the statements and includes brief notes about each one. First, net
income is determined, including shareholders’ equity (on the income
statement and the statement of shareholders’ equity); then assets and liabilities
are determined and presented on the balance sheet. The statement of cash
flows is used to reconcile the other statements.
Of the four financial statements, the three essential ones that a facility
manager should have a fundamental awareness of are the income statement,
the balance sheet and the statement of cash flows. Shareholders’ equity is a
financial statement that starts with the balances from the end of the prior
period and shows changes due to net income (loss) and dividends for the
period or any new issuances or repurchases of stock. This is not a statement
that directly impacts FM. Therefore, we focus our attention on the remaining
three statements.
Income Statement
Balance Sheet
As you review the sample financial statements, keep in mind two points:
• In most organizations, financial statements are prepared by a stand-alone
financial accounting division or department.
• Much of the content of financial statements comes from departments or
divisions outside the FM arena.
Income statement The income statement is an accounting document that represents the
company’s revenue and expense transactions for the reporting period. Also
called the profit and loss (P&L) statement or the earnings statement, it shows
the profitability of an organization for a specific period. In other words, the
income statement indicates cumulative business results within a defined time
frame. However, it does not reflect the organization’s financial solvency. An
capturing data for different departments, programs and other cost centers on
one statement. However, there may also be separate income statements
prepared for FM operations or other departments, programs and cost centers.
The next rendition of the adapted income statement, in Exhibit 2-11, shows
the dollar and percentage changes through a comparative horizontal analysis.
Increase (Decrease)
Current Year Prior Year Amount Percentage
US $623
Percentage change = = 0.080 = 8%
US $7,757
While revenue increased by 8 percent in the current year, the bottom line grew by
only 5.8 percent. This may be attributed to the fact that expenses grew faster than
revenues (the cost of operating expenses by 8.5 percent and the cost of goods sold
by 9.1 percent).
Depreciation and amortization had the largest percentage increase (62.5 percent),
but this should not be a cause for concern because the dollar amount is low.
Our sample adapted income statement shows comparative figures on the same
page (e.g., current year to prior year). There are different variations of income
statements. For example, a two-column format may be prepared showing current
month totals and a second column with year-to-date figures. Or income
statements may show only a singular period. Generally, analysis is greatly aided
in a multiperiod format, allowing the reader to spot trends and turnarounds.
Balance sheet A balance sheet is a “snap shot” of a firm’s financial position at a specific point
in time. It reports on an organization’s assets, liabilities and net assets at a
specified date. The statement illustrates an organization’s solvency and cash
position; it does not reflect profitability. The balance sheet is comparable to the
statement of financial position (SOFP) prepared by not-for-profit businesses.
A balance sheet is usually divided into two sections, with assets on top and
liabilities and shareholders’ equity (owners’ equity or net assets) listed below.
As implied by its name, in the balance sheet assets must always equal
liabilities plus equity. You will see in Exhibit 2-12 that total assets equal total
liabilities and shareholders’ equity.
In this adapted balance sheet, FM would principally impact the plant, property
and equipment asset.
The next rendition of the adapted balance sheet, in Exhibit 2-13 on the next
page, shows the dollar and percentage changes.
Assets
Current assets:
Cash and cash equivalents $192 $130 $62 47.7%
Short-term investments 15 27 (12) (44.4)
Accounts receivable, net 169 168 1 0.6
Inventory 67 63 4 6.3
Prepaid expenses and other 363 342 21 6.1
Total current assets 806 730 76 10.4
Plant, property and equipment, net 3,280 3,037 243 8.0
Intangible assets 878 849 29 3.4
Other assets 656 784 (128) (16.3)
Total assets $5,620 $5,400 $220 4.1
Current liabilities:
Accounts payable and other current $1,213 $1,166 $47 4.0%
Income tax payable 238 208 30 14.4
Short-term debt 10 146 (136) (93.2)
Total current liabilities 1,461 1,520 (59) (3.9)
Long-term liabilities 2,056 2,299 (243) (10.6)
Other liabilities 983 987 (4) (0.4)
Total liabilities 4,500 4,806 (306) (6.4)
Shareholders’ equity:
Common stock 916 1,046 (130) (12.4)
Retained earnings (accumulated deficit) 414 (203) 617 303.9
Accumulated other comprehensive (loss) (210) (249) 39 15.7
Total shareholders’ equity 1,120 594 526 88.6
Total liabilities and shareholders’ equity $5,620 $5,400 $220 4.1
Statement of cash A statement of cash flows is used to show cash levels across the operating
flows period so as to ensure that predicted liabilities due to be paid at any given
time do not exceed the ability to pay. The statement provides relevant
information about cash receipts and cash disbursements—where the
organization’s cash came from and how it was used—during the time
interval specified in its heading. The specific time frame may vary (e.g., a
quarter), and multiperiod or multiyear presentations may be prepared.
As we see in the simple cash flow statement in Exhibit 2-14, uses of cash
are recorded as negative figures and sources of cash are shown as positive
figures. A legend of key terms follows the sample.
Note that this sample provides the traditional (financial accounting) view
of cash flow—a year-end annual statement—a “snap shot” of the year-end.
Nevertheless, a facility manager should be generally aware of the
statement and the implications. Later in this chapter, in Exhibit 2-17, the
FM perspective of cash requirements at each period end over the year is
shown.
Operating activities
Net income $35,000
Adjustments for noncash items
Depreciation $14,000
Net increase in current assets other than cash (24,000)
Net increase in current liabilities 8,000 (2,000)
Net cash flow from operating activities 33,000
Investing activities
Sale of plant, property and equipment $91,000
Net cash flow from investing activities 91,000
Financing activities
Borrowing $22,000
Payment of long-term debt (90,000)
Purchase of treasury stock (9,000)
Payment of dividends to stockholders (23,000)
Net cash used for financing activities (100,000)
Net increase (decrease) in cash $24,000
Some of the analysis findings from this statement of cash flows reveal:
• Operations provides less cash than net income; this may be harmless or it
may signal difficulty collecting receivables or selling inventory.
• The sale of plant, property and equipment is the major source of cash; due
to the amount, it is probably a one-time situation or a sell-off of
unproductive assets. However, sale of plant assets should not persist or the
organization could go out of business.
• There was more payment of long-term debt than new borrowing—a
positive indicator.
Cash flow statements are prepared by rearranging items on the balance sheet
and income statement. Much like a bank statement for a checking account, a
cash flow statement shows where the organization’s money went and how
much is left for the given period. Further, the statement portrays how an
organization is able to turn accounts receivable into cash. It provides a
reasonable indication of solvency and the ability to pay bills as they come due.
Notes to financial Notes are an important part of financial statements because they help to portray
statements an organization’s finances beyond the actual numbers. Notes to financial
statements for a publically traded organization generally start with highlights of
significant accounting policies and proceed to describe matters of importance
such as (but not limited to):
• Major acquisitions.
• Changes in operations.
• Pension requirements.
Auditors review notes and footnotes as part of the annual audit process. Other
interested parties should also carefully review notes and footnotes for the
relevant information they contain.
Depreciation Depreciation is a noncash charge against assets, such as cost of property, plant
and equipment over the asset’s useful life. It is an expense associated with
spreading (allocating) the cost of a physical asset over its useful life.
In the United States, GAAP allows organizations to set their own guidelines for
defining certain expenses and assigning them to assets to be depreciated. There is
also no prescribed time frame for depreciation, leaving that decision up to the
organization, but requiring the organization to do it the same way every time. For
example, a new building may be depreciated over 40 or 50 years, while certain
other improvements may have a shorter life span. The bottom line for a facility
manager is to learn and know the rules of the organization and ensure that the FM
organization adheres to those rules in every way.
Depreciation reduces the balance sheet value of the asset over time. To
depreciate an asset, it is necessary to start with the original cost and then
determine the asset’s depreciable base. The depreciable base is the asset’s
original cost less its salvage value. Salvage value (sometimes called residual
value or scrap value) is the estimated value of an asset if it is sold at the end of
its depreciation period or service life. Salvage value can be zero. The
difference between the cost and the salvage value is the depreciable cost.
The example below shows the depreciable cost for maintenance equipment.
(Example in USD)
Why depreciate Generally speaking, there are two reasons to depreciate an asset—for
assets? accounting purposes and for tax purposes.
The second reason for depreciation is for tax purposes. Some nations tax the
depreciated value of an asset using a flat rate. Based on other taxation rules,
organizations may be allowed to depreciate assets according to accelerated
schedules—rates faster than their useful life—or methods that write off assets
over a predetermined amount of years that has nothing to do with the asset’s
useful life.
Depreciable base
Straight-line depreciation per period =
Estimated service life
Capitalization Whether an asset should be capitalized or expensed is defined by tax law and
versus organizational policy. Typical considerations in making the determination are:
expense • The useful life of the asset (e.g., less than or longer than one year).
• The cost of the item (e.g., whether it exceeds the organizational
capitalization cutoff point).
This capitalization cutoff point is a designated limit (or floor) for capital
requests under which an item is expensed in the period purchased and over
which it will be capitalized and depreciated for the length of its useful life.
A facility manager needs to balance a customer’s real estate and related work
and space requirements and the organization’s financial, legal and strategic
requirements. On one hand, there is the need to increase or create value for
customers with a focus on the physical location and customer needs for space,
furnishing, equipment, amenities and so forth. But of paramount consideration
is the aggregate amount of capital dollars available for investment and how
capital investments align with organizational decisions related to staffing,
contracting and investing. There’s an overarching need for balance.
There are myriad financial, legal and tax issues that enter into lease versus
purchase decisions. The outcomes influence the organization’s financial
statements, FM budgets, cash position and many other factors. We will
examine this complex issue further in subsequent content on business cases
and financial analysis.
Pro forma In the realm of finance, the term “pro forma” generally describes financial
statements statements (income statement, balance sheet, and cash flow statement) that
have one or more assumptions or hypothetical conditions built into the data.
Stated another way, pro forma financial statements are forecasts of goals for a
future period. They predict how the income statement, the balance sheet and
the cash flow statement will look in the future if expected events occur.
Pro forma statements are the end result of the budgeting process. An
individual pro forma statement is a budgeted financial statement based on
forecasted data—historical documents adjusted for events as if they had
occurred. Pro formas portray financial conditions for the end of the specified
budget period if events happen according to plan.
Exhibit 2-15 provides basic descriptions of each type of pro forma statement.
Statement Description
Forecasting cash The importance of forecasting cash flows cannot be overstated. Running out of
flows cash is not a desirable position for any organization. Even a profitable organization
can end up in bankruptcy if it runs out of cash at the wrong time (e.g., when loans
and other large payments are due).
Cash flows are influenced by the collection of accounts receivable and the payment
of accounts payable. Speeding up the collection of receivables and postponing the
payment of payables can have a positive short-term effect on cash flows.
Exhibit 2-16 provides a sample cash flow forecast showing the monthly
effects over a six-month period.
Revenue
Month of receipt of payment due 500.00 600.00 600.00 600.00 600.00 750.00
Working capital
Salaries 200.00 200.00 250.00 250.00 250.00 250.00
Employer’s tax payments 50.00 50.00 55.00 55.00 55.00 55.00
Other staff costs 1.50 1.50 2.00 2.00 2.50 2.00
Expenses 3.00 2.00 2.50 2.00 2.00 2.00
Operating costs 200.00 250.00 250.00 150.00 200.00 250.00
Capital expenditure 0.00 0.00 500.00 0.00 0.00 0.00
VAT/sales tax 75.00 90.00 90.00 90.00 90.00 112.50
Total outgoings 529.50 593.50 1,149.50 549.00 599.50 671.50
Surplus (deficit) for month –29.50 6.50 –549.50 51.00 0.50 78.50
If senior financial management has serious concerns about the pro formas
resulting from the FM budgeting process or cash flow forecasting, a
facility manager may have to revisit the budget process and re-create the
pro forma statements. This reiterative process may continue until senior
management finds them acceptable or is convinced there are no better
alternative plans.
“Smoothing” Planning is critical in FM. But the reality is that FM decisions exist in a
facility resource-constrained environment. Forecasting and other financial
management
analysis techniques can provide voluminous information. But many times
investments
decision making comes down to what can or should be afforded and when.
Financial statements, pro formas and other cash flow forecasting helps to
quantify FM investments. Yet organizational management tends to bristle
at sudden spikes in FM budgets.
Critical and noncritical projects are generally obvious. For example, major
building renovations might be mandated to comply with the passage of new
occupational safety and health regulations. But in FM, there’s often a struggle
for funding and resources for many mainstream middle-ground items.
• As assets reach the end of their useful life, the cost of the replacement
is identified in the appropriate column.
• At the far right, a column can be added for comments.
Since this plan is revised on an annual basis, each year the RUL will
decrease by one year.
The spreadsheet format easily and quickly communicates assets and their
costs and the date of scheduled replacement. It can provide a logical way to
augment financial planning and decision making.
Summary Simply stated, facility managers must have efficient and effective financial
guidelines for systems and procedures in place. Reflecting back on the content just
effective and presented, we conclude with the general guidelines in Exhibit 2-17 that
efficient facility managers should keep in mind. Organizations may vary in how
financial information is gathered, implemented, monitored, adjusted and the like, but
operations the guidelines that follow are appropriate in all environments: public, not-
for profit, government, nongovernmental organization (NGO), partnerships
or sole proprietorships.
The facility manager recalls that in its most recent strategic plan, the
organization committed to various sustainability goals. Facility
management’s alignment to the strategic plan includes adopting
sustainable design standards for all new construction and significant
renovations. The facility manager is extremely aware that this will be of
prime importance in the proposal to senior management.
This story is fictional, but the issues expressed here are often the reality for
facility managers. The moral of this story: Facility managers need to be
conversant with business terms that upper management and colleagues
understand. They also need to sell facility management projects and
initiatives. A business case is a marriage of the two.
Components of Similar to a good news story, a well-crafted written business case tells
a written readers about the what, when, where, how and why of the proposed
business case initiative. All relevant narrative and financial data should be linked
together into a cohesive presentation to justify resource and capital
expenditures.
For now, let’s momentarily return to the business case needed for the café.
The facility manager realizes it is likely that the proposed initiative will be
challenged. At best, it will be questioned with a skeptical eye because the café
renovation will require the organization to make out-of-the-ordinary
investments at the front end. The business case will have to pass muster with
finance.
There are various ways this facility manager can capture and convey this
information in a business case. Proposed capital investments in facility
management (both in this hypothetical scenario and in real life) have to
compete for capital funding. Finance and other senior management will
review the case and prioritize the project against the many other initiatives
that may require capital investment. Several concepts and techniques that
are useful in developing a solid business case are examined next.
The level of due diligence required to quantify costs and benefits and
secure the necessary funding will vary depending on the specific business
case need. The concepts and techniques that follow may not apply in
every scenario, but a facility manager should understand their potential
utility.
Authors Atkin and Brooks make succinct points underpinning best value
decisions:
• Value is about the relationship of cost or price and quality or
performance.
• Ideally, cost and quality should both be considerations in FM
decisions.
• Cost should take sole priority only when financial constraints are
severe and dictate so.
An organization may think it is achieving best value when it pays less for
goods and services. Costs are typically easier to measure and by their nature
more readily quantified. But to equate value with a mere reduction in cost can
be shortsighted. According to Atkin and Brooks, value for money
encompasses the quality of a service and the economy, efficiency and
effectiveness with which it is delivered.
Life-cycle costing Life-cycle costing (LCC) is the process of determining (in present-value
terms) all costs incident to the planning, design, construction, operation and
maintenance, and disposition of a structure over time. LCC involves the
analysis of the costs of a system or a component over its entire life span. The
term “whole-life costing” is synonymous with life-cycle costing.
Because life-cycle costing considers all of the costs incurred during the service
life of an asset, it facilitates making economically sound decisions. Compiling
all costs related to creation and operation for facility system components
(costs related to planning, design, construction, operations, maintenance and
disposal) provides a basis to compare the relative merits of competing project
implementation alternatives. The economic consequences of mutually
exclusive project alternatives (where the acceptance of one capital budgeting
project precludes the acceptance of others) can be evaluated over a period of
time.
In practice, there are different methodologies for LCC. It is beyond the scope
of our discussion here to present any specific methodology, but the basic
considerations inherent in most approaches are:
• Identifying alternatives.
• Estimating costs.
• Computing life-cycle costs for each alternative.
• Making cash flows time-equivalent by converting them to present
values.
• Totaling all costs.
• Conducting appropriate risk and uncertainty assessments.
There are different ways to test assumptions made and “what-if” scenarios for
high-cost items (such as what happens if maintenance costs are 15 percent
more or less than planned). Sensitivity analysis, scenario analysis and other
ways of assessing and mitigating investment risks will be covered later in this
topic.
As a facility manager, if you have control for the go/no-go decision for a
capital project, LCC is a useful decision-making tool. But even if you do not
have sole authority for the decision, LCC is valuable for ranking
(prioritizing) projects when making recommendations to a CFO, finance
director or other finance personnel.
Capital investments Capital is a limited organizational resource. Organizations often have great
and time value of difficulty recovering money tied up in bad capital investments. Given these
money
two simple facts, all FM capital projects or initiatives must be carefully
evaluated.
If finance grants FM funds for a capital project, the organization loses the
potential to invest that money in an interest-bearing account.
To further explain the time value of money, let’s consider the café renovation
again. The facility manager estimates the project to be a $3 million
investment. As shown below, if finance could invest it and secure a 10 percent
annual interest rate (rather than granting FM that money), $3,000,000 would
be worth almost $3,630,000 in two years because of the cumulative interest
earned.
This simple example demonstrates that money has value over time. It also sets
the stage for a discussion of two additional capital investment concepts:
present value and future value.
Present value (PV) is the method used to compare costs; all cash flows are
converted to their present value or the value of past and future dollars
corresponding to today’s value. PV is the amount that a given future amount is
worth today at a specific rate of interest. In our example, the $3,000,000 is the
present value.
Future value (FV) is the amount that a given amount, invested today at a given
rate of return or interest rate, will be worth at some designated future time.
The $3,630,000 is the future value.
There’s a simple formula used in finance to calculate the time value of money.
Note that the future value amount arrived at in this calculation is the same as
the future value shown earlier. Where did the 1.2100 future value interest
factor come from? Finance has interest factor tables. In fact, open any
financial textbook and you’ll find a set in the text to explain the time value of
money and investments. For years, it was necessary to locate the appropriate
interest multiplier in a table (in this case, for 10 percent over two years, the
factor is 1.2100) and then do the calculation. But take heart: Business
calculators and electronic spreadsheets now have the interest factors and
formulas preprogrammed. If you know the variables, the time values are easy
to determine.
Understanding present value is bit more involved but not overly complex.
Present value is the monetary value today of a future payment that is
discounted at some appropriate interest rate. The present value of $3,630,000
is $3,000,000. In finance jargon, the 10 percent interest rate is called the
discount rate. As with future value, there are present value interest tables for
calculating the present value of money received in the future.
The present value interest factor for 10 percent over two years is 0.826. The
reason for $2,998,380 (not $3,000,000) is because of rounding of the present
value interest factors in the table. Again, facility managers do not have to do
manual calculations like this. Financial calculators and spreadsheets can
perform the calculations. We have shown it here for explanatory purposes.
Capital investment There are four key questions that finance typically considers when
analysis evaluating potential capital investments.
• Are the projects independent or mutually exclusive?
• Do the projects have the same or different size, cash flow pattern and
life?
• Are the projects subject to capital rationing?
• Do the projects have the same risk?
Let’s consider some of the terms and concepts behind these questions.
• Size, cash flow pattern and life. Size is self-explanatory. Cash flow
is net cash before financing, including acquisitions. Stated another
way, cash flow is the income from all sources less expenses,
indicating how much cash is available at a given time. It refers to the
actual flow of cash into cash receipts and savings and out of cash
payments of an organization during a given period of time. Estimating
capital project cash flows is critical because erroneous assumptions or
inaccurate or unreliable data can corrupt the entire capital budget.
“Life” in this context generally refers to the duration of the project or
the stages of a project over time (from initiation to completion).
• Risk. Risk is the possibility that the actual benefits provided by the
investment will deviate from the investor’s initial expectations; the chance
of loss.
Net present value, internal rate of return and the payback method can be
classified as discounting methods and nondiscounting methods. The use of
discounting methods has increased over the years; however, some
organizations still use the nondiscounting methods, and many organizations
use both types.
Discounting methods recognize the time value of money. The net present
value method and the internal rate of return are two approaches to making
capital budgeting decisions using discounted cash flows. The same basic
assumption underlies both the NPV and IRR methods: risk, or uncertainty, is
not a major problem. They evaluate a capital investment by comparing the
equivalent present values of all future net cash flows for the initial investment.
Discounting methods also acknowledge that those projects promising earlier
returns are preferable to projects promising later returns.
Exhibit 2-19 summarizes key characteristics of net present value, internal rate
of return and the payback method. The intent of the information is to help
facility managers understand enough of the principles to know what
information finance needs from them. A discussion comparing the three
methods follows the exhibit.
Both the NPV and IRR methods have gained widespread acceptance as decision-
making tools. In comparing the two methods, it is important to keep in mind that:
• The NPV method is often simpler to use because the IRR method requires a
process of trial and error. However, computer spreadsheets can be used to
automate the IRR method.
• The NPV method makes a more realistic assumption about the rate of return
that can be earned on cash flows from a project. If the NPV and IRR methods
disagree about the worthiness of a project, it might be wiser to use the data
from the NPV method.
A major difference is that the end result of NPV is a monetary value whereas
the final computation for IRR is a percentage. Therein is an advantage for
NPV, as the NPV values of individual projects can be added to estimate the
effect of accepting some possible combination of projects. Because IRR yields
a percentage, multiple projects cannot be added or averaged to evaluate any
combination of capital investment projects. However, some people have
difficulty understanding the NPV measure of present value monetary return
(as compared to IRR’s percentage return).
But among all the various methods to analyze capital investments, the discounted
cash flow methods are theoretically some of the most reliable. The NPV and IRR
methods will typically yield similar results as long as there are no differences in:
• The project size (the amount of the initial investment).
• The net cash flow pattern.
• The life of the project.
• The cost of capital over the life of the project.
However, the payback method is useful as a screening measure and can help
identify investment proposals that managers should consider further. If a
proposal doesn’t provide a payback within some specified period, the potential
project can be rejected without additional consideration.
Minimizing risk By definition, risk implies uncertainty and instability. Fundamentally, there
in capital are no risk-free capital investments. Consider just a few reasons why this is an
investments accurate statement:
• Future cash inflows can vary unexpectedly throughout the life of a project.
• The rate of return used in calculations may not be accurate for the life of
the project.
• The cost of financing may increase during the life of a project.
• New mandatory regulatory factors can require additional investments at
any given point in time.
• The life of the related product or service could be significantly shorter or
longer than anticipated.
• Inflationary or recessionary economic conditions may impact the value of
cash flows.
• Domestic or global political events may impact project cash flows or the
viability of the project as a whole.
Sensitivity analysis Sensitivity analysis measures the change in one variable as a result of a change
in another variable. It helps determine which variables have the greatest
impact on a capital project’s outcome.
Sensitivity analysis can be used to answer questions such as (but not limited to):
• What happens to NPV if cash flows increase or decrease for each year of the
project?
• Will NPV remain positive throughout a project if there is no cash inflow in
the second year of a three-year project?
• What will happen to NPV if the discount rate increases or decreases?
• What would happen to NPV if a major redesign, requiring additional capital
investments, becomes necessary at some point during the project in order to
address competitive new products?
• What would be the impact on NPV if the project is extended, with decreasing
cash flows and increased maintenance costs in the extended years?
The principal merits of sensitivity analysis are its ability to pinpoint forecasting
errors and the fact that computer spreadsheet programs eliminate many tedious
manual calculations. However, sensitivity analysis does not account for the
probability of any of the outcomes or the impact of simultaneous changes in
variables and it does not provide a decision rule for accepting/rejecting projects.
Scenario analysis Scenario analysis examines what happens to profitability estimates such as
NPV if a certain set of events (called a scenario) arises. Probability estimates
are examined against different sets of assumptions or conditions.
Example: The initial cash outlay and the tax rate could be greater
than expected; the useful life could be less than expected.
• Most likely—the most likely scenario results from the range of possible
optimistic and pessimistic values for each variable.
Pros and cons exist for scenario analysis. A distinct benefit is that the
“what-if” analysis considers other possible outcomes beyond the most
likely case. A pessimistic scenario can, for example, help avoid surprises
and a tendency for forecasting optimism. Severe consequences of a worst
case scenario might lead to rejecting a project. But there are also
weaknesses in scenario analysis, a principal one being that it is typically
limited to a few discrete outcomes. Realistically, many other possibilities
exist because subjective judgments are involved in what forms optimistic
and pessimistic scenarios may take. While sensitivity analysis has uses, it is
by no means routine and is usually led by a specialist accountant.
Business case Excerpts of a sample business case are shown on the following pages. This
sample example compares the choice between two different investment options.
The presentation highlights a comparison of the long-term financial
implications for a purchase decision.
As you review this business case sample, keep in mind that this scenario is
hypothetical and only business case excerpts are shown. This is not a
complete case example. The spirit of this information is to describe some of
the likely components of a business case. Content presented here would
vary with the organization’s needs and expectations.
Executive Summary
In the organizational strategic plan, the mandate is: “Strive to become more competitive and effective and
provide the best workplace possible for employees.” Facilities are a vital component in this strategy.
In terms of the critical comfort needs of the people and the things in a building, a high-performance
heating, ventilating and air conditioning (HVAC) system makes a building a more desirable work
environment. To continue to provide air conditioning and sustain a competitive and pleasant workplace, a
chiller must be replaced. The current chiller is beyond its useful life.
This proposal for capital funding is based on the analysis of two mutually exclusive investment choices.
The recommendation is a new 300-ton chiller. The new chiller will play a significant role in creating the
right comfort environment. Not only will a new chiller provide the right temperature, humidity and
ventilation; it will also help reduce the building cost of operation, provide energy efficiency, and minimize
environmental impact.
Current Status
Keeping the HVAC system running at maximum efficiency is one of the best ways to minimize service
calls, eliminate surprises and control total cost of operation. The reliability of the current chiller is
declining, and repairs are both expensive and problematic.
This proposal for capital funding analyzes two mutually exclusive investment choices:
• Option 1: 300-ton chiller
• Option 2: Six 50-ton package units
Based on a life-cycle costing analysis that considers all of the costs incurred during the service life of an
asset, the economically sound choice between the two alternatives is option 1, the 300-ton chiller.
Assumptions
The following assumptions support the choice of the 300-ton chiller:
• There are no physical constraints to installing the recommended 300-ton chiller.
• There is adequate space to accommodate the chiller.
• The 300-ton chiller model is one of the latest and most reliable products on the market and will
enhance the reliability of the building HVAC system.
Business Analysis
The financial analysis shown here outlines the initial cost estimates for the two options under
consideration.
The last column (PV$) identifies the present value in dollars. That number is derived using an annually
decreasing factor (PV factor) based on a discount rate of ten percent. The PV factor is a discount factor
that establishes future costs in today’s dollars.
It is also important to note that both the maintenance and utility costs are subject to an annual 4 percent
increase (FV factor in column 3). The annual adjustment is included in this analysis and is totaled in
column 6.
Note that in year ten, an expense of $170,000 is identified. This expense is for a major overhaul of the
chiller system based on the manufacturer recommendations.
FV
Year Initial Cost Factor Maintenance Utilities Total M&U Total Cost PV Factor PV$
0 $ (295,000) 1.0000 $ (1,725) $ (20,000) $ (21,725) $ (316,725) 1.0000 $ (316,725)
1 1.0400 (1,794) (20,800) (22,594) (22,594) 0.9091 (20,540)
2 1.0816 (1,866) (21,632) (23,498) (23,498) 0.8264 (19,419)
3 1.1249 (1,940) (22,498) (24,438) (24,438) 0.7513 (18,361)
4 1.1699 (2,018) (23,398) (25,416) (25,416) 0.6830 (17,359)
5 1.2167 (2,099) (24,334) (26,433) (26,433) 0.6209 (16,412)
6 1.2653 (2,183) (25,306) (27,489) (27,489) 0.5645 (15,517)
7 1.3159 (2,270) (26,318) (28,588) (28,588) 0.5132 (14,671)
8 1.3686 (2,361) (27,372) (29,733) (29,733) 0.4665 (13,870)
9 1.4233 (2,455) (28,466) (30,921) (30,921) 0.4241 (13,114)
10 (170,000) 1.4802 (2,553) (29,604) (32,157) (202,157) 0.3855 (77,932)
11 1.5395 (2,656) (30,790) (33,446) (33,446) 0.3505 (11,723)
12 1.6010 (2,762) (32,020) (34,782) (34,782) 0.3186 (11,081)
13 1.6664 (2,874) (33,327) (36,201) (36,201) 0.2910 (10,533)
14 1.7317 (2,987) (34,634) (37,621) (37,621) 0.2633 (9,906)
15 1.8024 (3,109) (36,047) (39,156) (39,156) 0.2405 (9,415)
16 1.8730 (3,231) (37,460) (40,691) (40,691) 0.2176 (8,854)
17 1.9494 (3,363) (38,988) (42,351) (42,351) 0.1988 (8,417)
18 2.0258 (3,495) (40,516) (44,011) (44,011) 0.1799 (7,917)
19 2.1085 (3,637) (42,169) (45,806) (45,806) 0.1643 (7,524)
20 2.1911 (3,780) (43,822) (47,602) (47,602) 0.1486 (7,074)
$ (636,364)
FV
Year Initial Cost Factor Maintenance Utilities Total M&U Total Cost PV Factor PV$
0 $ (265,000) 1.0000 $ (1,600) $ (18,750) $ (20,350) $ (285,350) 1.0000 $ (285,350)
1 1.0400 (1,664) (19,500) (21,164) (21,164) 0.9091 (19,240)
2 1.0816 (1,731) (20,280) (22,011) (22,011) 0.8264 (18,190)
3 1.1249 (1,800) (21,092) (22,892) (22,892) 0.7513 (17,199)
4 1.1699 (1,872) (21,936) (23,807) (23,807) 0.6830 (16,260)
5 1.2167 (1,947) (22,813) (24,760) (24,760) 0.6209 (15,373)
6 1.2653 (2,024) (23,724) (25,749) (25,749) 0.5645 (14,535)
7 1.3159 (2,105) (24,673) (26,779) (26,779) 0.5132 (13,743)
8 1.3686 (2,190) (25,661) (27,851) (27,851) 0.4665 (12,992)
9 1.4233 (2,277) (26,687) (28,964) (28,964) 0.4241 (12,284)
10 (392,253) 1.4802 (2,368) (27,754) (30,122) (422,375) 0.3855 (162,826)
11 1.5395 (2,463) (28,866) (31,329) (31,329) 0.3505 (10,981)
12 1.6010 (2,562) (30,019) (32,580) (32,580) 0.3186 (10,380)
13 1.6664 (2,666) (31,244) (33,910) (33,910) 0.2910 (9,866)
14 1.7317 (2,771) (32,469) (35,240) (35,240) 0.2633 (9,279)
15 1.8024 (2,884) (33,794) (36,678) (36,678) 0.2405 (8,819)
16 1.8730 (2,997) (35,119) (38,116) (38,116) 0.2176 (8,294)
17 1.9494 (3,119) (36,551) (39,670) (39,670) 0.1988 (7,884)
18 2.0258 (3,241) (37,984) (41,225) (41,225) 0.1799 (7,416)
19 2.1085 (3,374) (39,533) (42,907) (42,907) 0.1643 (7,047)
20 2.1911 (3,506) (41,083) (44,589) (44,589) 0.1486 (6,626)
$ (674,585)
Recommendation
The recommendation is the purchase of option 1, a new 300-ton chiller.
As shown in the following table, when initially comparing two options in a total cost analysis, the
projections for the initial capital costs and annual maintenance costs and utility costs for option 1 (300-ton
chiller) are higher than for option 2 (six 50-ton package units).
Option 1 Option 2
300-Ton Chiller Six 50-Ton Package Units
Initial capital cost $295,000 $265,000
Maintenance costs* $1,725 $1,600
Annual utility costs* $20,000 $18,750
Useful life span 20 years 10 years
While the inclination may be to select option 2, the package units, because it is initially less expensive,
this is not the best choice. A decision based solely on the initial purchase price is a short-term tactical
one.
Note that the service life of the option 2 package units is 10 years, compared to the 20-year useful life
span for the option 1 300-ton chiller.
Based on life-cycle costing that considers all of the costs incurred during the service life of an asset, the
economically sound choice between the two alternatives is the option 1 300-ton chiller. The decision to
purchase the 300-ton chiller is based on a long-range strategic evaluation.
What does the term cost mean to you? Is it the price paid for an asset? A
cash outflow? Something that affects department profitability? Speaking in
general business terms, costs are a measurement of the resources necessary
to achieve a specific objective—to produce a product or a service. Costs are
usually monetary measures.
In this topic we examine some of the principal cost terms and cost
accounting concepts encountered in FM. Understanding basic cost
terminology and concepts facilitates communications with other managers
and organizational finance personnel. It also facilitates effective and
efficient management, accurate cost accounting, proper financial analyses,
and sound recommendations to senior management.
Cost terms and Quite often, it is necessary to predict how a particular cost will behave. Cost
classifications behavior doesn’t refer to good or bad behavior but rather how a specific cost
will behave in response to changes in business activity levels. Costs may stay
the same or may change proportionately (rise or fall) in response to a change
in activity.
In order to develop an accurate budget for next year, the facility manager
needs to understand the behavior of all the different costs affected. To help
make distinctions about which costs will change and by how much, costs are
often categorized as variable, fixed, mixed or total.
Variable costs Recall from the primer of financial terms that variable costs are costs that
change in total in proportion to changes in the related level of total activity.
For example, fuel costs depend on mileage driven. Stated another way, a
variable cost routinely increases and decreases proportionately with changes in
activity level.
Utilities, waste disposal, costs of materials and supplies, travel expenses and
billing costs are customary examples of variable costs in FM.
Fixed costs Fixed costs remain unchanged in total for a given time period, despite wide
changes in the related level of total activity.
There are some additional points to understand about fixed costs. Fixed
costs remain constant in total unless they are influenced by some outside
force (such as a price change). Also, to say a cost is fixed means that it is
fixed within some relevant range.
Relevant range is the range of activity within which the assumptions about
fixed costs (and variable costs) are valid. Relevant range is typically
expressed as specific cost drivers for a specific duration of time.
Cost drivers are those activities that have a direct and causal relationship to
the incurring of overhead costs. A cost driver (also called allocation base)
can be any factor that has a cause-and-effect relationship on costs. A
change in a cost driver will result in a change in the total cost of a related
cost object.
A cost object is anything for which cost data is accumulated. A cost object is
used to determine how much a particular thing or activity costs. In FM, items
or activities such as customers, projects and services are considered as cost
objects.
The following example puts all these concepts together to illustrate fixed costs
and relevant range.
Example: The assumption that the rent for an FM copier is USD $200
per month is valid within the relevant range of 0 to 20,000 copies per
month. But a significant increase in the demand for copy services that
skyrockets the monthly copy count would mean renting an additional
copier. The fixed cost of monthly rent for reprographics will increase
because of the second copier.
Most fixed costs do not have cost drivers. However, fixed overhead is
allocated to cost pools using an allocation base.
Mixed costs Mixed costs (also called semivariable costs) are costs that vary with changes
in volume or activity, but not by a direct proportion. Many mixed costs are a
combination of fixed and variable costs. They change in response to a change
in volume and activity but by less than a proportionate (equally
corresponding) amount.
The time horizon is important for determining cost behavior, because costs
can change from fixed to variable depending on whether the decision takes
place over the short run or the long run. All three cost patterns (fixed, variable
and mixed) are found in most organizations.
Total costs As the name implies, total costs are all the fixed and variable costs for a cost
object.
Direct costs Direct costs are costs that can be specifically traced to an item or activity
(for example, repairing a hole in the roof). They can be easily and
accurately traced to a cost object (usually direct labor and direct
materials).
Indirect costs Indirect costs are costs that are spread over a period of time, regardless of
specific activities (for example, yearly insurance premiums).
Indirect costs are related to a cost object but cannot be easily and accurately
traced to a cost object (such as overhead). In other words, indirect costs are
related to an item or activity but not directly and solely associated with that
item or activity. In addition to annual insurance premiums, other examples
of indirect costs in FM include some maintenance costs, utility costs for a
building, or salaries.
There are different schools of thought about the use and merits of
traditional versus activity-based cost measurement systems. For the most
part, organizations use different cost systems because they produce
different outputs. Most facility managers do not have a choice in the
matter, so the point of our discussion here is to provide an overview of how
traditional and activity-based systems differ and then explain the basics of
how each cost measurement system converts data into information of
interest to management.
Traditional and activity-based costing both start with the same basic cost
elements. But as shown in Exhibit 2-20, traditional and activity-based cost
measurement systems are built on conceptually different foundations.
* An activity is generally described as a series of related tasks performed by a person; an operation is a series of
tasks performed by a machine. Sometimes the distinction is not totally definitive.
Traditional cost Traditional cost measurement systems reflect the influence of mass
measurement production and focus on inventory measurement. As noted in Exhibit 2-20,
systems
they use responsibility centers for cost tracking and a single base for
allocating costs to products and services. A responsibility center groups
units and sub-units, departments and divisions based on the functions they
perform.
Two popular forms of traditional cost measurement systems are job order
costing and process costing. In practice, many organizations use hybrids of
the two but to explain their differences, we will look at each one in a pure
form.
Job costing systems assign costs (e.g., the direct materials, direct labor and
overhead) that go into the product or service to a specific job (a distinct unit,
batch, or lot of a product or service). Overhead costs are typically applied at a
predetermined percentage rate. Each job is given a unique identification code or
number, and a job cost sheet is used to record and accumulate job order costs.
A job order costing system assigns costs to individual jobs using the following
steps.
• Identify the job by a unique code or other date-specific reference method.
• Trace the direct costs for the job.
• Identify indirect cost pools associated with the job (overhead).
• Choose the cost allocation base (cost drivers) to be used in allocating
indirect costs to the job.
• Calculate the rate per unit of each cost allocation base.
• Assign cost to the cost object by adding all direct and indirect costs (based
on a combination of machine and labor hours).
Process costing
Process costing involves costs not associated with specifically identifiable
units of production or customer identifiable jobs; [it is] usually used where
there are no distinct jobs associated with processes. A process costing
system accumulates product or service costs by process or department and
then assigns them to a large number of nearly identical products by dividing
the total costs by the total number of units produced.
Costs of direct materials, direct labor and overhead are traced to individual
departments or processes. Costs are accumulated for each step in the
process, and a record of units worked on is also maintained. At the end of
the accounting period, the total cost is allocated to units processed in that
given time period. This is accomplished by simply dividing the total cost of
production in that time period by the units produced, resulting in a cost per
unit.
However, despite the similarities, the differences between the systems are
significant, as shown in Exhibit 2-21.
Exhibit 2-21: Key Differences Between Job Order Costing and Process Costing
• Used with a wide variety of distinct • Used with similar or identical products
products or services. and a steady stream of units.
• Total job costs consist of actual direct • Costs are assigned uniformly to all units
materials, actual direct labor and passing through a department during a
overhead applied using a predetermined specific period.
rate or rates. • Costs accumulate by process or
• Costs accumulate by the individual job or department.
order and are tracked separately. • The flow of costs is simplified because
• Unit cost is computed by dividing total job costs are traced to fewer processing
costs by units produced or served at the departments.
end of the job. • Unit cost is computed by dividing total
process costs of the period by the units
produced or served at end of the period.
Activity-based Activity-based costing (ABC) is most often used to track and control
costing overhead costs; it accumulates costs of activities that consume
resources.
The basis for ABC is that activities use resources but produce products or
services. The resource cost is calculated using a cost driver; the amount of
an activity consumed in a period is multiplied by the cost of the activity.
The calculated costs are assigned to the product or service.
ABC systems are often used in organizations that have multiple products
and services and/or products and services that use varying amounts of
resources, which include not only materials and other direct costs but also
indirect costs such as customer service, quality control and supervision.
When each product or service consumes each of these costs at different
rates, a broad brush or uniform cost for all items tends to make some
products and services appear more profitable and others less profitable than
they really are.
Step 1: Extract from a selection of cost driver activities all costs that represent the gross
overhead component of each of those activities; set them aside.
Step 2: Identify separate and unique overhead activities associated with each full cost driver’s
gross overhead component, and create a cost pool for each of those overhead
activities. From here on, each cost pool will be used to accumulate activity base costs
from many different and often widely varying cost drivers (hence the name activity-
based costing). Cost pools might include overhead activities such as building
maintenance, heating the building, service equipment repairs, etc.
Step 3: Determine how overhead costs can best be measured by determining an activity base
unit for each overhead activity base (square feet, per person, per hour, etc.).
Step 4: Determine the exact amount or proportion of activity base units consumed by each
cost driver activity.
Step 5: Consolidate identical activity base units under their appropriate cost pools.
Step 6: For each associated cost pool, sum the activity base units to arrive at a gross activity
base for that cost pool.
Step 7: Calculate an overall cost per unit for each overhead activity by dividing the total cost
pool for that overhead activity by its gross activity base.
Step 8: Allocate future overhead activity costs to non-overhead activities based on usage
using proration of the cost pool or, better still, by applying the unit costs derived in step
7.
Step 9: Periodically repeat the process (especially steps 4 through 7) to ensure the validity of
the applied overhead activity costs.
• Allocation. Two basic conditions must exist before a facility manager can
allocate costs: (1) the cost center must have caused the overhead to be
incurred and (2) the exact amount of overhead must be known.
Examples:
• Power consumption in a stand-alone data center
• Courier delivery costs (such as FedEx or a similar courier) that can
be tracked directly
• Rebranding a reception area (usually the marketing or public affairs
department)
• Hospitality catering
• Overtime costs for FM staff to keep a building open and provide
services (for example, during a corporate acquisition)
• Staff canteen subsidy—when FM has usage figures by department
(for example, from payment cards) and can allocate by proportion
of users or money spent by each department
• Internal moves requested by a department—where FM can allocate
whole cost and any related “knock-on” costs
Examples:
• Power consumption in a shared office (and rent, property taxes, water)
apportioned by floor area occupied or by head count
• FM office salaries, apportioned by departmental head count
• Staff canteen subsidy, apportioned by departmental head count when
there is no data on departmental usage
• Internal moves dictated by corporate need, apportioned by departmental
head count or by numbers of heads/desks actually moved
Computer databases have made tracking individual costs using ABC more
feasible. Organizations that adopt ABC will be able to use it not only in
accounting for costs but also for decision making. They can cost products and
services, analyze processes, assess management performance and assess
profitability better than firms that use a volume-based (traditional) costing system.
Additionally, the information derived from ABC can be used to eliminate non-
value-adding activities. Some activities and resources necessary to create and
deliver a product or service are also valued by customers. However, there are other
activities and resources that customers are indifferent to. Such non-valued-added
activities are not absolute necessities. If an activity or resource can be eliminated
without increasing the cost and/or without decreasing the desirability of the
product or service to customers, potential cost savings are possible.
ABC has many advantages. But there also are some limitations. Exhibit 2-23
lists general advantages and disadvantages of activity-based cost systems.
Advantages Disadvantages
• More accurate costing of products/services; • Not all overhead costs can be related to a
reduces distortions caused by traditional cost particular cost driver; some may need to
allocation methods. be arbitrarily allocated.
• Utilizes unit cost rather than just total cost. • Cost of buying, implementing and
• Better understanding of overhead; measures maintaining activity-based system; requires
activity-driving costs. numerous development and maintenance
hours, even with software and databases.
• Makes waste/non-value-added visible; allows
management to better understand how overall • Generates vast amounts of information;
cost/value are affected if changes are made. the volume of information can mislead
managers into concentrating on the wrong
• Facilitates benchmarking.
data.
Using costs in Costs are an important part of many business decisions in FM. Consider but
decision a few:
making • What sorts of property, plant and equipment should the organization
hold?
• Should the organization modernize or sell an old property?
• Should the organization upgrade mechanical systems at a property?
• Should services be reduced to save cost, or could they be improved with
little or no cost impact?
• Should a service be done in-house or outsourced?
Differential costs The differential cost concept implies that costs and revenues differ depending
on the conditions. Incremental costs and relevant costs are other names for
differential costs.
Differential costs are relevant to a decision maker because they are costs that
differ between two or more possible uses of funds.
Sunk costs Sunk costs are money that has already been spent on decisions that cannot be
changed. A sunk cost should be ignored in a decision-making process because
the cost was incurred in the past and cannot be changed. The money is history
and therefore irrelevant to decisions made about any future business activities.
Example: Three years ago, the organization made a significant capital
investment in a wastewater system. Due to new environmental
regulations, the system has been rendered obsolete. Looking back, the
decision may have been unwise, but no amount of regret can change or
undo the decision. The money paid is gone and cannot be applied as a
differential cost in the purchase of a new system or any other future
investment decision.
Financial Financial statement ratio analysis assesses how various line items in
statement ratio financial statements relate to one another. Such ratio analysis is a more
analysis useful exercise than discovering the dollar amount spent because of the
variables affecting an organization’s spending that uniquely apply to it.
Many organizations use ratios to analyze budget and financial report data.
However, ratios are useful at any given point in time.
All ratio calculation examples are shown in U.S. dollars (USD). Note that
in practice, some ratios may have different formulae. The point here is to
understand what the ratio measures.
Current ratio
The current ratio answers the question, “Does the organization have
sufficient current assets to pay its bills during the year?” It indicates the
general availability of cash to pay off liabilities (debts) as they come due.
The equation for the current ratio and an example are shown below. The
example is based on a situation in which:
• Current assets = US $250,000.
• Current liabilities = US $100,000.
Current assets
Current ratio =
Current liabilities
US $250,000
= = 2.5 times to 1
US $100,000
The ratio indicates that the organization has US $2.5 in current assets for each
dollar of its current liabilities, or 2.5 times the current assets.
The current ratio cannot provide data on cash flow timing, however. Lowering
current ratios over time shows declining liquidity but if too high could show
that the organization has too much invested in low-yield short-term assets.
The equation for the quick ratio and an example appear below. The example is
based on a situation in which:
• Cash = US $200,000.
• Cash equivalents = US $10,000.
• Accounts receivables = US $10,000.
• Current liabilities = US $100,000.
= 2.2 times to 1
The quick ratio may be a more accurate indicator than the current ratio of an
organization’s ability to meet its financial obligations in a short span of time.
Since the quick ratio excludes the least liquid current assets, primarily
inventory, comparing it to the current ratio shows the effect of inventory on
liquidity. A stable current ratio plus a declining quick ratio imply increasing
inventory that could be temporary or permanent.
Asset management Asset management ratios measure how efficiently an organization’s assets are
ratios used to generate income—in other words, how well the organization uses
resources to generate revenue.
Sales
Inventory turnover =
Average inventory
US $1,500,000
= = 5 times
US $300,000
If relatively high, the inventory turnover ratio shows that the inventory is
efficiently managed, while a declining ratio could show excess inventory due
to poor sales or obsolescence. Too high a ratio could mean lost sales due to
stockouts (ineffective buying).
Average inventory turnover is generally calculated using sales, but it may also
be calculated with cost of goods sold (COGS). Although the first calculation is
more frequently used, COGS may be substituted because sales are recorded at
market value, while inventories are usually recorded at cost. Also, using
average inventory instead of the ending inventory levels helps to minimize
seasonal factors.
Profitability ratios Profitability ratios measure an organization’s earning power. They help judge
operating performance (sales versus related expenses), leverage and risk.
Profitability ratios answer the question “How well did the organization operate
during the period?” They indicate the effectiveness of management in controlling
expenses and earning a reasonable return for owners (and shareholders in public
companies).
Gross, operating and net profit margin are three measures often compared to
each other. For example, if compared to industry averages over several years
gross profit margin has been holding steady but operating profit margin and
net profit margin have been declining, then the cause must be from indirect
costs since gross profit equals net sales less COGS while operating profit and
net profit deducts COGS and a number of indirect items.
The gross profit margin is calculated as shown below. The example is based on
a situation in which:
• Gross profit = US $750,000.
• Net sales = US $1,500,000.
Gross profit
Gross profit margin =
Net sales
(US $750,000 )
= = 0.50
US $1,500,000
For each dollar of sales, the organization generates US $0.50 in gross profit.
Operating profit
Operating profit margin =
Net sales
(US $1,500,000 − US $1,100,000 − US $150,000 )
= = 0.167
US $1,500,000
For each dollar of sales, the organization makes US $0.167 in operating profit.
The net profit margin is calculated as shown below. The example is based on a
situation in which:
• Net income = US $140,000.
• Net sales = US $1,500,000.
Net income
Net profit margin =
Net sales
US $140,000
= = 0.093
US $1,500,000
Normal net profit margin depends on the industry; a relatively low margin
could mean that competitors are forcing price cuts or that the organization has
poor cost controls.
Return on assets
A return-on-assets (ROA) ratio indicates how profitable an organization is
relative to its total assets. ROA gives an idea as to how efficient management
is at using its assets to generate earnings; it is displayed as a percentage.
Net income
Return on assets (ROA) =
Total assets
US $140,000
= = 0.116 = 11.6%
US $1,200,000
For each dollar invested in total assets, the organization makes US $0.116 in
net income, or 11.6 percent. A variation adds interest expense to net income to
give organizations with high debt financing a more appropriate ratio.
Return on equity
Return on equity (ROE) reveals how much profit an organization earned in
comparison to the total amount of shareholder equity found on the balance
sheet. The ratio is usually expressed as percentage.
The equation for the ROE ratio and an example appear below. The example is
based on a situation in which:
• Net profit = US $120,000.
• Equity = US $900,000.
Net profit
Return on equity =
Equity
US $120,000
= = 0.133 = 13.3%
US $900,000
The equation for the ROCE ratio and an example appear below. The example
is based on a situation in which:
• EBIT = US $1,000,000.
• Total assets = US $400,000.
• Current liabilities = US $320,000.
EBIT
Return on capital employed =
Total assets – Current liabilities
US $1,000,000
=
(US $400,000 – $320,000)
US $1,000,000
= = 12.5 = 12.5%
(US $80,000)
A note of caution about using ratios as benchmarks: Keep in mind that every
organization’s circumstances are different. When using ratios for benchmarking,
consider any mitigating circumstances that might explain variance or conformity
with a norm. Ratios themselves have many variations. Even though they share a
common name, one organization may use different numerators or denominators
than another in performing the calculation.
While no universal metrics exist per se, several possibilities are shown in
Exhibit 2-25. Computer software can be used to accumulate and process the
required data and calculate ratios. The metrics chosen to track and report should
be appropriate to the organization and whatever senior management considers
important to financial well-being.
Sisyphus was once king of Corinth. After insulting the Greek gods
with trickery, he was punished by being forced to push a huge
rock up a steep hill without ever reaching the summit. The rock
always escaped from him and rolled back down before he
reached the top of the hill, forcing him to begin again. This was to
be Sisyphus’s fate for eternity.
In this topic, we look at some practices that can help transform the potential
bleakness of a Sisyphean situation into positive cost-containment actions no
matter what your unique organizational demands. We first consider ideas for
cost containment in FM, and we conclude with guidelines for implementation.
Cost- In theory, few would dispute the merits of cost-containment strategies. In practice,
containment however, implementing cost containment is not exactly like driving on a well-
implementation groomed racetrack. There can be twists and turns and speed bumps. Oftentimes,
management embraces any and all ideas for cost savings but employees and
customers may be cynical and resistant if change potentially disrupts the status quo.
Topic 7: Chargebacks
What is a To answer this question, let’s consider a hypothetical example.
chargeback?
Facility management in a manufacturing environment bills business
units for facility management services according to their use.
The concept of allocating costs was introduced earlier in this chapter in the
discussion of cost measurement systems. A chargeback system would be the
opposite of general allocation practices. It is an accounting practice that allows
facility management to apply the expenses for goods and services where they
are actually used. A chargeback is a cost control that requires the requesting
party to pay for work done to its area, a service provided, or some allocation
of costs to tenants or end-user departments in an organization.
In most chargeback systems, FM still budgets and controls funds for building
services such as heating, ventilation and air conditioning (HVAC), grounds
maintenance, and janitorial services, and end users are charged an allocated
fee for them. Typically, discretionary FM goods and service requests such as
space alterations, signage and furniture must be performed or purchased
through FM to ensure compliance with applicable standards. Customers may
have the option to obtain optional services such as picture framing or catering
at a competitive cost from facility management or the ability to purchase from
an outside vendor.
Advantages Chargebacks offer an organization and FM some important benefits. The main
and dis- advantages of chargebacks include:
advantages of • In organizations, they make FM costs more apparent and understandable to
chargebacks line managers.
• In manufacturing environments, they allow FM costs to be more easily tied
to a product.
• They promote cost-conscious behavior and encourage thrift and efficiency.
• For those FM services where end users have options to use an outside
provider, facility management must earn the business and that can lead to
department efficiencies.
Particularly in the manufacturing area, the FM chargeback has real benefit to the
FM customer as the FM services are part of the process to determine the real
cost of producing a product.
Chargeback Chargebacks are not done in every organization. If they are, the practices must
systems be tailored to the organization.
1. True or false? The treasurer’s office prepares a forecast to help in FM cash flow planning. The facility
manager takes the forecast into consideration when preparing the operating budget. Because the
forecast was the first planning document, the treasurer has responsibility for keeping the cash
expenditures in line during the budget period.
( ) a. True
( ) b. False
2. Which budgeting method requires a facility manager to justify all budgeted expenditures, not just
changes in the budget from the previous year?
( ) a. Incremental
( ) b. Continuous
( ) c. Zero-based
( ) d. Activity-based
3. When reviewing a financial statement, what is the primary distinction between a current liability and
a long-term liability?
4. True or false? When estimating cash flows, beginning accounts receivable and payable balances are
$40,000 and $20,000. The facility manager estimates ending balances for accounts receivable and
payable as $50,000 and $10,000, respectively. Based on these projections, cash available will decline.
( ) a. True
( ) b. False
5. Present value a. Estimates the discount rate that makes the present
value of net cash inflows equal to the initial
6. Net present value investment
b. The monetary value today that an investment project
7. Internal rate of return
earns after yielding the desired rate of return for each
period during the life of the investment
c. The equivalent dollar value today of future net cash
inflows
9. An organization has a declining current ratio. This most likely indicates a problem with
( ) a. equity financing.
( ) b. collecting accounts receivables.
( ) c. liquidity.
( ) d. operating profits.
At times, the procurement process and FM needs may not align. Consider a
few such scenarios.
• FM situations may arise necessitating a swift response not conducive to a
prolonged open bidding process.
• A facility manager may have a preference for a particular vendor because
of superior quality and best value.
Procurement All procurement actions should be based on conformance with all applicable
principles laws and regulations. All prospective suppliers and their representatives
should be treated fairly and impartially. Additional general procurement
principles include (but are not limited to):
• Achieve the best value for money on all procured goods and services.
• Reduce procurement process costs and ensure continuous improvement.
• Ensure that all procurement activity adheres to organizational policies
(such as sustainability, diversity, equality and workforce issues).
• Ensure that procurement is undertaken in accordance with high
professional standards and ethics.
• Ensure that procurement activity is organized in an effective, structured
way and is embedded in the organization.
• Develop management information and the use of performance measures
of procurement.
This may entail collecting information from product and service providers
and may require the development of contract language to ensure that vendors
provide environmental information.
Consider but a few distinctions between the following calls for bids.
The RFP may dictate to varying degrees the exact structure and
format of the vendors’ response. The creativity and innovation that
suppliers choose to build into their proposals may be used to judge
proposals against each other. At the risk of failing to capture
consistent information between bidders, suppliers are allowed to
make their best efforts in their response. Effective RFPs typically
provide sufficient details upon which suppliers will be able to offer a
matching perspective.
The type and complexity of the acquisition and the level of the expenditure
also influence the practices and process. Along a continuum, simple
procurements with a low monetary value generally take a lot less time and
rigor than procurements of high monetary value or those that require a public
bidding process.
• Do not try to outsource known problem • Be clear about any elements of a normal
areas without resolving them first. service specification that you don’t require (for
example, if they are provided by internal
• Ensure that you understand completely
teams).
the current levels of contracted and
actual expenditure on the services. • Make clear the resources (accommodation, IT,
storage facilities and so on) that will be
• Ensure that you understand all
available to the contractor.
constraints, especially:
• Existing contract end dates. • Set out a clear pricing model to allow
comparison between proposals/bids.
• Ownership of materials and
equipment. • Be clear about the evaluation criteria before
• Ownership of software used in the issuing the solicitation (e.g., RFP, ITT or
services. RFQ), and tell the bidders what they are.
• Data ownership and location. • To get the best out of the bidders, offer an
• Planned process of transfer opportunity for alternative proposals as well as
between contractors. (but instead of) a compliant proposal.
• Any key staff whom you might want • Ensure that you request a mobilization plan
to retain (and who employs them). and mobilization costs from the bidders.
• The roles and availability of client (Mobilization is the initial phase of
team members, especially decision implementation; it puts in place the necessary
makers and signatories. physical and organizational arrangements
needed for the activity.)
• Labor unions or work councils
• Establish and publish the process for
• Assemble all the information that management during the bid process
bidders will need to know to provide a preparation phase, including:
complete and accurate price.
• The overall timetable.
• Create a complete service specification • A bidder briefing.
that lends itself to objective
measurement through performance • Sample site visits.
indicators. • How you will manage questions and
clarification requests.
• Provide suggested performance
indicators, based if possible on current • What the process for returning the
performance. proposals to the client is.
• The period allowed for negotiation (if any).
• Do not prescribe service methodologies
or specialist subcontractors unless it is • The period allowed for mobilization.
absolutely essential; focus on the • Establish clear variation and change control
outputs (performance) you require. processes.
Forms of Facility management outsourcing can take many forms. Organizations may
facility hire a full-service, single-source vendor to provide many services bundled
management together, or an organization may “out-task” and hire individual, specialized
outsourcing vendors to provide one or more functions.
Finance
Strategic Client Procurement
Audit
People management
Finance
On-Site Procurement
Tactical Client
FM Team Health and safety
Project management
Technical
Service Delivery
Operational
Supply Chain
Client
Strategic
Soft Services Hard Services Finance
Manager Manager Procurement
Audit
People management
Finance
Site-Based Procurement
Tactical Site Based FM
FM Health and safety
Project management
Technical
Operational
Specialist Services Specialist Services
Supply Chain Supply Chain
Finance
Strategic Client Procurement
Administration
People management
Finance
On-Site Off-Site Procurement
Tactical Client
FM Team Support Health and safety
Project management
Technical
Client
Strategic Representative
People management
Finance
On-Site FM Off-Site Procurement
Tactical PC Director
Team Support Health and safety
Project management
Technical
The shortcomings of the managing agent model often lead organizations to the
next stage, which is to procure a specialist management provider that is
independent of the supply chain. The principal contractor directly procures the
service delivery contracts. In this scenario, the client will usually retain control
of the specification of services and often imposes key contract terms to be
passed down to the supply chain. Occasionally, clients may specify suppliers
to be used for critical equipment maintenance or to meet warranty obligations,
but otherwise the client has no involvement in the relationship between the
principal contractor and their suppliers. The impact of this is that the client
receives a single monthly invoice and is able to reduce other resources and
costs for supporting management activities that become the responsibility of
the principal contractor. Integration of services and management is much more
effective, and the client is able to benefit from the procurement of best-in-class
specialist service providers under a single management regime.
Finance
Strategic Client Procurement
Audit
People management
Finance
On-Site On-Site Procurement
Tactical Client
FM Team Support Health and safety
Project management
Technical
Operational
Why There are many reasons to outsource in FM. Outsourcing offers cost
outsource? reduction opportunities. Other reasons include (but are not limited to):
• Access to expertise not available in-house.
• Improved resource flexibility.
• Improved cost flexibility.
• Improved career opportunities for FM staff.
• Access to investments or systems that would require capital that
cannot be justified in the host organization (as noted in the business
case issues raised previously).
• Management time freed up to focus on strategic issues and planning.
Outsourcing Although outsourcing offers many attractive advantages, it may not be the
benefits and answer for all activities or functions. In the U.S. federal government, for
cautions example, certain functions described as “inherently governmental” may
not be outsourced. These functions are typically found in jobs that require
decisions about the use of resources (e.g., spending money, accepting
work, management, and ownership/landlord functions).
At best, outsourcing has some potential cautions. Exhibit 3-8 lists notable
advantages and disadvantages.
Advantages Disadvantages
• Can save FM administration and • May cost more to go outside for specific
management time expertise
• Increases FM ability to focus on core and • Potential loss of control
strategic revenue-generating activities • Potential for poor staff morale
• Provides flexibility (by allowing staff to • May necessitate a learning curve by the outside
complete other projects) organization
• Can improve efficiency and effectiveness • Managing the relationship may require different
(by gaining access to staff and skill sets) supervisory skills than used for internal staffing
• Can reduce operational expenses (extends and a change management approach with
staff capabilities without incurring fixed customers, staff and management
staffing/benefit costs) • Potential for privacy and confidentiality issues
• May lead to sharing of savings with the
outsourced firms on a risk/shared reward
basis
• May improve the quality and/or timeliness
of FM services
• May provide FM staff hired by the
outsource company with training and career
paths that would not be available in the FM
department
• May provide specialized FM services or
best practices that the FM department
cannot provide or would not have the
financial resources to provide
It is also important to realize that some national laws and regulations and
standards and legal conventions set forth by international organizations such
as the International Labour Organization, the Organisation for Economic Co-
operation and Development, and the European Union have implications for
outsourcing.
Setting the Facility managers have responsibility for developing, managing and
stage for overseeing contracts. But even before reaching the point of contract, the
outsourcing facility manager needs to spend up-front time on properly defining the
outsourcing objectives and requirements and the quality needed to meet those
requirements. To do so helps to mitigate problems in the procurement process
and performance execution of the contract terms.
This often involves having secured approval from senior management and
working with procurement personnel and possibly legal counsel in the
organization. To be prepared to do so, a facility manager should have invested
due diligence regarding items such as (but not limited to):
• Definition of objectives and key attributes of services required (including
description of the current arrangement and identification of stakeholders).
• Adequate documentation of direct and indirect costs for in-house delivery
and outsourced services to facilitate comparison and decision based on
best value.
• Identification of special demands (uniqueness) of the service.
• Identification of high-priority services (and risk assessment of these areas
so the consequence of failures is documented and the speed of response
can be planned).
4. A facility manager is working with the procurement officer to secure a new provider for janitorial
services. At what point in the procurement process should a service level agreement be drafted?
( ) a. While FM prepares the procurement request
( ) b. At the time the contract is drafted
( ) c. While the bid is out for solicitation
( ) d. After contract award but before a PO is assigned
5. The award selection criteria appropriate for reorders, routine and well-defined user requirements is
( ) a. lowest responsive bid.
( ) b. evaluated/best value for money bid.
( ) c. unique service.
( ) d. standard bid.
6. Facility management decides to outsource administrative services. Which of the following potential
advantages is the organization most likely to realize?
( ) a. Greater flexibility, because the vendor will be able to customize employee benefits
( ) b. Improved staff morale by gaining outside expertise
( ) c. More technically competent level of service
( ) d. Greater leverage to secure employee benefits at reduced costs
Contracts are one of the primary vehicles through which organizations identify
and define opportunities for products or services procured from external
providers. In a complex, globally networked world, many believe that the quality
of contract management has become a key indicator of an organization’s
performance and integrity. Ideally, the contracting process provides a framework
for regulatory compliance, reputational risk management and effective change
control as well as offering a source for added value and innovation. Added value
has the potential to go much further than simple price cuts or cost reduction to
drive measures such as improving the safety and reliability performance of
contractors or ensuring continuous upgrading of speed and quality of services.
A contract defines the basis of understanding for the delivery of goods, services
or construction efforts between the owner and the contractor or consultant. This
is true in facility management—no matter whether for planned services (e.g.,
preventive maintenance, planned replacement/refurbishment maintenance,
planned minor works), unplanned services (e.g., breakdown maintenance,
Facility managers must address many contract issues to ensure that their
organization receives the right quality, in the right quantity, on time, with the
right services, at the right price. Thus, we begin this chapter on contracts with an
overview of fundamental contract elements. Customary types of contracts and
terms found in FM contracts are discussed. The topic concludes with a
discussion of fraud and irregularities in contracts.
Contract A contract is a legal device used by two or more persons to indicate they have
fundamentals reached an agreement. It implies a meeting of the minds, with terms and
conditions that describe the agreement and constitute a legal obligation. To be
deemed valid, a contract typically requires the following elements.
• Consideration. Once the parties have had a meeting of the minds, they
must each exchange something of value in order to create a contract. While
consideration can take many forms, customary exchanges are cash, goods
or a promise to do something (e.g., the price paid by one side and the goods
supplied by the other). The Latin term quid pro quo (meaning “something
for something”) is sometimes used to refer to contract consideration.
• Competent parties. This element means that the person who signs the
contract must have the legal authority to sign on behalf of an organization
or another person. Also, the parties involved must have the capacity to
understand the terms of the contract. For example, minors cannot enter into
contracts without the additional signature of their parents or guardians.
Individuals considered to be lacking sound mind (e.g., mentally
handicapped or impaired by the use of drugs or alcohol) usually cannot
enter into contracts.
Contracts are legal documents developed with the direct or indirect review
and input of lawyers/solicitors. Even simple contracts have legal jargon.
The content that follows won’t make you an expert in contract “legalese,”
but the fundamentals presented should enable you to achieve far better
negotiated results on behalf of FM and help in contract administration and
management.
When the intent is solely to negotiate the issues through e-mail leading to a
formal written and signed contract, that should be clearly stated in the e-mail
correspondence. During contract negotiations, “subject to contract” wording
should be included in any document exchanged by parties (e-mails or hard
copy). The expression “without prejudice” is often used when “subject to
contract” is meant; it denotes that the document is not an offer or acceptance
and negotiations are ongoing.
Types of Facility managers may be involved with the administration, management and
contracting oversight of contracts in many different areas. Contracts may be performance-
mechanisms based or prescriptive.
Individual contract terms will be covered in more detail later, but general and
special conditions merit further explanation here.
• Special conditions. As the name implies, these terms and conditions relate
to a specific procurement. They define items such as working hours,
security requirements, special access, safety rules and so forth. Purchasing
drafts special conditions based on requirements defined by FM. In simple
contracts, special conditions may be incorporated directly in the contract.
For complex procurements, special conditions may be put in a
performance work statement.
Purchase orders A purchase order (PO) is a written contract between an organization and a
vendor using a preprinted standard form. One-time purchase orders and
blanket purchase orders are common practice in FM.
Fixed price A fixed price contract (also called a fixed sum or lump sum contract)
contracts requires a contractor to successfully perform the contract and deliver
supplies or services for a price agreed to up-front. A firm fixed price
contract is appropriate for supplies and services that can be described in
sufficient detail to ensure that both parties completely understand the
contract requirements and the inherent risks associated with performing the
contract as written.
Indefinite delivery Indefinite delivery quantity, line item contracting (known as IDQLI) is one
quantity, line item way to deliver certain FM services and also significantly reduce procurement
contracting
time. They are actually very similar to BPOs except that the IDQLI is more
often for services and the BPO is typically for goods.
Typical IDQLI contracts can cover such typical and atypical FM services as:
• Painting and plastering.
• Floor covering.
• Systems furniture disassembly, relocation and reassembly.
• Furniture repair and cleaning.
• Interior electrical work.
• Plumbing.
• Carpentry.
• Paving (concrete and asphalt).
• Roofing repair and replacement (all types).
• Fencing.
• Railroad track repair and replacement.
The most essential element of the IDQLI contract is the line item menu of FM
goods and services to be provided. Very specific component tasks that are
normally required to complete common, trade-oriented work requests are
listed individually. Each of these line item tasks is then unit-costed according
to an accepted measure of quantity such as:
• Dollars per linear foot (conduit, wire, etc.).
• Dollars per square foot (painting, floor covering, etc.).
• Dollars per item (receptacle, valve, etc.).
• Dollars per service (clean restroom, assemble workstation, etc.).
Whenever possible, the line item cost is a complete cost. It includes labor,
material, overhead, profit and so forth. Execution delivery times and required
quantities for these line item tasks remain indefinite or on call. They are
contracted for by purchase order on an as-needed basis only and at the
discretion of the facility manager. Only the overall IDQLI base contract itself
has a specific start and expiration date.
A key thing to understand about the IDQLI contract system is that it is more
than just a contract document. In administering IDQLI contracts, the FM
function acts as a general contractor to execute single trade tasks or to
National buy National buy contracts are specialized procurement contracts, primarily
contracts applicable to large organizations. They may also be called national
purchasing contracts, or they may be referred to as framework contracting.
Additional contract There are still other types of contracts, such as the following:
types • Open book contract— the cost of the delivery is passed on in the price,
with a profit margin (percentage) agreed on top.
• Labor hour/time and materials—pay for services rendered at fixed rates
and for materials at cost plus a handling fee.
Contract terms Notwithstanding legal constraints that make a contract valid, the form and
substance of an FM contract will vary. Exhibit 4-1 provides a checklist of
customary terms found in FM contracts. Not all of these provisions will be
included in every contract, and some contracts will have additional inclusions
that relate specifically to the particular subject matter. A facility manager must
review all terms of a contract, understand what they mean, and be able to
execute the various terms.
Exhibit 4-1: Checklist of Facility Management Contract Terms (continued on next page)
When reviewing contracts to ensure that they are complete and clear and
comply with legal requirements, some commonsense principles also apply. In
Exhibit 4-2, a simple list of contract do’s and don’ts is shown.
Do: Don’t:
• Entitle the document “Contract” so that there • Include legalese or archaic phrases such as
can be no mistake as to its intent. “the party of the first part” or “heretofore” as
• Include the date in the first paragraph for easy they generally add little in terms of clarity.
reference after contract execution (e.g., so the • Include overly long sentences; break
contract can later be identified by date, such sentences down into easily digestible
as “the January 4, 20XX, Contract for thoughts.
Property Snow Removal.” • Be repetitive unless it is absolutely necessary.
• Make sure the parties are properly identified (It is preferable to refer to a previous provision
in the first paragraph, names are spelled according to its number or heading rather
correctly and addresses are accurate. than to repeat it verbatim.)
• Use commonsense headings to make it • Assume the other party defines terms the
easier to find particular contract provisions. same way. If there is any doubt, include a
• Number the paragraphs for ease of reference. definition in the contract.
• Pay attention to punctuation and conjunctions • Accept the other party’s oral explanation of a
(especially “and” and “or”) since grammar confusing term; include everything in writing.
errors and words chosen can change • Start acting according to the terms of the
meaning. contract until both parties have executed it.
• Use plain language whenever possible. • Assume that use of a standard or form
• Make sure the contract addresses all possible contract eliminates the need for legal review.
contingencies and that nothing is left to Even if a standard contract worked well in the
chance. past, a change of circumstances, date or
• Have an attorney review every contract before party can change the whole equation.
signing. • Agree to a contract modification without
• Sign in blue or other colored ink to make the documenting it in writing.
original easily distinguishable from • Rush reading the contract. It takes time to
photocopies. understand all of the possible nuances of the
• Initial every page of the contract and make language used.
sure the other party does the same so that • Sign any contract unless you understand what
nothing is missed it aims to do and what the terminology means.
• Retain a copy of the contract for your records. Clarify any questions with legal counsel.
The procurement manager for an organization solicited and received bids for
an extensive FM renovation project. Although qualified contractors were
required to submit bids by a specified date and time, there was no formal bid
opening process. Instead, the procurement manager received all bids and
opened them in his office. He then called his friend at XYZ Construction and
disclosed the bids. Based on this information, XYZ submitted the lowest bid
and was awarded the contract. Some time later, it was learned that XYZ
Construction performed construction work at the manager’s home in return
for the renovation contract.
Types of contract Fraud as it relates to contracts can take many forms. The primary ones are
fraud described below.
Price fixing
Price fixing in contracting describes an agreement among competitors to raise,
fix or otherwise maintain the prices at a specified level. It is not necessary that
the competitors agree to charge exactly the same price.
Price fixing can take many forms such as (but not limited to):
• Establishing or adhering to price discounts.
• Holding prices firm.
• Eliminating or reducing discounts.
• Adopting a standard formula for computing prices.
• Maintaining certain price differentials between different types, sizes or
quantities of products.
• Adhering to a minimum fee or price schedule.
• Fixing credit terms.
• Not advertising prices.
If you believe that price fixing is taking place between your bidders or
suppliers, you should consider contacting your legal department to ask for
direction. Also, you might want to include this and related topics as part of your
regular ethics training for FM staff.
Bid rigging (like price fixing) also takes many forms, but bid rigging
conspiracies usually fall into one or more of the following categories.
• Bid rotation. In bid rotation, all conspirators submit bids but take
turns being the low bidder. The terms of the rotation may vary; for
example, competitors may take turns on contracts according to the size
of the contract, allocating equal amounts to each conspirator or
allocating volumes that correspond to the size of each conspirator
company.
Almost all forms of bid rigging schemes have one thing in common: an
agreement among some or all of the bidders that predetermines the winning
bidder and limits or eliminates competition among the conspiring vendors. The
goal is to win a contract and share in the award.
Cartels
A cartel is a formal (explicit) agreement among suppliers, producers or
other organizations that agree to coordinate prices and/or production.
Cartels are typically found in markets that are dominated by a small number
of sellers and usually involve homogeneous products. Cartel activities may
include price fixing, allocation of customers, allocation of territories,
reducing competition, bid rigging and more. Some trade organizations,
especially in industries dominated by only a few major players, may serve
as fronts for cartels. In some countries, labor unions have been labeled a
form of cartels, as they seek to raise the price of labor (wages) by
preventing competition.
Principles of In Total Facilities Management, authors Brian Atkin and Adrian Brooks offer
contract fraud the following succinct points about fraud and control:
control
• Fraud should be deterred.
• Prevention is preferable to detection.
• Strong preventive controls should be applied.
Segregation of duties
Segregation of duties (or separation of duties) means that no single person has
sole responsibility over the procurement process and award and execution of
a contract. As feasible, the contracting process should not be handled by one
person from start to finish.
Example: One individual would order the work; another person would
be responsible for the certification and authorization of payments.
Proper authorization
Before any transaction or specific activity is undertaken, it should be approved
by the appropriate manager or responsible person. Limits are often set as to
what a person can approve. Authorization helps to ensure that proper
responsibility is taken for all activities and transactions and that delegated
limits are complied with.
Competitive bidding/tendering
Contracts should normally be awarded through a competitive process.
Budgetary controls
Budgets should be aligned to organizational strategies and objectives to help
ensure that expenditures are warranted. Costs must be monitored on a regular
basis appropriate to the contract. It is imperative to quickly discover whether
costs will exceed budget projections.
Fraud indicators Facility managers should be able to recognize fraud indicators in the
bidding/tendering process and the award of contracts. They are signs that
indicate both the inadequacy of controls in place to deter fraud and the
possibility that some perpetrator has already overcome these weak or absent
controls to commit fraud. Such indicators are often referred to as red flags.
Examples: Bids that come in well above the estimate may indicate
collusion, or they may simply be an incorrect estimate. Also, a bidder
can lawfully submit an intentionally high bid that it does not think will
be successful for its own business reasons (such as being too busy
to handle the work but wanting to stay on the bidders’ list).
Fraud can occur in almost any contracting situation, but it is more likely to
occur in some scenarios than in others.
• Few providers. The fewer the contractors, the easier it is for them to
get together and agree on prices, bids and the like.
Ideally, a facility manager is involved with the bidding process and has
firsthand knowledge of the contract terms. In situations where the facility
manager was not involved from the outset, he or she should begin by
reading the contract to become familiar with all terms. In this situation, it
may be appropriate to review with purchasing any major issues that took
place during the procurement and negotiation process of the contract award.
This collaboration with purchasing will help in understanding the tone of
the relationship and the requirements for the completion of a successful
contract.
Contract The specific nature and extent of contract administration varies from contract
monitoring to contract, as does a facility manager’s involvement. It can range from the
simple acceptance of a delivery and payment to the contractor to extensive
involvement throughout the contract term.
Contract performance monitoring and contract cost monitoring are the two
areas for which a facility manager typically has some level of responsibility.
Collectively, implementation and monitoring activities in these areas cost-
effectively measure the contractor’s performance and provide documentation
to pay accordingly.
Possibilities include:
• FM reports.
• Performance score sheets.
• Vendor scorecards.
Use of service A facility manager has management and oversight responsibilities for services
specifications and provided to tenants. (This, of course, is true whether the service is outsourced
service level
or performed by internal FM staff.) All services must be fulfilled according to
agreements in
performance expected performance and time standards. The inclusion of service
monitoring specifications and service level agreements in a service contract or as an
addendum are extremely helpful in contract administration.
Example: Ensure that rubbish containers and recycle bins are emptied
regularly before they are full and contents are deposited in the
appropriate disposal dumpsters. The containers and bins should be
kept clean so they do not pose a health concern or result in tenant
dissatisfaction.
Exhibit 4-4 illustrates the contents for a service specification for a work
management center.
Provide a help desk service using the CAFM system to coordinate and manage all fault reports and provide a primary
source of management information.
The help desk will operate on a full 24/7 basis so as to provide emergency response for critical infrastructure. It will:
• Provide a single point of contact for the reporting of building and equipment faults, service problems and
requests, and incidents requiring a response.
• Assess priorities and issue work orders or purchase orders to resolve the problem in line with the time scales set
out for those priorities.
• Track work progress and completion.
• Manage and report on work completion and exceptions.
• Provide information on cost center charging for all internally chargeable services, including business card
production, archiving, catering requests, equipment hire and so on.
• Provide backup systems to operate the service in the event of any failure of IT or power in the building.
• Maintain records and report on help desk activities in line with best practice.
• Maintain a log of customer complaints, special requests and instructions. Items recorded in this log will be dealt
with in line with published processes.
• Provide a mechanism to receive and take action on fault reports in the event of software, telephone or other
system failure.
Priorities
The contractor will assess each request for breakdown or incident response service and categorize and manage it on
the following basis:
Response Time
Priority Classification Condition
(During Normal Working Hours)
1A Emergency (high Failures or conditions of installation that Investigate and make safe or
priority) constitute an immediate danger to people compliant within 4 hours,
or risk immediate operational failure in OR, if not remediable in 4 hours,
Sites with no critical systems or that threaten the invoke business continuity planning
resident client staff integrity of security. response to minimize impact.
1B Emergency (high Failures or conditions of installation that Investigate within 1 hour and make
priority) constitute an immediate danger to people safe or compliant within 2 hours,
or risk immediate operational failure in OR, if not remediable in 2 hours,
Sites with resident critical systems or that threaten the invoke business continuity planning
client staff only integrity of security. response to minimize impact.
2 Urgent Failures or conditions of installation that Investigate within 4 hours and make
constitute a potential danger to people or compliant within one working day.
risk negative operational impact or that
weaken the integrity of security.
3 Routine Failure or conditions that affect the Investigate within 1 working day and
amenity but do not pose a risk to people, make compliant within 7 working days.
operations or security.
4 Service visit/no call- Any reactive work that can be deferred Investigate within 28 days and/or notify
out required until the next scheduled service visit by a maintenance supplier to rectify at next
supplier. scheduled visit.
5 Parts order Work required to develop services or Assess request within 7 working days
or improve cost-effectiveness for which a and provide parts or quotation within
request for preliminary quotation is required to 28 working days thereafter.
quotation ensure that a cost-benefit case is
supported.
Exclusions
Only if the system is based in the client’s premises, the contractor is not required to provide:
• Computer hardware.
• Telephones or telephone lines.
• Call management software.
• Telephone software.
• Any service outside the current specified hours.
Exhibit 4-5: Example of KPIs for a CAFM System and Work Management Center
** Frequency key:
A = Annual
Q = Quarterly
M = Monthly
The key in SLAs is to define the level of service that the provider should
deliver. SLAs also specify incentives and financial penalties. Once
defined, the levels can serve as benchmarks across multiple locations.
They may also be used to compare service delivery between an in-house
department and an external service provider.
The service contract may involve the right to terminate if SLAs are
consistently missed. Termination is normally only against specific failures
to achieve the agreed target KPIs (which is implied by the inclusion of the
word “key” in “key performance indicators”). But SLAs should also retain
flexibility to accommodate changes in customer requirements. In
outsourcing, they are often utilized as one of the primary tools for contract
governance.
Once service specifications and SLAs are in place and operational, a facility
manager’s responsibilities may include (but are not limited to):
• Serving as the point of contact for problems or concerns.
• Coordinating and implementing modifications.
Contract cost Cost monitoring goes along with performance monitoring. Monitoring of
monitoring contract expenditures includes activities such as (but not limited to):
• Ensuring that there are sufficient funds to pay for all services rendered as
required by contract.
• Ensuring that invoices are paid consistent with the most favorable
contract payment terms.
• Identifying low spending levels and reassignment of funds, if appropriate.
• Ensuring that vendor payments are commensurate with the level of goods
and services received.
• Reviewing vendor invoices and following the organizational and
departmental standard procedures for processing vendor payments.
Frequency of Contract work is checked and monitored frequently enough to confirm that
performance and the conditions of contract are satisfied and actual costs are tracked. Activity
cost monitoring
levels are dictated by terms of the commitments and responsibilities as laid
out within the contract agreement. The driving factors in frequency are the
complexity and value of the contract.
* 0 = Below expectation
1 = Meets expectation
2 = Exceeds expectation
The overall score found in the Exhibit 4-6 performance scorecard could be
used in conjunction with a performance payment scale to reward the service
provider for scores that exceed expectations. Conversely, low scores might be
tied to penalties for not meeting minimum requirements. It should be clear as
to what triggers any adverse actions.
Closeout Checklist
Contract: Elevator Maintenance
Recipient: ABC Elevator Repair
Performance period: January 1, 20XX, to December 31, 20XX
This topic first explores the basic elements of risk management—how to assess
the likelihood that potential financial risks and other risk exposures have been
identified. As we will see, applying a systematic risk management approach
can help to identify and prioritize financial contract risks while improving the
collaboration between the organization and contractors. We then look at several
types of procurement contract management risks a facility manager should
understand.
Risk To a certain degree, every facility manager is a risk manager, whether they
management know it or not. They manage risks every day. But they become better risk
managers when they do it consciously, in a disciplined and consistent way.
Further, risk does not present a single point estimate; it represents a range of
possibilities. Without a single outcome, the range is what creates uncertainty
when understanding and evaluating risk. Risk may relate to preventing bad
things from happening or failing to ensure that good things happen. Risks may
present threats to an organization or be the failure to achieve positive outcomes.
Risk identification Risk identification answers the question, “What are the contract risks?” The
objective of risk identification is to search for and capture those risks that, if
they occurred, could threaten the business or specific projects, or simply
where uncertainty of outcome exists.
Risk categorization Categorization groups the identified FM contract risks into categories such as
(but not limited to):
• Scope of services and nature of work.
• Subcontracting.
• Geography and vendor delivery capability.
• Pricing and costing options.
• Contract duration and renewal options.
• Service and resource flexibility.
• Vendor company failure.
• Service failure.
• Reputational risk.
• Change and transition.
Risk assessment Risk assessment (or risk analysis) is the identification and measurement of
risk and the process of prioritizing it.
Risk events are rated in terms of the likelihood and impact using:
• Qualitative terms—continuums such as high to low or almost certain to
improbable and catastrophic to negligible.
• Quantitative measures such as numerical scales of 1 to 5, percentages,
frequency of occurrence or other metrics.
Low
Likelihood High
Variations of the risk rating scales or the risk map are possible. Format
and specific terminology are not as important as developing an effective
risk assessment to evaluate risk events pertaining to contracts.
Risk response Once risks are identified and prioritized, the next step is to consider the best
response to manage the risk. Risk response (sometimes called risk
mitigation) refers to the measures taken to avoid or reduce the impact of a
risk or to control the effects of a risk.
Risks in facility Next we revisit the list of risks customarily associated with FM contracts. In
management an outsourcing relationship, a facility manager must understand the nature of
contracts the contract risks in order to ensure that the vendor relationship is successful.
Scope of services Whether a contract is for a single service or full service, the scope of services
and nature of work and nature of work must be well-defined at the outset. These terms and
conditions specify what the contractor will do, by when and for how much.
The terms and conditions should also specify the measures and indicators to
be used to monitor the contractor’s performance. Contractors should have
sufficient time and information to assimilate the detail in the bid phase.
Subcontracting Some service providers may contract with third parties. FM can benefit from
the specialization of subcontractors, but there are risks associated with
subcontracting when services are distributed among parties with whom FM
has no direct relationship.
The fundamental objective is to hold the primary service provider to the same
standard regardless of who performs the work. Therefore, the primary service
provider contract should require their subcontractors to meet the same
obligations they are required to meet. Some of this risk may be mitigated by
requiring the contractor and any subcontractor to have quality assurance or
quality management systems in place.
Geography and In all locations, competent and reliable vendors must be found. A
vendor delivery contractor is expected to provide services or complete the work with
capability
certain operator/own/industry performance targets. If performance targets
are not achieved, customer dissatisfaction and other ramifications follow.
Pricing and costing When an organization procures services from a contractor, the type of
options contract and the basis for payment influence the allocation of risks. Recall the
two broad categories of fixed price contracts, which are for items or tasks
that can be defined fully, and cost-reimbursement contracts, which are for
those that cannot.
In Exhibit 4-11 we see a graphic representation of contract types and the risks
associated with pricing and costing options.
High risk
Contractor Client
risk organization
risk
Contract Risks
(Technical and
Other
Performance
Uncertainties)
Low risk
Ideally, the contract type and price (or estimated cost and fee) results in
reasonable contractor risk and provides the contractor with the greatest
incentive for efficient and economical performance.
Contract duration This type of contract risk involves understanding specifics about the contract
and renewal options term—whether it has a specific end date and termination, automatic renewal
provisions, or continuance contingent on performance (as evaluated by the
client organization). Many risk considerations are a part of contract duration,
such as vendor learning curves, capital investments and amortization.
Example: A vendor contract may have a statement that the contract will be
automatically renewed if the facility manager does not notify the vendor
within a specific time frame before the initial contract termination date. A
contract may add an automatic increase percentage to the cost of products
or services at the automatic renewal of the contract—again, unless
stopped by the facility manager per the contract requirements. A facility
manager should not agree to automatic renewals unless he or she sees a
specific benefit to the organization.
Service and Regarding the product or service provided, FM needs to consider what things
resource flexibility might change during contract duration. Are there foreseeable external events
that may warrant additional people on standby? Will there be extra associated
costs? Can there be substitutions in labor categories? (Or do labor regulations
prohibit substitutions?)
Examples: Types of things that might impact service needs can be either
short-term (flooding or other emergency; sudden changes in production
patterns to meet additional demands) or longer-term (an extended
economic recession). Or they may be structural to the client organization
(a merger with another company or the addition of operational capacity
by adding premises). Effective FM contracts deal with these
contingencies by having clear pricing structures that balance fairness for
both buyer and vendor, with the ability to predict and model price
changes based on the changed circumstances.
Vendor company If contractors have consistently low or negative profit margins and/or
failure accumulated losses, the result is a viability-threatening situation.
Service failure Minor mistakes or problems can (and do) happen in service execution. For
example, an individual piece of equipment (e.g., a single printer or desktop
computer) may break down. These do not necessarily constitute a service
failure. However, the consistent inability to manage a contract, repeated poor
performance versus the contractual intent, or an entire service becoming
unavailable (e.g., the entire printing service, Internet access and e-mail) are
service failures that pose potential serious risks.
Vendors should have a process with defined goals for response to service
failures. Contingency plans should be in place. For some situations, an
organization may need business continuity insurance.
Reputational risk Bad press and a tarnished organizational image can result from
inappropriate vendor actions and noncompliance or from sourcing and
contracting failures. There are many reputation risks such as (but not
limited to):
• Discrimination against minorities.
• Unequal treatment of men and women.
• Violations of a drug-free workplace policy.
• Noncompliance with immigration laws.
• Occupational health and safety violations and/or inappropriate
corrective actions.
Change and Contracts should have an appropriate mobilization process. There should be
transition provisions for the transfer of assets at the contract start and end as well as
mechanisms for dispute resolution and arrangements for transition to a
succeeding contractor at the end of the contract.
Importance of The establishment of any contract creates a range of issues and potential risks
examining that need to be managed. A facility manager needs to review contracts to
financial understand the conditions, what potential risks exist, and how much risk the
contract organization can accept.
elements
When facility managers analyze and interpret financial contract elements
(lease agreements, service contracts, cost statements and so forth), it allows:
• The terms of the agreements to be clearly understood in reference to their
financial, risk and security implications.
• An understanding of the controllable and variable items in the contract to
aid cost and resource flexibility.
• Identification and prevention of situations or requests that violate the
terms of the agreement.
• Identification and improved control over (or avoidance of) situations or
requests that may impact the budget through increased costs due to
unplanned time, usage or additional services.
• Appropriate review of situations or requests that may reduce costs to
determine that all contracted services have been met satisfactorily and
that a reduction in billed services is appropriate.
There is great potential for many mutual benefits through systematic risk
management. Among the possibilities are:
• Reduced contract risks.
• Increased revenues.
• Reduced costs and fewer cost overruns.
• Improved contract performance.
• Improved compliance.
• Strong communication and trust between all parties.
Constructive and Conflict is an inevitable part of interactions with vendors. Resolving conflict
dysfunctional is seldom easy. But the way conflict is handled is what distinguishes between
conflict with
constructive experiences and dysfunctional ones for both parties.
vendors
Arbitration is less formal than a court trial. The hearing is private. Few
awards are reviewed by the courts because the parties have agreed to be
bound by the decision of their arbitrator. In some cases, it is prearranged that
the award will be only advisory.
An additional caveat about the dispute resolution clause in the contract deals
with the selection of the mediator and arbitrator. Many think that there is a
definite advantage to have a mediator or arbitrator who has extensive experience
in the particular field. As an example, if the dispute is of a specialized nature
such as green building/remodeling, it would be wise to have a mediator or
arbitrator who has experience in the construction industry and sustainability.
As they are shown here, the types are self-explanatory. What is drafted in the
actual clause is key. In the United States and many other countries, when
parties agree to an ADR process to settle all disputes they give up their right
to a trial by a judge or jury. All contract dispute clauses generally include
verbiage acknowledging that the parties are knowingly forfeiting their right to
use the court system.
Example: Mindful of the high cost of litigation, not only in dollars but
also in time and energy, the parties intend to and do hereby establish
the following out-of-court alternate dispute resolution procedure to be
followed in the event any controversy or dispute should arise out of or
relating to this contract or relating to any change orders or other
changes or addendums to this contract.
This verbiage should not be construed as legal advice. It is shown here merely
as an example. Given the significance of including a statement like this in a
contract, organizational legal counsel should always review and approve a
dispute resolution clause before a contract is signed.
Dispute resolution provides the potential for a simpler, more expeditious, and
less expensive process than litigation through the court system. Well
executed, it has the potential to yield a more fair and equitable decision or
award than would be rendered through litigation.
4. A contract where both parties promise to do something—one promise is given in exchange for
another—is described as
( ) a. open book.
( ) b. bilateral.
( ) c. fixed.
( ) d. unilateral.
5. Which of the following items would not be part of the general condition clauses in a construction
contract?
( ) a. Change orders
( ) b. Specifications control over drywall drawings
( ) c. Terms of progress payments
( ) d. Alternate dispute resolution mechanisms
6. Which type of contract would be used for frequently required trade tasks and not one-time annual
services?
( ) a. Prescriptive contract
( ) b. Unique service award
( ) c. IDQLI contract
( ) d. Evaluated bid award
7. A labor strike has disrupted a construction project. Which contract provision suspends or excuses a
contract party’s performance?
( ) a. Novation clause
( ) b. Terms for incentives and penalties
( ) c. Indemnification agreement
( ) d. Force majeure clause
8. A facility manager is assessing a contractor’s performance for an elevator maintenance contract. All
of the following would be valid performance evaluation criteria except
( ) a. car speed.
( ) b. receipt of an industry award.
( ) c. service level expectations.
( ) d. door operation.
9. True or false? Service level agreements reflect expectations for the quality, performance and value of
service; service specifications reflect standards of service required.
( ) a. True
( ) b. False
11. Binding mediation a. Any dispute over $10,000 but less than $50,000 in
value shall be subject to mediation followed by
12. Arbitration binding arbitration.
13. Graduated processes b. A binding award is rendered upon the parties that is
enforceable in any court of competent jurisdiction.
c. This final resolution process will allows the parties to
work together with the assistance of a trained
facilitator.
The following resources were used during the development of the Finance and Business course.
Anderson, D. Brent, Jeffrey L. Campbell, Carol E. Farren, Christopher P. Hodges, Jon Hosford,
Scott Hulick, Diane H. MacKnight, Jon Martens, Anne M. Moser, and James P. Whittaker.
The Business of FM. Houston, Texas: International Facility Management Association
(IFMA), 2006.
Ansari, Shahid, and Carol Lawrence. Cost Measurement Systems: Traditional and
Contemporary Approaches. New York: Irwin/McGraw Hill, 1999.
Anthony, Robert N., and Vijay Govindarajan. Management Control Systems, 11th edition. New
York: Irwin/McGraw Hill, 2004.
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Definitions,” www.ifma.org/know-base/fm-knowledge-base/knowledge-base-details/asset-
lifecycle-model-for-total-cost-of-ownership-management.
Atkin, Brian, and Adrian Brooks. Total Facilities Management, 3rd edition. Chichester, United
Kingdom: Wiley-Blackwell, 2009.
Barringer, H. Paul. “A Life Cycle Cost Summary,” Barringer & Associates, Inc., 2003,
www.barringer1.com/pdf/LifeCycleCostSummary.pdf.
Blocher, Edward J., Kung H. Chen, and Thomas W. Lin. Cost Management: A Strategic
Emphasis, 2nd edition. New York: Irwin/McGraw Hill, 2002.
Clayton, John. “Crafting a Powerful Executive Summary.” Harvard Business School Working
Knowledge, hbswk.hbs.edu/archive/3660.html.
Cotts, David, and Edmond P. Rondeau. The Facility Manager’s Guide to Finance and
Budgeting. New York: AMACOM, 2003.
Cotts, David G., Kathy O. Roper, and Richard P. Payant. Facility Management Handbook, 3rd
edition. New York: AMACOM, 2010.
Epstein, Shari F. Benchmarks V, Annual Facility Costs—Research Report #30. Houston, Texas:
International Facility Management Association (IFMA), 2008.
Fuller, Sieglinde. “Life-Cycle Cost Analysis (LCCA),” National Institute of Standards and
Technology (NIST), www.wbdg.org/resources/lcca.php.
Garrison, Ray H., and Eric W. Noreen. Managerial Accounting, 10th edition. Boston: McGraw
Hill/Irwin, 2003.
Harvard Business Essentials. Finance for Managers. Boston, Massachusetts: Harvard Business
School Press, 2002.
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Upper Saddle River, New Jersey: Pearson Prentice Hall, 2006.
Kieso, Donald E., Jerry J. Weygandt, and Terry D. Warfield. Intermediate Accounting, 10th
edition. New York: Wiley, 2001.
Martin, David M. The A–Z of Facilities and Property Management. London: Thorogood
Publishing, 2006.
McWatters, Cheryl S., Dale C. Morse, and Jerold L. Zimmerman. Management Accounting:
Analysis and Interpretation. Boston: McGraw-Hill Irwin, 2001.
Melaver, Martin, and Phyllis Mueller, editors. The Green Building Bottom Line: The Real Cost
of Sustainable Building. New York: McGraw Hill, 2009.
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Business Decisions. Mason, Ohio: Thomson/South-Western, 2006.
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edition. Hoboken: New Jersey: John Wiley and Sons, 2006.
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A benchmarking
and business case, 89
ABC. See activity-based costing
state/cross-border, 57–58
accelerated depreciation, 76
benefits/costs, quantifying in business case, 86–97
accounting, 5, 10
benchmarking, 89
accrual basis, 5, 56
best value, 87
cash basis, 56
capital investments, 90, 93–97
cycle, 26–28
life-cycle costing (LCC), 87–89
double-entry, 6, 23–26
time value of money, 90–93
financial, 7, 11–12
best value, 87
goals of accounting system, 10
bid
management, 8, 11–14
rigging, 166–167
principles for financial statements, 29–30
rotation, 167
records, 17–23
suppression, 166
standards, 14–17
bidding
accounts, chart of, 5, 17–21
competitive, 169
accounts payable journal, 22
complementary, 167
accrual basis accounting, 5, 56
bilateral contracts, 155
accumulation, cost, 109
blanket purchase orders, 157–158
acid-test ratio, 119–120, 124
BPOs (blanket purchase orders), 157–158
activity method of depreciation, 76
budgetary controls, and fraud/irregularities in
activity-based budgeting, 51
contracts, 170
activity-based costing, 109–110, 113–115
budgeting, 33, 34–37
advantages/disadvantages, 115
activity-based, 51
allocation, 114
and facility management, 51–53
apportionment, 115
fixed, 48
ADR (alternative dispute resolution), 199–202
incremental, 7, 49
agreement to enter into contract, 155
multinational considerations, 56–58
allocation
state/cross-border, 57–58
in activity-based costing, 114
variable, 48
base, 106
zero-based, 9, 50–51
cost, 109
budget(s), 5, 33–34, 35
alternative dispute resolution, 199–202
analysis, 53–55
annual budget analysis, 54
approaches, 37–40
annual work plan, 41–43
assumptions, 39–40
apportionment, in activity-based costing, 115
capital, 5, 45–46
arbitration, 200, 201
closeout, 55–56
asset management ratios, 120, 124
expense projections, 47
assets, 5
methods, 49–51
in balance sheet, 66
monitoring, 53–55
capital, 5, 45, 78–79
operating, 8, 40–44
in chart of accounts, 17–18
periods, 48–49
assignment, cost, 109
revenue projections, 47
audited financial statements, 61–62
types of, 40–46
authoritative budget approach, 38
business, 3
average inventory turnover, 120, 124
business cases, 83–84
AWP (annual work plan), 41–43
components of, 84–86
costs/benefits, quantifying, 86–97
B sample, 99–103
balance sheet, 5, 62, 63, 66–70, 79
balance, trial, 9, 27, 28
C contract(s) (continued)
duration, 194
capital assets, 5, 45, 78–79
and e-mail, 156
capital budget, 5, 45–46
examining elements of, 197–198
capital expenditures, 45, 90
express, 155
capital investments, 90, 93–97
fixed price, 158–159
and capital rationing, 94
fraud in, 165–172
and cash flow, 93
IDQLI (indefinite delivery quantity, line item),
independent vs. mutually exclusive, 93
159–161
and risk, 94, 97–99
implied, 155
capital projects, and due diligence, 46
indefinite delivery quantity, line item, 159–161
capital rationing, 94
informal, 156
capitalization vs. expense, 77–78
irregularities in, 165–172
cartels, 168
mechanisms, 156–161
cash basis accounting, 56
monitoring, 173–185
cash disbursement journal, 21
mutual agreement, 154
cash flow(s), 5
mutual right to remedy, 155
and capital investments, 93
national buy, 161
forecasting, 80–81
performance monitoring, 174–183
statement of, 9, 62, 63, 70–72, 79
prescriptive, 156
cash receipts journal, 21
proper subject matter, 154
CEN (European Committee for Standardization), 57–
purchase orders, 157–158
58
renewal options, 194
change and transition, in facility management
risk management, 187–198
contracts, 195–197
service, 175
change order controls, and fraud/irregularities in
service level agreements, 175, 181–183
contracts, 169–170
service specifications, 175, 176–180, 182–183
chargebacks, 129
terms, 162–165
advantages/disadvantages, 130
unenforceable, 155
facility manager’s role, 131–132
unilateral, 155
systems, 130–131
void, 155
chart of accounts, 5, 17–21
voidable, 155
closeout
cost allocation systems. See cost(s): measurement
of budgets, 55–56
systems
of contracts, 185–186
costing
collusion, 165–166
activity-based, 109–110, 113–115
combined budget approach, 37, 38
job, 111, 112
comparability, and generally accepted accounting
job order, 111, 112
principles, 16
life-cycle, 87–89
competent parties, in contracts, 154
options, in facility management contracts, 192–
competitive bidding/tendering, 169
193
complementary bidding, 167
process, 111–112
consideration, in contracts, 154
traditional, 109–112
consistency, and generally accepted accounting
cost-reimbursement contracts, 159
principles, 16
cost(s), 5, 104, 105
containment, cost, 126–129
accumulation, 109
contract(s), 153–154, 186–187
allocation, 109
administration, 172–186
assigning to cost objects, 107–108
agreement to enter into, 155
assignment, 109
bilateral, 155
containment, 126–129
closeout, 185–186
decision making, use in, 116–117
competent parties, 154
differential, 116
consideration, 154
direct, 107
cost monitoring, 183–185
drivers, 106
cost-reimbursement, 159
fixed, 7, 48, 106–107
dispute resolution, 199–202
indirect, 107–108
payment for work not carried out, 167 return on assets, 122–123, 124
payroll journal, 22 return on capital employed, 123–124
performance monitoring, in contracts, 174–183 return on equity, 123, 124
performance specifications, 177 return-on-investment ratios, 122, 124
phantom charges, 167 revenue(s), 9
prescriptive contracts, 156 in chart of accounts, 18
prescriptive specifications, 176 projections of, 47
present value (PV), 9, 91–92 recognition, 29–30, 75
price fixing, 166 RFP (request for proposal), 139
pricing RFQ (request for quotation), 139
and costing options, in facility management risk
contracts, 192–193 assessment, 188–190
noncompetitive, 166–167 and capital investments, 94, 97–99
principal contractor model of FM outsourcing, 146 categorization, 188
pro forma statements, 9, 79–82 in facility management contracts, 191–197
process costing, 111–112 identification, 188
procurement, 136–137 management, 187–198
and facility management outsourcing, 143–150 reputational, 195
principles, 137–138 response, 190
process, 138–142 ROA (return on assets), 122–123, 124
sustainable practices, 138 ROCE (return on capital employed), 123–124
profitability ratios, 120–121, 124 ROE (return on equity), 123, 124
gross profit margin, 121, 124
net profit margin, 122, 124 S
operating profit margin, 121, 124 Sarbanes-Oxley Act, 59–60
proper subject matter, in contracts, 154 scenario analysis, 97–98
purchase or lease considerations, for capital assets, scope of services, in facility management contracts,
78–79 191
purchase orders, 157–158 segregation of duties, and fraud/irregularities in
PV (present value), 9, 91–92 contracts, 168
qualified opinion, in audited financial statement, 61 self-delivery total FM (TFM) package model of FM
quarterly budget analysis, 54 outsourcing, 146–147
quick ratio, 119–120, 124 semivariable costs, 107
sensitivity analysis, 98–99
R service contracts, 175
ratio analysis, 118, 125 service failure, 195
asset management ratios, 120, 124 service level agreements, 175, 181–183
and facility management metrics, 125–126 service/resource flexibility, in facility management
liquidity/short-term debt ratios, 118–120, 124 contracts, 194
profitability ratios, 120–122, 124 service specifications, 175, 176–180, 182–183
return-on-investment ratios, 122–124 shareholders’ equity, statement of, 9, 62, 63
realizable, in accrual basis accounting, 30 short-term debt ratios. See liquidity/short-term debt
realized, in accrual basis accounting, 29 ratios
recharging. See chargebacks SLAs (service level agreements), 175, 181–183
recognition, revenue, 29–30, 75 “smoothing” facility management investments, 81–82
relevance, and generally accepted accounting SOX (Sarbanes-Oxley Act), 59–60
principles, 15 specifications
relevant range, 106 performance, 177
reliability, and generally accepted accounting prescriptive, 176
principles, 16 service, 175, 176–180, 182–183
renewal options, in contracts, 194 standards, accounting, 14–17
reputational risk, 195 state/cross-border benchmarking/budgeting, 57–58
request for proposal, 139 statement of cash flows, 9, 62, 63, 70–72, 79
request for quotation, 139 statement of shareholders’ equity, 9, 62, 63
resource/service flexibility, in facility management straight-line method of depreciation, 76
contracts, 194 strategic plans, 35, 36–37
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