Many construction companies suffer from a disabling condition called “profit fade.” It occurs when a contract is complete or near complete, but the job continues to incur additional costs – often not factored into the estimate. Here are three steps to fighting this malady.
1. Review estimating procedures.
To get started, select several projects that represent a profitability cross-section of your company’s business – from some of the least profitable to some of the most. Review each project’s estimate by comparing its figures to the actual ones, drilling down to the minutest detail in job costs. Identify areas where the job didn’t meet the budget and determine whether expenses were properly assigned by job phase.
Next, review the primary assumptions for each estimate, including productivity presumptions such as asphalt, bricks, blocks or pipe laid per day, or cubic yards of concrete poured per day. Check with the jobs’ foremen or other experts within your company to assess the reasonableness of these assumptions.
Also determine whether your application of indirect costs, average labor rates, fringe benefits and other construction-related expenses used in the estimating process was consistent with the actual costs.
2. Evaluate project performance.
To evaluate the jobs’ overall performances, take the information you learned in step 1 and ask yourself:
How was the project cost information communicated from management to the foreman?
What job costing tools did the foreman use to manage the project?
When were problems identified, communicated to the project manager and resolved?
When were change orders identified, priced and completed?
What caused other delays in completing the project?
By finding out the answers to these questions, you should be able to determine the cause of any profit fade that you could have prevented.
3. Focus on the fix.
Based on any weaknesses within your company that you found in step 2, you can create and implement procedures to increase efficiencies. For example, if project managers aren’t receiving bid cost amounts for items such as materials and labor, it will be difficult to hold these individuals accountable for not bringing in jobs on budget.
In this case, consider creating a report that provides bid cost amounts to project managers. (Many construction accounting packages offer this capability.) Update the report with the actual costs throughout each job. That way, managers can better track and minimize costs while work is under way rather than waiting until completion to learn they’re over budget – when it’s too late.
Never assume you know instinctively why your construction company isn’t more profitable. Instead, establish a thorough review process to diagnose and cure profit fade. Doing so will help you not only evaluate your current financial condition, but also refine your business processes going forward.