Running a successful construction company is a tricky balancing act. On the one hand, you want to grow by taking on new construction projects. On the other hand, you don’t want those project costs to get so out of control that they eat into your profits. This is where the right construction cost management strategies can help you stay on target.
It’s hard to prevent cost overruns if you don’t know where exactly you’re bleeding profit though. To give you a better idea of where and what to look for, we’ll go over the most common areas general contractors lose profit on the job.
Key Takeaways
- Effective cost management is all about staying proactive. Prioritizing good communication, documentation, and project planning can eliminate a lot of common profit pitfalls.
- Good cost control methods take historical project data into account. If you know how much material prices rose on average year over year, you can build those anticipated costs into project budgets.
- Cost optimization isn’t about cutting important corners. It’s about knowing where every dollar is going, and why.
8 Ways Contractors Lose Profit (And What to Do Instead)
The average project lifecycle is full of financial risks. Of course, there are always the ‘unknowable unknowns’ (like bad weather) that can strike any moment, but there are a surprising amount of ‘knowable’ risks that can be avoided when carefully planned for.
Here are some of the most common profit traps we see contractors fall into, and the construction cost management tips you can use to avoid them.
1. Change orders
One mistake we see pretty often is contractors going ahead with change orders without getting the proper authorization and documentation. This happens a lot when jobs are moving quickly through project phases; you might get the verbal go-ahead from the owner or other stakeholder but it’s not “official”. And when it comes time to bill for that change order, the owner doesn’t want to pay.
If you want to avoid situations like this, always get change orders in writing. It doesn’t matter if you’ve already had a conversation on the job site - document everything so there’s no question later. This one item can lead to a project going from being a successful project to a loss.
2. Inaccurate estimates
Accurate cost estimates are your first line of defense in making sure your construction project costs come in accurately. Whenever possible, get your cost estimates double-checked for any discrepancies (preferably by a third party) before they go out. If something was missed in the project scope, you’ll want to catch it before you start building the budget. Reviewing your estimates after a project is done can help you streamline your estimate process over time.
3. Budget overruns
Uncontrolled construction budget overruns are a one-way ticket to unprofitable jobs. To help catch and address potential overruns, you should aim to do monthly (at a minimum) cost report reviews. This will allow you to forecast the amount needed to stay on track as the project progresses. When you work budget overruns and look at your estimates you can learn to make both of these items better over time. This is all part of what we call the Builder’s Feedback Loop which uses job costing to continuously improve the profitability and consistency of projects.
If a job is labor-heavy, we recommend cost reporting weekly. You’ll also need to know if you’re going to be working overtime, and if that was included in the construction cost estimate.
4. Lack of Transparency
Everyone responsible for the financial performance of a job needs to know:
- What the baseline budget is
- What the gross margin goal is
- What the construction plan is
- The expectations for overall project success
Anytime you’re putting people on a job (construction project management teams, key subcontractors, etc), you need to let them know what to shoot for. Good communication and transparency aren’t just nice-to-haves, they’re a necessity for meeting your profit goals. If your project management team does not know what is expected with the project budget you cannot end up being successful over the long term.
5. Missed Scope in Subcontractor Bids
Something particularly easy to overlook is missed scope in subcontractor bids. Double-check that anyone doing work for you has all of the scope included in their bids. This is an important part of creating accurate cost estimates. This one plays into item two and three, and again this can be an iterative process to get better over time. We would suggest you keep a database of bids to get an idea of what you might come in at.
6. Not Thinking Historically
If you’re working on a longer job that might take a year or more to complete, make sure you build potential cost variances/increases into your budget. Material costs are a good example here, but don’t stop there. Yearly pay raises for your workforce, along with higher costs for vendors and subcontractors should always be accounted for.
If you’re not sure where to start here, take a look through your historical project expenditures. For example, if the cost of a certain material has consistently risen 2% each year, you have a good idea of what to expect moving forward, and can add that 2% to the total cost allocated for that material in your budget.
7. Underestimating Overhead
A lot of contractors we talk to have missed out on profits because they’ve consistently underestimated their overhead costs. These aren’t direct costs, but all of the other costs associated with running your business, like rent or insurance.
Every bid you send out should include an appropriate amount of overhead. Ideally, you want to be bidding at a level where the job not only pays for part of your company's overhead, but allows you to meet your net margin goal after it’s finished.
👉 Check out our two-part guide to overhead allocation if you’re new to this.
8. Team Members Not Charging Appropriately to Jobs
Bonuses tied to project performance are pretty common in the construction industry. Where this can get hairy is when employees charge their time based on a job’s performance, instead of where they’re originally assigned. For example, someone could undercharge on a job going poorly, and put their time elsewhere.
This is something to watch out for, because any deviations here can affect what your project’s actual costs look like. You need to know you can do the work how you planned for it, both operationally and financially. This also makes it possible to give more accurate estimates on future projects.
Good Construction Cost Management Protects Your Bottom Line
Successful projects shouldn’t come at the expense of your company’s financial health. In fact, they should go hand-in-hand. By avoiding common pitfalls and implementing proactive cost control measures, you can keep up the cash flow you need to grow your business.
Want to go more in-depth with the topics we covered here? Read the Ultimate Guide to Construction Accounting for Contractors.