Early in my project management career at a small general contractor, I often found myself navigating an onslaught of financial challenges. From fluctuating material costs to unexpected project delays, it felt like I was fending off threats to my livelihood from all sides (and often at the same time). What I quickly learned though, is that managing financial risk isn’t just the project managers, or even the general contractor’s problem – it’s everyone’s problem.
Risk management in construction is a team effort. And, when done well, it can have a ripple effect across your whole community.
Key Takeaways
- From PMs and GCs to clients themselves, risk management in construction is everyone’s responsibility.
- Managing financial risk can have a huge impact on your ability to both stay in business, and be profitable for years to come.
- Focusing in on a few common risk factors, like unrealistic budgets or unclear contracts, can solve some of the most frequent issues.
Why Risk Management is Vital in Construction
It’s easy to see the stakes for both owners and contractors. For owners, it’s the budget and schedule that are always at risk. For GCs and speciality contractors, good risk management is simply a matter of survival. Effective financial risk management is a necessity, especially when you consider the state of construction today. New data from the US Bureau of Labor and Statistics found that only 37.6% of construction businesses that started in 2011 made it to their 10-year anniversary. If anything, that should be a wake-up call.
Let’s zoom out even further. Beyond owners and GCs, financial risks can have direct impacts on everyone in the pipeline. Halted or delayed projects can spell job insecurity, or even layoffs in extreme cases. These economic ripples quickly extend beyond the job site, affecting local communities in many different ways. Unfinished or delayed projects, for example, bring declining property values, and less infrastructure to adequately support thriving local communities and businesses.
Let’s talk about how to avoid these issues in the first place. Below are some of the most common risks I’ve encountered in my career, and strategies to mitigate them.
💥 Dive deeper into construction mangement with a pro in our guide: Foundations of Construction Management for SMBs
4 Common Types of Construction Risks and How to Mitigate Them
Of course, I could write a whole book on all of the risks contractors face, but for simplicity’s sake, I’ll focus on the four I encountered most often in my time as a project manager.
Budgeting Risks
It’s a song and dance we all know – the client comes in with an unrealistic budget and you have to have tough conversations without stepping on any toes. No one enjoys it, but the way you handle these communications – especially when it comes to sudden changes in scope – can have a huge impact on your ability to avoid unnecessary financial strain. In my experience, the more collaborative you can be with budgeting, the easier it becomes to set realistic expectations and create a stable financial environment for yourself.
Allowances and contingencies were an area of the budget where I got myself in trouble early on. By relying too much on allowances during the budgeting phase in place of good competitive bids, I set myself up to pay over market pricing once the subcontractors I needed to do the “extra” or “undefined” work were already on my project. Contingencies were also debated with owners in many of my projects. Sometimes we needed a ten percent contingency that I allowed to be negotiated down to five percent. Combine that with the fact that I didn’t define in the contract that the contingency should be GC controlled versus owner controlled. I ended up debating each and every use of that contingency throughout the project. Moral of the story: the more collaborative you can be with budgeting, the easier it becomes to set realistic expectations and create a stable financial environment for yourself.
Contract Risks
Reading every contract, in full, seems like a given. That assumption didn’t last long. In fact, I saw the same big issues arise over and over again when my colleagues didn’t read the provisions in full.
You have to know the language behind a contract before you get to the jobsite. In particular, pay special attention to language like Indemnification Clauses or Pay-when-Paid Clauses, because these are put in place to shift the risk of financial losses. If you need a refresher, the American Bar Association has an excellent article on these clauses. Ultimately though, it’s best to have a lawyer review all your contracts.
Nowadays, there’s even software like Document Crunch that uses AI to help even the newest PMs or Superintendents understand the content of contracts. With tools like these, you can clearly define payment terms, project scope, and potential penalties for delays. When it comes down to it, well-drafted contracts can protect your interests and set clear expectations with clients and subcontractors.
Macroeconomic Risks
Rising interest rates, new federal policies, and even global events can change construction at a local level. That being said, no one reading this article is going to be large enough to have much of an impact on those risks, which is why mitigation through diversification is the move.
Try your best to avoid overly relying on a single client or even a single project type. Just like your retirement account, diversifying your project portfolio can help spread financial risk. For example, if one project faces challenges, other projects may continue to provide a steady stream of income. Stay informed about industry trends, regulations, and best practices. Continuous education and awareness will empower you to adapt to changes, choose the right projects to take on, and safeguard your financial interests.
On a similar note, sometimes things just happen. That’s where insurance comes in. Take the time to invest in a comprehensive insurance policy tailored to the construction industry. This could include general liability insurance, builder’s risk insurance, and professional liability insurance. At the end of the day, getting covered here can provide a much-needed financial safety net in the event of accidents, property damage, or legal disputes.
Cash Flow Risks
This one seems simple, and it actually is. Time and time again, I saw cash flow drying up on projects due to little mistakes – like not completing buyout in an urgent manner when the project was awarded, or billing for all change orders approved. Even leaving out items in an estimate can delay owner payment while being negotiated.
So how can you stay on top of this and avoid those little but costly mistakes? Effective cash flow management starts with monitoring receivables and payables closely. A good software, particularly one built for construction, will make this much easier. On top of this, timely invoicing and payment collections, along with negotiating favorable payment terms with subs and suppliers will all help you maintain a healthy cash flow.
Lastly, consider using a standardized set of cost codes . These will help enable cross-project reporting and help you consistently spot areas in need of improvement.
👉🏻 Check out our article on how to overcome cash flow challenges.
Final Notes
Managing financial risk as a general contractor is certainly daunting, but also incredibly rewarding. Growth happens when you’re able to successfully maintain both your profits and your reputation, so take care to communicate transparently, conduct thorough risk assessments, and advocate for fair practices – because the alternative is the opposite of growth.