Ebook Construction accounting and financial management (2E) Part 1

www.downloadslide.com


www.downloadslide.com

C ONSTRUCTION A CCOUNTING
AND F INANCIAL M ANAGEMENT
SECOND EDITION

Steven J. Peterson, MBA, PE
Weber State University

Prentice Hall
Upper Saddle River, New Jersey
Columbus, Ohio


www.downloadslide.com

Library of Congress Cataloging-in-Publication Data
Peterson, Steven J.
Construction accounting and financial management / Steven J. Peterson. 2nd ed.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-0-13-501711-1
ISBN-10: 0-13-501711-4
1. Construction industry—Accounting. 2. Construction industry—Finance.
3. Managerial accounting. I. Title.
HF5686.B7P48 2009
624Ј.0681—dc22
2008019396

Vice President and Executive Publisher:
Vernon R. Anthony
Acquisitions Editor: Eric Krassow
Editorial Assistant: Sonya Kottcamp
Production Manager: Wanda Rockwell
Creative Designer: Jayne Conte

Cover Designer: Bruce Kenselaar
Cover Image: Getty Images, Inc.
Director of Marketing: David Gesell
Marketing Manager: Derril Trakalo
Marketing Coordinator: Alicia Dysert

This book was set in 10/12 ITC Mendoza Roman Book by Aptara®, Inc. It was printed and bound by Hamilton Printing
Company. The cover was printed by Phoenix Color Corp.
Microsoft® Excel is a trademark of the Microsoft Corporation. Microsoft product screen shot(s) reprinted with permission from Microsoft Corporation.
DISCLAIMER: The sample Excel spreadsheets in this book are to provide the reader with examples of how Excel may be
used in accounting and finance, and as such, are designed for a limited number of accounting and finance situations.
Before using the spreadsheets in this book, the reader should understand the limits of the spreadsheet and carefully verify
that the spreadsheets (1) are applicable to their situation and (2) produce an acceptable answer. The reader assumes all
risks from the use and/or performance of these spreadsheets.
Copyright © 2009, 2005 by Pearson Education, Inc., Upper Saddle River, New Jersey 07458.
Pearson Prentice Hall. All rights reserved. Printed in the United States of America. This publication is protected by
Copyright and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a
retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or
likewise. For information regarding permission(s), write to: Rights and Permissions Department.
Pearson Prentice Hall™ is a trademark of Pearson Education, Inc.
Pearson® is a registered trademark of Pearson plc.
Prentice Hall® is a registered trademark of Pearson Education, Inc.
Pearson Education Ltd., London

Pearson Education Singapore. Pte. Ltd
Pearson Education Canada, Inc.
Pearson Education—Japan

Pearson Education Australia PTY, Limited
Pearson Education North Asia Ltd., Hong Kong
Pearson Educación de Mexico, S.A. de C.V.
Pearson Education Malaysia, Pte. Ltd.
Pearson Education Upper Saddle River, New Jersey

10 9 8 7 6 5 4 3 2 1
ISBN-13: 978-0-13-501711-1
ISBN-10:
0-13-501711-4


www.downloadslide.com

This book is dedicated to John Peterson, a good friend who
encouraged me to study business.


www.downloadslide.com

This page intentionally left blank


www.downloadslide.com

Preface

Several years ago I was asked to teach a course on construction accounting and finance. The course was to cover the fundamental principles needed by construction managers to successfully manage the finances of construction companies. In
preparing to teach this course I found that these principles were scattered among
many disciplines, including business management, engineering economics, accounting, estimating, project management, and scheduling. After I reviewed the
available textbooks, two things were apparent. First, the material was often presented in a generic fashion and failed to address how the principles applied to the
construction industry. For example, in most accounting textbooks only a few
pages were devoted to the accounting procedures for long-term contracts, which
comprise a bulk of the projects for general construction companies. Second, with
the topics scattered among many disciplines and textbooks, the topic of how the
different components of construction financial management were interrelated
and interacted was being ignored.
Financial management may be defined as the use of a company’s financial
resources and encompasses all decisions that affect a company’s financial health.
Many everyday decisions affect a company’s financial health. The difference between a marginally profitable and a very profitable company is good financial
management. Business schools teach the fundamental principles of financial
management; however, because of the many unique characteristics of the construction industry, the usefulness of these financial principles as taught by business schools is limited. To be useful, these principles must be adapted specifically
to the construction industry. For example, in the construction industry equipment is mobile and may be needed for multiple jobs during a single month. Traditional accounting methods and financial statements do not allow a company to
properly manage and account for its equipment.
This book was written to help construction professionals—both those who are
working in the construction industry and those seeking a degree in construction
management—learn how the principles of financial management can be adapted to
and used in the management of construction companies. This book will be most
useful for general managers and owners of companies who are responsible for
managing the finances of the entire company; however, many of these principles
are useful to project managers and superintendents. For the project manager or

v


www.downloadslide.com

vi

PREFACE

superintendent who desires to stand out in a company, there is no better way than
to improve the profitability of their project through the principles of sound financial management. The book also discusses how owners and general managers can
manage construction projects by sound management of their project managers,
superintendents, and crew foreperson.
This book explains common financial principles, demonstrating how these
principles may be applied to a construction situation and how these principles affect the financial performance of a company. Many of the examples included in
this book are based on actual situations encountered by the author.
This book is organized in five parts: introduction to construction financial
management, accounting for financial resources, managing costs and profits,
managing cash flows, and making financial decisions.
The first part—comprising Chapter 1—introduces the reader to construction
financial management, explains why construction financial management
is different than financial management in other industries, and defines
the role of a construction financial manager.
The second part—comprising Chapters 2 through 6—describes how to
account for a company’s financial resources. Accounting for these
resources is built around a company’s accounting system.
The third part—comprising Chapters 7 through 11—examines how to
manage the costs and profits of a construction company. This must be
done at the project level as well as at the company level.
The fourth part—comprising Chapters 12 through 16—looks at how to
manage a company’s cash flows and how to evaluate different sources
of funding cash needs.
The fifth part—comprising Chapters 17 and 18—explores ways to quantitatively analyze financial decisions.
After reading this book, you should have a better understanding of the

following:
❑ The basic financial principles that are widely used in the business
world and how to modify them so that they work for the construction
industry. Application of these principles will help you better manage
your business.
❑ Construction accounting systems, which will help you manage the
accounting systems and use accounting information to manage a
company.
❑ Financial and accounting principles, so that you may interact with
accountants and bankers at a professional level.
To access supplementary materials online, instructors need to request an instructor access code. Go to www.pearsonhighered.com/irc, where you can register


www.downloadslide.com

PREFACE

vii

for an instructor access code. Within 48 hours after registering, you will receive a
confirming e-mail, including an instructor access code. Once you have received
your code, go to the site and log on for full instructions on downloading the materials you wish to use.
This textbook brings all of the key financial management principles needed
by construction managers under one cover, addressing how they are applied in
the construction industry and how they interact. Many of the examples in this
book are based on my fourteen years of experience in construction financial
management. Join me on a journey of discovery as we discuss the fundamental
principles of financial management that are needed to make a construction company a financial success.
Particular thanks are due to Richard J. Gebken (Missouri State University),
Ahmad Hadavi (Northwestern University), Kelly Strong (Iowa State University),

Syed M. Ahmed (Florida International University), Laura Lucas (Indiana University–Purdue University, Indianapolis), Jonathan Shi (Illinois Institute of Technology), and Brent H. Weidman (Brigham Young University) for their assistance
with the text review.
Best Wishes,
Steven J. Peterson, MBA, PE


www.downloadslide.com

This page intentionally left blank


www.downloadslide.com

Contents

PART I INTRODUCTION TO CONSTRUCTION FINANCIAL
MANAGEMENT 1

C HAPTER

1
CONSTRUCTION FINANCIAL MANAGEMENT

3

What Is Financial Management? 5
Why Is Construction Financial Management
Different? 5
Project Oriented 6
Decentralized Production 7

Payment Terms 7
Heavy Use of Subcontractors 7
Who Is Responsible for Construction
Management? 8
What Does a Financial Manager Do? 8
Accounting for Financial Resources 8
Managing Costs and Profits 10
Managing Cash Flows 11
Choosing among Financial Alternatives 13
Conclusion 13
Problems 13

ix


www.downloadslide.com

x

CONTENTS

PART II ACCOUNTING FOR
FINANCIAL RESOURCES

C HAPTER

15

2
CONSTRUCTION ACCOUNTING SYSTEMS

17

Cost Reporting versus Cost Control 18
The General Ledger 20
Method of Accounting 20
Cash 20
Accrual 22
Percentage of Completion 22
Completed Contract 23
The Balance Sheet 24
Assets 24
Liabilities 27
Owner’s Equity 29
The Income Statement 30
Revenues 31
Construction Costs 31
Equipment Costs 33
Overhead 36
Other Income and Expenses 36
Income Tax 36
The Job Cost Ledger 37
The Equipment Ledger 43
Conclusion 45
Problems 46

C HAPTER

3
ACCOUNTING TRANSACTIONS

Invoice Charged to a Job without Retention 48
Invoice Charged to a Job with Retention 49
Paying Invoices 50
Labor Charged to a Job 51
Labor Charged to General Overhead 53
Paying an Employee’s Wages 55
Paying Payroll Taxes 56
Paying for Benefits 56

47


www.downloadslide.com

CONTENTS

xi

Vacation Time for Jobsite Employees 57
Recording Office Rent 58
Recording Office Depreciation 59
Recording General Overhead Invoices 60
Billing a Client 61
Billing for Retention 62
Receiving Payment from a Client 62
Purchase of Equipment with a Loan 63
Loan Payment 64
Equipment Depreciation 64
Leased Equipment with an Operating Lease 65
Leased Equipment with a Capital Lease 66

Lease Payments on a Capital Lease 67
Amortization of a Capital Lease 68
Invoice for Equipment Repairs 69
Equipment Charged to a Job 70
Equipment Charged to an Employee 71
Sale of Equipment 72
Purchase of Inventory 73
Charging Inventory to a Job 74
Recording Changes in Costs and Profits in Excess of Billings 75
Recording Changes in Billings in Excess of Costs and Profits 76
Conclusion 77
Problems 77

C HAPTER

4
MORE CONSTRUCTION ACCOUNTING

81

Committed Costs and Estimated Cost at Completion 81
Overbillings and Underbillings 86
Internal Controls 89
Computerized Accounting Systems 90
Conclusion 92
Problems 92

C HAPTER

5

DEPRECIATION
Straight-Line Method 96
Sum-of-the-Years Method 98
Declining-Balance Method 102

95


www.downloadslide.com

xii

CONTENTS

MACRS 108
Placing in Service and Disposing of an Asset 108
IRS Standard Recovery Periods and Depreciation Methods 109
Section 179 Deduction 118
Depreciation for Nontax Purposes 118
Conclusion 121
Problems 122
References 124

C HAPTER

6
ANALYSIS OF FINANCIAL STATEMENTS

125

Depreciation and Financial Analysis 127
Quick Ratio 128
Current Ratio 129
Current Liabilities to Net Worth Ratio 130
Debt to Equity Ratio 131
Fixed Assets to Net Worth Ratio 132
Current Assets to Total Assets Ratio 133
Collection Period 134
Average Age of Accounts Payable 136
Assets to Revenues Ratio 137
Working Capital Turns 138
Accounts Payable to Revenues Ratio 140
Gross Profit Margin 141
General Overhead Ratio 141
Profit Margin 142
Return on Assets 143
Return on Equity 144
Degree of Fixed Asset Newness 145
Conclusion 146
Problems 146

PART III MANAGING COSTS AND PROFITS 153

C HAPTER

7
MANAGING COSTS
Monitoring and Controlling Construction Costs 155
Material Purchases 155
Labor 158

155


www.downloadslide.com

xiii

CONTENTS

Subcontracts 159
Equipment 160
Other 161
Monitoring and Controlling General Overhead Costs 161
Monitoring Job Profitability 161
Cost-Loaded Schedule 164
Schedule Performance Index 165
Cost Performance Index 168
Target Levels for CPI and SPI 170
Project Closeout Audit 172
Conclusion 173
Problems 173

C HAPTER

8
DETERMINING LABOR BURDEN

177

Cash Equivalents and Allowances 181
Payroll Taxes 182
Unemployment Insurance 184
Workers’ Compensation Insurance 186
General Liability Insurance 187
Insurance Benefits 187
Retirement 188
Union Payments 188
Other Benefits 189
Conclusion 190
Problems 190

C HAPTER

9
MANAGING GENERAL OVERHEAD COSTS
What Is General Overhead? 193
The General Overhead Budget 194
Items to Include in the General Overhead Budget 195
Estimating General Overhead 201
Types of Costs 203
Sample of a General Overhead Budget 205
Conclusion 216
Problems 216

193


www.downloadslide.com

xiv

CONTENTS

C HAPTER

10
SETTING PROFIT MARGINS FOR BIDDING

221

The Profit Equation 221
Contribution Margin 223
Projecting Break-Even Volume of Work 224
Projecting Break-Even Contribution Margin Ratio 226
Adjusting the Financial Mix 228
Profit and Overhead Markup 230
Conclusion 233
Problems 233

C HAPTER

11
PROFIT CENTER ANALYSIS

237

Sources of Profit 237
Allocation of General Overhead 241
Profit Center Analysis 244

Crews as Profit Centers 244
Project Management as Profit Centers 246
Estimators as Profit Centers 247
Types of Jobs as Profit Centers 247
Customers as Profit Centers 251
Equipment as Profit Centers 252
Conclusion 253
Problems 254

PART IV M ANAGING C ASH F LOWS

C HAPTER

257

12
CASH FLOWS FOR CONSTRUCTION PROJECTS
Cash Flow for Projects with Progress Payments 260
Cash Flow for Projects with a Single Payment 285

259


www.downloadslide.com

CONTENTS

xv

Conclusion 288

Problems 289

C HAPTER

13
PROJECTING INCOME TAXES

295

Corporate versus Personal Income Tax 295
Taxable Income 296
Payment of Income Taxes 298
Income Tax Rates 298
Marginal or Incremental Tax Rate 302
Capital Gains and Losses 303
Tax Consequences of Depreciation 304
Nondeductible Expenses/Costs 308
Tax Credits 309
Alternate Minimum Tax 309
Projecting Taxable Income 310
Conclusion 310
Problems 311
References 312

C HAPTER

14
CASH FLOWS FOR CONSTRUCTION
COMPANIES
Incorporating Construction Operations 314

Incorporating General Overhead 325
Income Taxes, Interest, Loan Payments, and
Cash Balance 328
Determining the Minimum Monthly
Balance 333
Fine Tuning, What If, and Sensitivity
Analysis 334
Conclusion 336
Problems 337

313


www.downloadslide.com

xvi

CONTENTS

C HAPTER

15
TIME VALUE OF MONEY

341

Equivalence 342
Single-Payment Compound-Amount Factor 343
Single-Payment Present-Worth Factor 347
Uniform-Series Compound-Amount Factor 350

Uniform-Series Sinking-Fund Factor 352
Uniform-Series Present-Worth Factor 355
Uniform-Series Capital-Recovery Factor 357
Cash Flow Diagrams 359
Complex Cash Flows 360
Find Unknown Periodic Interest Rates 366
Inflation and Constant Dollars 371
Conclusion 372
Problems 372

C HAPTER

16
FINANCING A COMPANY’S FINANCIAL NEEDS
Interest 378
Simple Interest 378
Compound Interest 378
Yield or Annual Percentage Yield 380
Fixed versus Variable Interest Rates 383
Loans and Lines of Credits 383
Loans 385
Long-Term Loans 386
Amortization Schedule 394
Closing Costs 396
Short-Term Loans 404
Lines of Credits 407
Compensating Balance 407
Commitment Fee 411
Leasing 413
Trade Financing 413

Credit Cards 415
Equity Financing 416
Selecting a Banker 416

377


www.downloadslide.com

CONTENTS

xvii

Applying for a Loan 417
Financial Documents 418
Conclusion 418
Problems 419

PART V MAKING FINANCIAL DECISIONS

C HAPTER

423

17
TOOLS FOR MAKING FINANCIAL DECISIONS

425

Sunk Costs 429

MARR (Minimum Attractive Rate of Return) 430
Adjusting Life Spans 431
Study Period 431
Shortening an Alternative’s Life 432
Lengthening an Alternative’s Life 433
Repurchasing an Alternative 433
Net Present Value or Present Worth 435
Incremental Net Present Value 444
Future Worth 448
Annual Equivalent 451
Rate of Return 453
Incremental Rate of Return 458
Capital Recovery with Return 461
Payback Period without Interest 462
Payback Period with Interest 465
Project Balance 467
Noneconomic Factors in Decision Making 471
Conclusion 471
Problems 471

C HAPTER

18
INCOME TAXES AND FINANCIAL DECISIONS
Losses Carried Forward 478
Different Tax Rates 479
Depreciation 481
Capital Gains 482

477

www.downloadslide.com

xviii

CONTENTS

Tax Credits 483
After-Tax Cash Flows 485
Conclusion 494
Problems 494

A PPENDIX A C OMPUTERIZED A CCOUNTING S Y S T E M S

497

A PPENDIX B E XCEL P RIMER

503

A PPENDIX C T REND A NALYSIS

511

A PPENDIX D D ERIVATION

519

OF

S ELECTED E QUATIONS

A PPENDIX E I NT E R E S T F ACTORS

523

A PPENDIX F A MORTIZATION S CHEDULE

555

A PPENDIX G G LOSSARY

565

A PPENDIX H L IST

575

I NDEX

OF

VARIABLES

577


www.downloadslide.com

PART

I
Introduction to Construction Financial
Management

In this section we introduce you to construction financial management, how it is different from financial management in other industries, and why construction companies need to use good financial management. This section includes:
❑

Chapter 1: Construction Financial Management

1


www.downloadslide.com

This page intentionally left blank


www.downloadslide.com

CHAPTER

1
Construction Financial Management

In this chapter you will learn what financial management is and why the financial
management of construction companies is different from financial management of
most other companies.
In 1997, 10,8671 construction companies in the United States failed, bringing the

total for the eight-year period beginning in 1990 to more than 80,0002 construction companies. These failures include only those business failures that resulted
in a loss to their creditors and do not include contractors who closed their doors
without leaving their creditors with a loss. The 1997 failure rate translates to 118
failures per 10,0003 construction companies or 1.18% of the construction companies. These failures are divided among companies of all ages. Figure 1-1 shows
the breakdown of these failures by age of the business. During 1997 the greatest
number of business failures was for construction companies that had been operating for longer than 10 years.4
FIGURE 1-1 Business
Failure by Age5

1
Dun & Bradstreet, Business Failure Record, 1986–97, annually as quoted by The Center to Protect
Worker’s Rights, The Construction Chart Book, 3rd Edition, September 2002. Note: Dun & Bradstreet
stopped publishing business failure data after 1997.
2

Dun & Bradstreet, Business Failure Record, 1986–97, annually as quoted by Surety Information Office, Why Do Contractors Fail?, downloaded from downloaded on April 3, 2003.

3

Dun & Bradstreet, Business Failure Record, 1986–97, annually as quoted by The Center to Protect
Worker’s Rights, The Construction Chart Book, 3rd Edition, September 2002.
4
Dun & Bradstreet, Business Failure Record, 1986–97, annually as quoted by The Center to Protect
Worker’s Rights, The Construction Chart Book, 3rd Edition, September 2002.
5
Dun & Bradstreet, Business Failure Record, 1986–97, annually as quoted by The Center to Protect
Worker’s Rights, The Construction Chart Book, 3rd Edition, September 2002.

3

www.downloadslide.com

4

CHAPTER 1

Since 1988 the construction industry has experienced a higher-thanaverage business failure rate when compared to the failure rate of all
businesses.6
The number of construction companies doing business in the United
States declined from 709,590 in 2000 to 698,898 in 2001,7 resulting in a net
decline of 10,692 companies or 1.5% for the year. This statistic does not represent the true number of companies that went out of business during the year
because the actual number of construction companies that went out of business is offset by the number of new construction companies that were started
during the year.
In 2002, two of Japan’s largest construction companies—Sato Kogy Company
and Nissan Construction—filed for bankruptcy in the same month.8 Also in
the same month, Germany’s second-largest construction company, Philipp
Holzmann AG, which had been in business for longer than 150 years, filed for
bankruptcy.9
By 2006, nearly one in four contractors (23.6%) of the 850,029 construction contractors that were in business at the beginning of 2004 had gone out of
business. These numbers include all sectors of the construction industry except
single-family residential contractors (SIC 1521).10
Large and small, old and new, domestic and foreign construction companies are among the statistics of failed construction companies. What are the
sources of failure for construction companies? The Surety Information Office—
an office that collects data on surety bonds—has identified six broad warning
signs that a construction company is in trouble. They are “ineffective financial
management systems . . . bank lines of credit constantly borrowed to the limits .
. . poor estimating and/or job cost reporting . . . poor project management . . . no
comprehensive business plan . . . [and] communication problems.”11 Four of
these six sources of failure are directly related to the financial management of the

company. Without sound financial management, construction companies are
setting themselves up for failure.

6

Dun & Bradstreet, Business Failure Record, 1986–97, annually as quoted by The Center to Protect
Worker’s Rights, The Construction Chart Book, 3rd Edition, September 2002.
7
U.S. Census Bureau, CBP United States Economic Profiles, 2000 and 2001 downloaded from http://
www.census.gov/epcd/cbp/view/cbpus.html.
8

The Associated Press, Nissan Construction to File for Bankruptcy, The New York Times on the Web,
April 1, 2002, and Ken Belson, Contractor in Japan Is Seeking Bankruptcy, The New York Times on the
Web, March 5, 2002.

9

Edmund L. Andrews, Kirch in Danger of Bankruptcy After Rescue Talks Break Down, The New York
Times on the Web, April 3, 2002, and Skyscrapers.com.

10

BizMiner, as reported by the Surety Information Office, Why Do Contactors Fail? Surety Bonds
Provide Prevention & Protection, 2007, downloaded from />
11

Surety Information Office, Why Do Contractors Fail?, downloaded from />whyfail.html downloaded on April 3, 2003.

www.downloadslide.com

CONSTRUCTION FINANCIAL MANAGEMENT

5

WHAT IS FINANCIAL MANAGEMENT?
Financial management is the use of a company’s financial resources. This includes
the use of cash and other assets—such as equipment. Many everyday decisions affect a company’s financial future. For example, the decision to bid on a large project can have great impact on the finances of a company. When deciding whether to
bid on a project, a manager may need to address the following questions: Does the
company have enough cash resources to perform this work or will the company
need outside financing? Can the company get bonded for this work? If not, what
changes need to be made in the company’s financial structure so the company can
get a bond for the project? Should the company hire employees to perform the
work or should the company subcontract out this labor? Should the company lease
or purchase the additional equipment needed for this project? If the company purchases the equipment, how should it be financed? Will this project require the
company to increase its main office overhead? And, finally, what profit and overhead markup should be added to the bid? The answers to all of these questions will
affect the company’s finances. The answer to one of the questions may change the
available options to other questions. For example, if the manager decides to hire
employees to perform the work on the project, the project will require more financial resources than if the company had hired subcontractors to perform the labor
and may leave the company with insufficient resources to purchase the additional
equipment, leaving leasing the equipment as the only option.

WHY IS CONSTRUCTION FINANCIAL MANAGEMENT DIFFERENT?
Construction companies are different from most other companies and are faced
with many unique challenges and problems not faced by other companies in
other industries. Although the construction industry is producing a product—as
do manufacturing plants—the construction of buildings, roads, and other structures is different from manufacturing of most other products. Because of these
unique characteristics the financial management principles applied to other
product-producing industries often need to be modified before they are applied to

the construction industry, otherwise they are useless.
To understand the unique characteristics and challenges faced by the managers of construction industries, let’s compare the management of a construction
company to the management of a manufacturing plant. For this example we look
at the manufacturing of fiberglass insulation. The manufacturing of fiberglass
batt insulation can be summarized in the following steps:
1. Sand and other ingredients necessary to make glass are delivered to the plant
and stored in silos.
2. The glass-making ingredients, delivered to the mixing bin by conveyor belts
or other means, are mixed in the specified proportions.


www.downloadslide.com

6

CHAPTER 1

3. After mixing, the ingredients are fed into a furnace, where they are heated to
make molten glass.
4. The molten glass is passed through a machine that spins the glass into fibers,
cools the fibers, and adds liquid binders which causes the glass fibers to stick
together.
5. The spun glass is placed on a conveyor belt, where the speed of the conveyor
belt controls the thickness of the insulation.
6. As the insulation proceeds along the conveyor belt, it is cut to width, and
paper backing is added if required.
7. Finally, the insulation is cut to length, packaged, and stored for shipment.
Now that you have a basic understanding of the process used to manufacture fiberglass insulation, let’s compare the management of this process to the
management of a construction company.

Project Oriented
The insulation manufacturer is process oriented, whereas the construction company is project oriented. Although the insulation manufacturer produces different types of insulation, the range of products that they produce is limited. In the
above example the insulation produced may be of different thickness or R values,
different widths, and with or without paper backing and packaged in rolls or
bundles of 8-foot batts. All of these products are similar with slight variations.
For many construction companies, each product is unique but often the products
are very different. It is not uncommon for a construction company to be working
on a tenant finish in a high-rise tower, a fire station, and an apartment complex
at the same time. Even when a construction company is working on similar
products—such as a homebuilder or a company building a number of convenience stores—the projects are often different due to site conditions and locations,
which affects the availability of labor and materials.
Because insulation manufacturers have a limited number of products they
produce repeatedly, it is easier for them to determine their production costs. When
a manager has produced a million square feet of R-11 insulation with paper backing
packaged in a 15-inch-wide by 40-foot-long roll it is easier to project the cost to produce the next 10,000 square feet than it is if the product has never been produced
before. Construction companies often give clients fixed prices for a product that the
company has never built or for a product that the company has never built using the
local group of suppliers and subcontractors available at the project location.
The insulation manufacturer sells the same product to a wide variety of
buyers at locations other than the place the insulation is manufactured. In the
construction industry, projects are often custom built for a specific owner on a
specific location. The insulation manufacturer can deal with fluctuation in demand by producing and storing extra products when demand is slower for use
when the demand is higher. It is relatively easy to store 5,000 square feet of insulation for immediate shipment to meet some future demand. With most of a