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How to Better Control Direct Construction Costs

03/28/2016 Jovana Krajewski

With rising materials costs and downward price pressures, it’s more important than ever to manage project expenditures. Since there are fewer jobs out there, it’s essential to make a profit on every project.

Customers are also looking for efficiencies and are examining quotes closely. Stay one step ahead by managing your direct and indirect costs and their effect 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 correct gross margin is an effective way to remain solvent on a job-by-job basis and companywide.

With a solid understanding of your cost structure, you can make informed decisions about taking low-margin jobs for cash flow’s sake rather than just hoping for the best.

To improve the future, first look at the past. Analyze the financial performance of projects over the past year in regards to revenue, job costs and gross margin. Identify the most profitable as to size and type of project. Your present company resources are best suited to handle those profitably, 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? Or did other factors contribute, such as unexpected increases in material costs or overtime labor? Delays on the job cost money, too, because you aren’t drawing down revenue, but the overhead clock is still ticking. Maybe you had too many change orders without corresponding revenue. All of this is useful information as you bid and plan new jobs.

There is a new emphasis on engineering and design today in regard to 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.

Help customers work through price-quality tradeoffs to build what is appropriate and functional. If you are using outside design firms, consider incentives for staying within budget.

Labor is one of the largest direct costs, and lack of performance will chew up profits. But however hard working the team is, paid slack time is inevitable as people wait for deliveries, travel between jobs or do company errands.

In figuring out an employee’s true cost, include 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 as well as managing productivity.

In today’s environment, productivity is even more important. 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. If jobs are done in a timely manner to the customer’s satisfaction, everyone benefits.

Quality improvements and productivity gains can save as much as 7 percent on a project, according to Paul Hessler of Construction Business Associates, LLC. Consider bonuses for time and materials savings to motivate your team.

Materials are another major cost center. Unfortunately, their cost is in large part out of the contractor’s control.

For instance, depressed construction demand is pressing builders to absorb price hikes. Sometimes prices leap during a job, eating up profits. Since demand for building materials is global, they are subject to shortages, bottlenecks and high transportation costs.

Some companies are stockpiling materials common to jobs, such as lumber and steel, to hedge against price surges. There is some risk, but the materials can always be resold.

Others are negotiating materials contracts ahead of time to ensure supply and negotiate prices. Onsite purchasing can boost costs 2.5 percent, Hessler asserts.

Materials with wildly fluctuating costs can be handled 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 adjustment if prices go down or stabilize.

For additional information or guidance related to this article, contact Jovana Krajewski at jkrajewski@vlcpa.com or 800.887.0437.

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