How to Better Control Direct Construction Costs
With rising materials costs and downward price pressures, it is more important than ever to manage project expenditures. There are fewer jobs out there so it is essential to make a profit on every project.
Customers are looking for efficiencies and are examining quotes closely. Stay one-step ahead by managing your direct and indirect costs and their impact on gross margin, which must cover administrative overhead and profit. The gross margin – what’s left after job costs are subtracted from revenue – will vary according to the type of construction project. The percentage can range from under 10 percent on large commercial jobs to more than 40 percent for home remodeling.
Managing to the right gross margin is an effective way to remain solvent on a job-by-job and company-wide basis. Moreover, a solid understanding of your cost structure will enable you to make informed decisions about taking low-margin jobs for cash flow’s sake rather than just hoping for the best.
A good way to improve the future is to look at the past. Start by analyzing the financial performance of project revenue, job costs and gross margin over the past year and identify the most profitable jobs by size and type. This exercise will help you identify what types of projects your company can perform profitably with existing resources, so bear that in mind while seeking new opportunities.
Next, review the jobs with gross margins below the appropriate threshold to see what went wrong. Was the problem in your estimating? Did other factors contribute, such as unexpected increases in material costs or overtime labor? Were there delays on the job, costing money because you were not drawing down revenue, but the overhead clock was still ticking? Maybe you had too many change orders without capturing additional revenue. All of this is useful information as you bid and plan new jobs.
There is new emphasis on engineering and design today that can enhance cost containment. With tight resources, customers are seeking the best prices but, of course, they want a good product. Avoiding overbuilding is key. For example, one small nonprofit was quoted a price for high-end offices when they were satisfied with basic walls and carpets. Helping customers work through price/quality tradeoffs will better enable you to build what is appropriate and functional for your customer’s needs. If you are using outside design firms, consider offering incentives for staying within budget.
Labor is one of the largest direct costs, and lack of performance by your work crews will chew up profits. Paid slack time is inevitable as people wait for deliveries, travel between jobs or do company errands no matter how hard working the team is.
To figure out an employee’s true cost, add salary or wage, benefits and taxes to create a total weekly cost, and then divide the total by the average hands-on working hours. If you frequently pay overtime, include a factor for that. This gives you a more accurate basis for preparing bids in addition to managing productivity.
In today’s environment, productivity is even more important than ever. Put together the best team you can, which of course, includes congeniality and good customer service in addition to fast and accurate work. A solid team can help you manage the project efficiently and minimize mistakes and do-overs. Experienced employees or subcontractors are a knowledge resource. Quality improvements and productivity gains can save costs on a project, so you should consider bonuses for time and material savings to motivate your team. Everyone benefits when jobs are done on time and to the customer’s satisfaction!
Materials are another major cost center. Unfortunately, their cost is in large part out of the contractor’s control. For instance, depressed construction demand would press builders to absorb price hikes. Since demand for building materials is global, they are subject to shortages, bottlenecks and high transportation costs and sometimes prices leap during a job, eating up profits. As a result, some companies negotiate materials contracts ahead of time to ensure adequate supply and controlled pricing.
Materials with wildly fluctuating costs can also be managed with a provisional allowance until the project starts, when the price can be locked in. This is an alternative to the practice of adding percentage increases in advance and allows adjustments if prices go down or stabilize.
Managing direct labor and material costs and using good estimating techniques can help ensure job profitability and ultimately improve company financial performance. When you make the effort to analyze your historic gross margins by project and assess past performance, you will be able to identify areas where you can increase profitability job by precious job, and in turn increase your bottom line!
If you would like to learn more about how we can help your company, contact the MKS&H construction accounting experts today!
Article Contributed by Wayne E. Baldwin, CPA
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture and your business goals. This approach enables our clients to achieve their greatest potential.