5 common budget mistakes and how to correct them
INSIGHT ARTICLE |
In an industry already known for tight margins, scheduling challenges and project overages, contractors do not need to make their financial situations any more difficult by making costly budget mistakes. But many contractors don’t perform adequate due diligence when putting together a project’s budget, resulting in underestimates of cost.
Following are five areas where contractors commonly make mistakes when managing their construction budgets and how to avoid them:
1. Estimate with accuracy
Cost estimating is the first step in determining the feasibility of a project, and evaluating profitability. Many small and midsize construction firms still rely on outdated spreadsheets to put together estimates. This highly manual process increases the risk of incorrect formulas, entry errors or information simply getting left out.
Missing or incorrect line items also hinder the process for successful bid leveling subcontracted components of the work. Contractors should provide potential subcontractors with detailed scopes of work and consistent estimate templates to avoid varied levels of complexity within a single trade. The ability to level bids drives the accuracy of an estimate or budget.
These types of errors and omissions create major havoc, but there are simple steps that can help alleviate problems and ensure accuracy:
- Have the estimate independently reviewed. Once the preconstruction team develops the estimate, bring in experienced, senior team members or even the accounting department to perform a review and ensure all pertinent information is included, the math is correct and the schedule is accurate.
- Develop a robust process for bid leveling. To ensure accurate bid leveling, provide subcontractors with detailed scopes of work and a consistent cost proposal format to ensure there are no gaps in information.
- Transition away from manual processes with a technology upgrade. A number of accounting software systems are specifically geared toward construction activities, and many integrate with or have their own estimating and project management modules, lowering the risk of miscalculation.
- Bid the job to make money. While it’s normal to want to do whatever it takes to win the bid, circumstances surrounding some projects simply do not lend themselves to being profitable. Know when to walk away when the budget just doesn’t work.
2. Establish a culture of integrity
A firm’s culture plays a significant role in the budgeting process. A culture that puts a premium on integrity encourages accurate and honest projections regarding where money can and cannot be made.
In addition to training a project manager (PM) on the correct way to develop budget estimates, a management team member can help the PM review budget details to ensure projections are accurate. It should be clear to the PM that management values accuracy above all, and that, just as with profitability, cost overruns and underruns should be reported during the job in as transparent and timely a manner as possible. As encouragement for PMs, a compensation incentive can be developed based on the profitability of a project, but should take into consideration the complexities of modern construction budgeting (contingency usage, shared savings clauses, etc.). But in any case, PMs should be made to feel comfortable relaying precise information, even if it includes potential losses.
3. Ensure accurate tracking
PMs typically do not have a background or education in accounting, so creating accurate budgets and continuously managing them through long projects can be challenging. Costs have to be recalculated, savings tracked, contingencies acknowledged, line items shifted and change orders made—it can be quite a complicated endeavor to maintain accurate accounting of a month-long or years-long project. This means construction firms must have an established, consistent method for tracking the details in real time throughout the entire course of the project.
4. Avoid contractual misalignment
It happens all the time in all industries: Two people have a conversation about a project, and a contract is drawn up. But the contract doesn’t accurately reflect the intent of the negotiation. Perhaps one or the other party neglected to confirm that the language in the contract reflected their original intent and, seemingly out of nowhere, there’s a major difference between what the contract requires and what one of them was expecting. Such a situation can mean major issues with numerous parts of the project.
To ensure that the intended scope of work is what is actually outlined in the contract, the contract must be analyzed at inception. It is critical to have the right team members involved in drafting the contract and examining all the details. Don’t rely strictly on the project manager to handle the contract—a PM isn’t an attorney, accountant or a banker. Get accounting involved as well to make sure that any financial references are accurate and manageable.
5. Review design and preconstruction expectations
Expectations are set at the beginning of every project by the owner, design professionals, and even the contractor during bidding. It’s not uncommon for an owner to develop or be given unrealistic ideas about what kind of work can be performed. For a project to be successful, there must be a realistic schedule and a realistic budget, and the owner’s expectations have to be aligned with what is possible. The preconstruction expectations should set practical contingencies and allowances and budget for cost escalation. Perhaps most importantly, contractors should know when to walk away from a bid; not every project is going to be right for every contractor.
Mistakes can be avoided
Every project has its own unique set of variables, so the mistakes made along the way and issues encountered aren’t always the same. But successful contractors not only understand the areas where they tend to make budget mistakes, they also are willing to take the steps needed to correct or avoid them.
To maximize profitability, it is crucial for contractors to create a clear and accurate construction budget. Successfully managing the construction budget often means creating an accurate estimate, sticking to the plan, and communicating with team members and project owners along the way. It can be the difference between a failed project and a profitable job. If there isn’t sufficient effort put into a project’s budget planning, the project may be set up to encounter numerous problems before it even begins.
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