Understand common missteps to lessen risk and better gauge profitability of your construction business.
Often, it’s not until a project is complete that one determines its profitability. And profitability at the time of completion can vary significantly from expectations at the time of the bid. The ideal scenario is that a construction business owner can gauge profitability before the project even gets underway. Otherwise, you’re not only losing money on jobs; you’re putting your business at risk.
Still, a common misconception is that when profits are lost, the loss occurs after the project is started and is due to circumstances beyond one’s control. The reality is that when contractors lose money, the loss is most often borne out of the cost-estimation process.
To help you more effectively navigate this process, here are 10 of the most common cost-estimating mistakes putting your business at risk, and what to do about them:
1. Lack of transparency. The estimate should provide a top-level view of the project as well as each line item’s most granular details and their associated costs. This way, you eliminate the black-box approach, and anyone can easily understand the process for determining cost, regardless of his or her level of experience. Transparency also invites collaboration and the sharing of best practices throughout the company.
2. Last-minute changes. Late changes result in simple mistakes such as forgotten line items and formula errors from cutting and pasting. Such errors can quickly turn a profitable project into a loss. Accurate cost-estimation systems with built-in formulas and assembly libraries, however, can eliminate most, if not all, of these errors.
3. Focusing on strengths alone, ignoring weaknesses. You likely have depths of expertise in certain areas and more moderate proficiency in others. For example, you may know everything about roofing, and your estimate for that part of a project would be highly detailed. Yet, there may not be as much detail in your estimates for windows or floors. The areas in which you have less expertise will, thus, also have the greatest margins of error. That’s why templates and predefined modules come in handy. They work well with information from reliable sources, such as your own employees and third-party pricing databases, so you can fill in your knowledge gaps.
4. Underestimating Labor Costs. Labor is one of the most difficult costs to estimate because it’s not as simple as applying an hourly rate per employee. Examples of other factors to consider are experience and whether subcontractors will be needed.
As you’re performing your cost estimate, be sure to include as much detailed labor information as possible and capture it in assemblies. This way, you ensure that any quantity changes will automatically be reflected in labor costs. The added benefit is that you have documentation of deviations to the original plan and how they affect the project. Another tip for estimating labor is to look at similar projects and compare the cost per square foot using key figures.
5. Lack of margin calculation algorithm. If you base profitability solely on a flat sales price, such as a 10-percent profit across every aspect of the project, your final cost will differ from your initial bid. Instead, determine how much each of the critical factors, such as labor, materials and supplies, should contribute to profit and estimate accordingly. For example, if labor is 40 percent of the cost and materials is 8 percent, the sales price should reflect these differing percentages.
6. Pursuing every project. There is a great temptation to pursue every opportunity to keep your crews busy and expand your expertise into new areas. However, you should know up front which projects are going to require more work and, therefore, deliver less profit. This isn’t to say you should bid on only projects perfectly aligned with your business; rather, you should know the real costs of each project before you begin so there are no surprises later.
You will want to use cost-estimation software that gives you a detailed scope of the project and its related costs across a variety of dimensions, including labor, materials, margin, equipment and financing. Once you understand the costs of each project element, you can arrive at a more realistic profit margin. Keep in mind that sales price is the result of knowing the cost and using a strategy for calculating a desired margin.
7. Allocating resources incorrectly. Invest the most time in the areas of the project that will contribute to the greatest amount of cost in the project.
8. Not taking a top-down approach. While it may be easier to start the cost-estimation process by plugging numbers and line items into a spreadsheet, this bottom-up approach lacks a strategic view and is time consuming. It’s best to start by looking at the entire project. Then, break it down to see how costs are distributed. This way, you can make adjustments and see how each adjustment affects overall profitability, as opposed to manipulating the costs for different line items until you arrive at a healthy profit margin
9. Lack of successive risk estimation. To determine risks and minimize uncertainty, analyze what has gone awry on previous projects. For example, it may not be the materials or the crew that drove up the cost. It could just as easily be the fact that the project didn’t factor in that the city had only one lane of traffic, making construction challenging.
If you don’t consider and estimate all the risks of a project, your projected costs won’t be accurate. Cost-estimation software can guide you by providing uncertainty fields to address similar issues to those cited above. As you perform the estimate from a risk perspective, remember to account for standard deviations, and make sure you’ve set cost parameters so you’re alerted if the cost is escalating beyond your profit margin.
10. Limited views of the project. During the cost-estimation process, you should be able to see your spreadsheet data automatically regrouped and filtered to display information according to activity, phase, crew, classification, or any other aspect of the project. Along with providingvaluable data during construction, this is also a fantastic way of validating the project costs. If you invest the time at the beginning to make sure the cost estimate is aligned with your business expertise and profitability goals, you will find that the profit margin on your completed projects will increase.
Additionally, you will be able to create a process that improves with each use because it serves as a platform that combines your employees’ experience with relevant information across every dimension of the project. And, more often than not, it doesn’t even consume more time–it’s just a smarter way of working.