MLR

Two dreaded words for builders: Profit Fade

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Does your construction company suffer from chronic underbillings, missed change orders and job deadlines you failed to meet? If so, you have probably fallen victim to two words every contractor dreads: profit fade.

Profit fade words

This costly problem happens when a job goes awry and takes with it your estimated gross profit. Most contractors know when their jobs are getting out of hand, but many feel they have limited resources to reclaim control.

So the question is: How can you prevent profit fade from wiping out the bottom line on your next project?

Expect the unexpected

The profit you estimate when bidding a job can fluctuate dramatically as work progresses and can be greatly affected by every scheduling complication, design modification or other production issue that arises over the life of a job.

Every significant cost increase should be accompanied by a change order that increases the value of the contract. If it isn’t, determine why. Was your initial estimate off? Have you done extra work that wasn’t covered by a change order?

Be conservative

Contractors that are consistently profitable year after year will typically have net overbillings and experience profit gain on their jobs.

These “best-in-class” companies will conservatively estimate their open job profit based on the facts of where the job stands but then allow for the possibility – within a reasonable range – of unexpected hurdles in completing the job.

When a new contract is signed, only the minimum amount of estimated profit is shown on the work-in-progress (WIP) schedule. As the contract progresses and performance hurdles are cleared, the contractor will increase the overall job profit, thus allowing for unexpected contingencies occurring in the later phases of a job.

But more importantly, best-in-class contractors run their jobs effectively, making sure they make money or meet budget every step of the way.

Sureties prefer a conservative approach to estimating your open job profit. When a contractor continuously shows profit fade on jobs, this undermines a surety’s confidence in the contractor’s ability to estimate and run jobs profitably.

Chronically underbilled jobs can indicate ineffective estimating, cost overruns and sloppy project management. Overbillings, however, indicate effective billing practices and proactive project management.

Do your homework

In addition to monitoring WIP, contractors should revisit their estimating and profit histories. They should review both good and bad jobs to determine where they either beat or failed to meet budgets.

Discuss with your supervisors whether the assumptions you used in estimating were valid. Did you, for example, realistically calculate the number of bricks, feet of pipe or yards of concrete that your crews could lay in a day? Were your average labor costs accurate? What kept your crews from meeting their quotas and your expectations?
Consider both direct and indirect costs, and compare your estimates by type of job, owner, location and project manager on jobs that lost money to those you used on profitable projects.

Then, use what you find to improve estimating procedures on future projects. If certain job types, owners, localities or project managers cost you money, take that into account in your bids. You may want to be sure any of those future contracts compensate for unforeseen, but anticipated, challenges.

At the same time, for those jobs, owners, localities and project managers with good margins, consider sharpening your pencil to get that work.

Make the contract clear

Before work begins, understand fully what you’re contracted to do. Contract language is often unclear, resulting in differences in interpretations that can disrupt and delay projects. Conducting a careful review of the contract and clarifying any uncertainties at the start of the job can help prevent disruptions and delays going forward.

As work progresses, meet with your project managers regularly to make sure they’re comparing their actual costs to the bid amounts by project phase. If a problem arises, they can address it with the owner immediately.
Be sure to note the reason for the issue, as well. For example, if you’re typically plagued by weather delays during a certain time of year, you may need to build a little more time (and cost) into your bids.

When there is a problem, remember that your leverage is strongest before the project is finished. Owners need your help to meet their goals, and they may be more amenable to approving change orders while you’re still on the job. If you wait until the project is completed, an owner will have use of the facility and may not release your retainage. At that point, they hold all the cards.

Profit fade can be perilous to any size construction company. It’s something you simply can’t ignore. But by implementing a few new processes and proactively monitoring your jobs, you will see major improvements to your bottom line – and that’s something you can take to the bank!