April 28, 2020 Growing & Complex Businesses en_US To keep a project on schedule and on budget, set yourself up for success with proper estimating processes. https://quickbooks.intuit.com/cas/dam/IMAGE/A8sEzTywB/Construction-job-costing-estimates-profitability.jpg https://quickbooks.intuit.com/r/growing-complex-businesses/how-to-make-accurate-construction-job-costing-estimates-and-improve-profitability/ How to make accurate construction job costing estimates and improve profitability
Growing & Complex Businesses

How to make accurate construction job costing estimates and improve profitability

By Ben Oliveri April 28, 2020

At the heart of every contractor project is a job costing estimate. An estimate is the beginning of the client relationship and is crucial to getting a project off the ground. An accurate assessment of costs is needed to verify the financial viability of a project—it’s also a prerequisite to a successful bid. Project planning details are all based on the original estimate, including:

  • Budget for materials and laborers
  • Direct and indirect expenses expected
  • Material delivery schedules
  • Timeline for completion and productivity targets
  • Progress invoicing schedule and milestone markers
  • Cash flow required at each stage of the project

In addition to serving as the foundation for project management, a job costing estimate also plays a vital role in customer satisfaction by setting the expectations for budget and timeline.

Without an accurate estimate, you can lack visibility into project costs—if your bid is too high you won’t win the project, and a failed bid represents sunk costs and resources. If your bid is too low, you will end up with a loss at project completion.

Accurate estimates shared with the client are also key to the proper management of invoicing and cash flow. Since invoices are typically based on project completion percentages or milestones laid out in the estimate, both the client and the contractor need to be in agreement on what those percentages or milestones look like. If there is an invoice dispute, it could delay payment and interrupt cash flow, and temporarily or permanently stall the project, resulting in losses for the contractor.

To keep a project on schedule and on budget, set yourself up for success with proper estimating processes.

Job costing at the estimate phase

Job costing is a cost control method that spans the life of a project—it starts with an estimate of anticipated costs and concludes with a job profitability analysis after project completion.

Coming up with an accurate project estimate is a detailed research process that requires a firm understanding of project scope and expectations, the ability to craft a plan to meet those expectations, and adequate knowledge of project inputs and their likely costs. A good estimation that can guide your project to completion includes several cost categories:

The cost of material

Once project details and scope are understood, determining the cost of material is a natural next step in the process. This is known as material takeoff. Material takeoff should be a comprehensive list of all material quantities and their expected costs. Beyond a simple price list, there are confounding factors that need to be accounted for. To arrive at a more true estimate of material costs, consider these questions during your calculation:

  • Could there be fluctuations in supply or demand for my required materials?
  • Will there be delivery challenges that add to costs?
  • Do I need any customized materials?
  • Will the installation of certain material require special equipment or skill sets?

When performing takeoff estimation, consult your material suppliers from the earliest moment possible. They can advise you on required lead times for orders, recommend materials with appropriate specs, and help coordinate a delivery schedule that matches your build schedule.

Hourly wage costs

In addition to materials, your human resource cost will be one of the project’s biggest expenses—and workers are arguably the most important input to successful project completion. You need to set hourly rates for general labor, specialty labor, and skilled craftsmen. You then need to estimate how many workers in each category will be required and how many labor hours are needed to complete the project. Wage calculation costs need to factor in the amount of federal and state taxes that will be deducted from paychecks. To align your compensation with industry standards, reference construction cost guides with wage data and consider whether you will be hiring union or non-union workers.

Project risk costs

Identify risk factors that could increase your costs or timeline and factor them into your estimate. Risk factors can include possibilities like:

  • Supply bottlenecks
  • Delays in the build schedule of subcontractors
  • The possibility of bad weather
  • Worker injuries

Predicting what could go wrong is tricky. To compile a list of potential risk factors and their costs, review completed projects and the source of unexpected costs that cut into margins. This process will be much easier with searchable job costing records accessible in a construction accounting solution.

Indirect costs

While wages and materials are billable directly to projects, you will incur other indirect costs that need to be accounted for. This includes home office costs like rent, utilities, and vehicle maintenance, as well as project-specific costs like non-billable hours for project estimation and administration, transport of workers and equipment, legal fees, and tool depreciation. Indirect costs should be estimated and allocated to projects on a pro-rata basis.

Tool and equipment cost

Tools use may be accounted for as a direct or indirect expense depending on whether tools are purchased, rented, or previously owned. You’ll need to determine if it will be more profitable to purchase or rent needed equipment and include this in your project estimate. To account for the depreciation of owned tools, allocate a tool use percentage to your project based on hours, days, or weeks, or sale value of the contract.

While these four categories can serve as a guide for general cost considerations, it’s easy to forget expenses like permit fees, prep work, trash removal, and other non-material costs. Look at past projects or use a checklist to make sure all potential costs are considered in your estimates.

Estimating is a process

As experienced contractors know, estimation is not a one-off exercise but an ongoing process—there should be several estimates leading up to and following a bid. The American Society of Professional Estimators prescribes a framework of 5 levels of estimation prior to a project starting, each with increasing accuracy as more information becomes available. Here is a brief description of each level:

Level 1: This initial assessment, sometimes referred to as an order of magnitude estimate, comes before the design phase and is considered a financial feasibility check. The estimator provides approximate figures based on general project scope and his or her familiarity with other similar projects.

Level 2: The level two estimate, or the intermediate estimate, is used to check whether the construction concept fits with the approximate budget proposed in level one. The contractor should decide to continue or abandon the project after this estimate.

Level 3: This phase is known as the preliminary estimate. It is the first estimate that includes a reliable projection of labor and material costs. Initial project budgets are usually based on this estimate.

Level 4: The level four estimate, or the substantive estimate, occurs after schematic designs and blueprints are available and project objectives are fleshed out. The estimator creates a detailed cost analysis with an itemized list of expected expenses and projected labor hours per project phase.

Level 5: This is a definitive estimate compiled by referencing the actual cost of materials, cost of purchasing equipment, and other worksite specific costs. Tenders, bids, and cash flow management plans will be based on this estimate.

Estimating during a project

The internal estimation process described above is the legwork needed to set up an accounting framework and financing plan for the actual project. Following these five stages, the contractor still needs to make a bid estimate and a control estimate (assuming the bid is successful).

A bid estimate is an extension of the level 5 estimate but with a markup so the contractor makes a profit. The markup needs to account for the contractor’s desired profit margin, indirect costs, and risk factors. To account for these project costs, the markup always needs to be greater than your percent of desired profit margin.

A control estimate is used to ensure a project remains on budget after a successful bid and through progress to completion. To account for changes to materials, labor use, or build schedule, the budget needs to be revisited periodically during a project. This helps to avoid cost overruns and ensure adequate cash flow to complete the project. If major changes in scope or timeline are necessary, a change order will likely be needed to secure the project’s continued viability.

Construction cost codes

From preliminary estimates to control estimates and project profitability reports, construction cost codes are key to tracking task-specific costs through the life of a project. Constructions codes include a broad category for deliverables and each type of work that falls within that category.

Many contractors base their codes off of the CSI Master Format, while others develop their own through years of experience in their construction niche. By using cost codes to track expenses, contractors can attribute costs to specific activities and materials. Historical job costing records that use cost codes also serve as a resource to improve future estimates. To get the most out using cost codes in your construction accounting, consider using accounting software with job costing functionality. Software solutions that support cost tracking with customized or standardized cost code lists enable live cost updates and budget adjustments throughout a project, as well as easy historical cost analysis.

Construction accounting software also brings a number of other benefits to contractors.

Accounting software for improved estimating processes

A construction accounting solution that stores historical data and generates vendor and job-specific reports empowers contractors to leverage their experience to sharpen estimating skills. By examining cost overruns per activity, reviewing cost allocation, and performing project profit and loss analyses, contractors can better anticipate the costs of future contracts.

Specialized reports can provide accountants and project managers with easy access to project cost insights that would otherwise be difficult to uncover. Some especially useful reports are:

  • Costs by Job
  • Cost-to-complete
  • Unpaid bills by job
  • Expenses not assigned to jobs
  • Billed/unbilled hours by person/job
  • Oper purchase order by vendor

In addition to providing the data insights needed for more accurate estimates, your accounting solution should include functionality that helps contractors manage costs and track their bottom line through the duration of a contract with automatic cost tracking, online invoicing, and change order functionality.

To get the most out of digital tools, make sure you have strong existing job costing practices.

Stronger job costing practices for more successful projects

Contractors need to have reliable estimating processes in order to accurately track expenses throughout a project and finish projects in the black. The following steps can serve as a general framework for contractors to build their own estimation processes to best suit their clients and their business needs:

  • Adopt a job costing practice that includes a financial feasibility estimate, a construction concept feasibility estimate, and a definitive estimate based on actual costs of materials and labor.
  • Make a reasonable bid estimate that accounts for the desired profit margin, indirect costs, and risk factors that can inflate project expenses.
  • Use a control estimate to keep costs in check and manage cash flow as a project gets underway.
  • Use cost codes to accurately track task-specific project expenses.
  • Consider whether your estimation processes could benefit from accounting software for contractors to eliminate redundant data input, automate calculations, and analyze historical project data.

With more accurate and efficient estimating and job costing processes, contractors can deliver quality work with fewer hiccups while improving profits and customer satisfaction.

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