Knowledge is power, and in our industry, the right knowledge can help you make better decisions – and reap the profits. But in an always changing economic landscape, how can you make sure you’re actually making good financial decisions and not just taking shots in the dark? Enter cost forecasting, one of the most important tools to have under your belt as a contractor.
Read on to learn more about cost forecasting in construction and how it can help you navigate financial uncertainty in 2024 and beyond.
Key Takeaways
- Cost forecasting is a process that helps contractors anticipate profitability or loss at the individual job level to in turn inform the financial forecast for your company as a whole.
- Making a regular habit of forecasting is a key component for ensuring each project is as profitable as you had initially estimated .
- Anytime you’re facing a major schedule change or large change order, it’s important to forecast your costs and adjust accordingly.
What is Cost Forecasting in Construction?
Cost forecasting is the process of both comparing your job’s initial estimate to the costs actually incurred and predicting any upcoming costs. You can think of cost forecasting as an extension of your estimate that allows you to plan for profit or loss on the job as changes happen during its lifecycle. Done effectively, this can help you visualize how you’ve spent money over time and see if that spending is progressing as you thought it would. Since a lot of contractors rely on their profits to fund new work, being able to create accurate forecasts can go a long way in making sure you’ve got the cash you need to continue growing your business.
Cost forecasting is different from cash flow forecasting. Cash flow forecasting predicts how much money will come in and out of your business during a specific time period. The aim of cash flow forecasting is to take the forecasted amount that you’re going to spend and break it into a time table so that both you and your client know when to have money on hand. While cost forecasting ultimately plays into cash flow forecasting, cost forecasting focuses more on adjusting an individual job’s estimated costs over time as compared to the job’s budget.
While the process of cost forecasting itself isn’t necessarily difficult, it can be difficult to make it a habit. To get the most out of it, it’s important to reassess your forecasts once a month at least (or even weekly if possible). Of course, you can never anticipate every single cost on a job, but making a habit of consistently revisiting your initial estimate over a project’s lifecycle can make sure you end up in the position you planned for.
When is Cost Forecasting Useful?
Under the larger project cost umbrella, cost forecasting is a helpful tool for estimating and monitoring spending around general conditions, subcontracts, and change orders.
General Conditions/Resource Monitoring
General conditions encompass everything you as the contractor are solely responsible for. This includes your own people, along with everything to support them (trailer rentals, portable toilets, etc). Your project schedule is what ties this all back to cost forecasting. By being able to look at the schedule and see if you’re hitting dates/milestones, you can get a good sense of how a project’s costs line up with your forecasts. For example, if you’ve completed 20% of the schedule and have spent 20% of your budgeted general conditions, then you’re probably in line and don’t need to adjust much. A more detailed forecast might account for costs according to scheduled tasks. For example temporary electricity costs will hit the budget early on while costs to protect finishes or cleanup the job would come toward the end.
Pro tip: if you can use a template (whether one you made yourself or downloaded), it will make keeping track of general conditions much easier.
The big goal here is to not only understand the costs you’re incurring, but exactly how do those costs impact the budget. Armed with this information, you can account for these costs as they relate to your schedule, and tighten up your spending as necessary.
Subcontracts
Here’s where you’ll learn just how well you wrote your contracts. For example, are you getting hit with a lot of change orders from subs that aren’t included in the subcontract? Taking the time to dig into the details here will give you the chance to identify any potential missed buys or scope gaps that you’ll need to cover (hopefully by increasing the contract amount you’re getting paid by the owner by as least as much as your new obligations to the subcontractor). If this ends up being the case, there’s not much you need to do by way of cost forecasting here – it’s just more scope for everyone.
In cases where change orders hit on the subcontract side and not the prime contract side though, it’s important to forecast so you know exactly how your bottom line will be affected. This is where contingency management can come into play.
Change Orders
On a slightly different note, cost forecasting is also useful in cases where you have potential change order work coming through that you want to plan for ahead of time. In these cases, make sure you’re capturing the amount of the change order, how much of it will be part of your subcontracts or prime contracts, and any schedule impacts it may have.
Final takeaway here: any time you’re dealing with a schedule change or large change order, you need to take a look at your costs (and beyond that, check in monthly).
Cost Forecasting in Construction at the Project vs. Company Level
The main point behind cost forecasting is to anticipate profitability (or loss). At the individual job level, regular forecasting can ensure your expected costs are in line with your actual costs. And over the span of multiple projects, this data can help paint a clear picture of whether your company as a whole is in a good financial position, or in jeopardy. For example, you might notice that a couple of projects are forecasting a net loss, but maybe a separate job you’re working on can cover it. Or, on the flipside, several losses could signal that you need to take out a second loan to get through a difficult season. Just like a doctor’s stethoscope, cost forecasting allows you to dial into the health of your business and get a bird’s eye view of your profits and time tables.
Final Thoughts
Sometimes, it’s easy to dismiss what’s learned during cost forecasting or kick the can down the road, especially if you’ve got several PMs working on multiple projects. At the end of the day though, honesty is always the best policy. Even if you’re looking at bad news, staying honest in your forecasting will benefit everyone, both in the moment and over the long-term. And, even if a certain job’s financials don’t go as planned, you’ll have the opportunity to learn from it and improve your bottom line over time.
Further Reading: Mastering Construction Job Costing: How to Enhance Profitability With the Builder’s Feedback Loop
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