The Fourth of the Seven Deadly Sins of the Construction Industry: Not Knowing Your True Cost

The Fourth of the Seven Deadly Sins of the Construction Industry:  Not Knowing Your True Cost

Seven Avoidable Mistakes Construction Businesses Commonly Make

We last discussed how to help your employees avoid making bad decisions for your company.  This week, we look at how to understand your true cost of doing business.             

Control sale and production from pricing to completion. Whether you are a contractor offering pre-construction services, a service operation, or some combination thereof, involve all of the necessary parties before commencing the sale output.  Know the costs to be incurred on the job, the hours your staff will put into the job, material requirements, material buy-out gain, delivery requirements/costs, and labor scheduling needs.  All of these make the difference between a proper valuation of your actual cost versus the revenue you will realize in the end.  Simply put, measure what the true profit on the job is supposed to be, so that ultimately, you can measure performance on the job. 

Get everyone on the same page.  Start with a clear understanding of what your profit will be after the direct costs of the job are paid.  If you use overhead or general conditions in your estimating process, have your accounting department measure your profit or loss based on the absorption rate of those costs.  If you attribute a labor overhead rate to the hourly cost of labor, measure those costs inclusive of overtime against hours estimated on jobs.  You may find your labor to be either a profit center (and therefore a tool to price tighter), or you may find it a loss that needs to be better managed.  You may find you are leaving money on the table with your rates, and that you can increase your labor rates without jeopardizing sales.  Review labor schedules, general conditions costs by category, maximization of equipment, the cost of owned equipment versus rental equipment, and the incremental costs of fuel.  All of these items become benchmarks to assist control, the ability of managers to manage more effectively, and to maximize your profit.

Learn to maximize your profit.  Review your profit centers routinely.  Almost every company does something really well.  Identify the product, job type, or service you can use to be more predatory in your sales to increase your bottom line.  Maximize the work you do well.  Correct or avoid the products, jobs or services that are hit-and-miss, or never seem to work out as planned.  If you have production/job controls, accurate and timely reporting, a strong pre-construction process, and a scheduling process linked to the budgeted estimate of costs (which supports your actual ability to produce the job within the estimate), you can focus your sales efforts, and increase the bottom line.  This process will also help when you to take that tightly-budgeted job that you want to do 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 company’s financial statements.  The categories of direct costs, job overhead, or general conditions are not depicted on the financial statements in the same manner that they are used in estimating.  For example, for a residential builder, the base home revenue and cost should be segregated from the post-sale “selections” revenues and cost or change orders.  The home should be segregated from the land revenue and cost, if any. 

The commercial or purely custom residential contractor should segregate direct costs from general conditions costs.  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/warranty department should segregate revenue and costs of warranty from 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, cell phones, etc.  This process avoids surprises when viewing financials versus internal job cost or management reports, and allows for a meaningful reality-check.  In the end, you are in the business of risk management.  The better the information you rely upon, the more strategic and effective your decisions.

Know what your gross profit should be.  In furthering your efforts to mirror 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, delivery, etc.  If you are primarily a “cost plus fee” builder, your gross profit is based on your real profit on labor after payroll added costs and costs of non-productive time planned, on your general conditions allowances, and your gross profit on materials based on your mark-up.  Variances for all contractors to be aware of are non-billed labor hours from overruns and excessive non-productive time, overtime, missed change orders, material waste and rework, missed parts/material billing, and pricing/estimating errors.  Be careful to segregate “buy-out” gains on materials, early pay discounts, or bulk purchase discounts from standards of cost on fixed priced contracts.  This “profit area” is “profit” from your cash flow, not from general operations.  Don’t let these numbers mask or mitigate operational inefficiencies.

The next topic in this series will help you to analyze whether you are truly working for a profit.  Ideas?  Thoughts?  Questions?  Post a comment and let’s discuss!