7 Deadly Mistakes Construction Businesses Make
Not Knowing Your True Cost
Control a sale/job from pricing to completion. Whether you are a contractor with a pre-construction process, a service manger with a dispatch process, or you are planning profitability via a service contract sales process, integrate all the involved parties up-front before commencing the sale output. Know the costs on the job, hours on the job, material requirements, buy-out gain, parts requirements, and know that the labor scheduling needs are relative to your actual cost versus the revenue you will realize. Simply put, measure what the true profit on this job or service is supposed to be, so the job or service can be measured against what it should be. Get everyone on the same page. Start with a clear understanding of what the profit is after direct costs of the job or service. If you use overhead or general conditions in your estimating/pricing process, have your accounting department measure your profit or loss based on the “absorption” rate of those costs. Measure the effectiveness of estimating. Determine what your true cost of time and expenses is on sold jobs, which will determine an effective sales strategy. If you attribute a labor overhead rate to the hourly cost of labor, measure those costs inclusive of overtime against hours estimated (not used) on jobs. You may find this to either be a profit center, and therefore also a tool to price tighter, or you may find that this is a loss that can be better controlled, or simply that you are “leaving money on the table” with your rates that you can increase without jeopardizing sales.
Learn to maximize profit. Review the categories of sales or “profit centers” routinely. Almost every company does something really well. Identify the job or service you can use to be more predatory in your sales process to increase your bottom line by maximizing your less risky type of work. Correct or avoid the jobs or services that are hit and miss and never seem to work as envisioned. If you have job controls, accurate and timely reporting, a strong pre-sales or pre-construction process, and an engineering/design process linked to the budgeted estimate of costs that supports the actual ability to build within the budget, you can target your sales efforts and increase revenue and bottom line. This will also allow you to take a “tight” job that you want for branding, overhead absorption, or competitive reasons, and drop whatever you make after direct costs to the bottom line.
Make sure the cost of sales on your financials mimics your management reports. All too often information is “lumped together” on the financial statements. Often the categories of direct costs, overhead, or general conditions are not depicted on the financial statements in the same manner that they are used in the estimate or in pricing. For example, for a residential developer, the base home revenue and cost should be segregated from the post sale “selections” revenues and cost, and the home should be segregated from the land revenue and cost. The commercial contractor should segregate direct costs within the estimate from general conditions costs within the estimate on the Income Statement. If there is a separate pricing process for change orders, segregate the revenue, and if possible within your current systems, segregate the cost of the change orders billed or not billed. The service company should segregate revenue and costs of service contracts from time and material work, and segregate the materials/parts that are billable from supplies. Labor and labor overhead should be listed as defined in the pricing, often inclusive of payroll added costs, uniforms, licenses, vehicles costs, radios, pagers, or cell phones. This basic process avoids surprises when viewing financials versus internal job cost or management reports, allows for a “sanity check” as to accuracy, and avails itself to analysis that is meaningful. In the end, construction is a business of risk management. The better the information and its use, the better the “intelligence”, and the better the intelligence used, the better the profit results.
Know what gross profit should be. In keeping with the previous section on “mirroring the estimate on your financials”, the next step is utilizing percentages. Know your gross profit percentage on revenue after direct costs of labor, materials, subcontractors, equipment rentals, permits, etc. If you own a service company, your gross profit is based on your real profit on labor after payroll added costs and costs of non-productive time planned, and your gross profit on parts and materials based on your mark-up is the combination of the relationship between labor and materials planned gross profit percentage compared to your actual gross profit percentage. Variances for all industries are non-billed labor hours from overruns and excessive non-productive time or overtime, missed change orders, missed parts/material billing and estimating mistakes are mitigated by material buy-out gains.
