In today’s construction environment of on-again, off-again project leads and uncertain progress payments, where each project stands in terms of percent-completion matters more than ever. Depending on a firm’s project forecasting capabilities, what ends up being billed each month could be dead-on or just wishful thinking.
Examples of Poor Job Cost Forecasting
Following are examples of off-the-mark project forecasting that negatively impacted cash flow and profits.
Scenario #1:
- A subcontractor based its percent-completion figure on original budgeted direct costs rather than projected, final direct costs. As actual direct costs mounted, the company believed it was moving toward project completion. The impact of costs related to change orders and other over-budget items inflated the original budgeted direct costs, so the projected final direct costs should have been adjusted.
- Underlying Causes: The subcontractor only had one project manager overseeing 30 jobs and lead men were acting as field managers. With only one foreman in the company, little focus or time was spent on cost tracking and cost controls. The president and the controller did not understand percent-complete and the project manager was overwhelmed with too many jobs, leaving no time available to factor new direct costs into monthly projections. The estimator could not assist due to being overwhelmed by a high volume of bids.
- Final Result: The company recognized its lack of commercial experience and returned to the residential market.
Scenario #2:
- A general contractor relied on its project managers to forecast where projects would end up. By fiscal year-end, the company showed a very strong gross margin of 12 percent. A major correction had to be made to the gross margin in excess of $1 million by the end of the new fiscal year’s quarter.
- Underlying Causes: The operations manager never visited the jobsites to verify job progress and project manager projections. Instead, the operations manager preferred to sell new work. The president was an absentee owner who relied on the operations manager. The company produced strong profits for three straight years, so managers and employees felt pressured to show unverified project profits.
- Final Result: The company terminated its operations manager and completed its over-budget projects. Though bonding was temporarily limited, the company is now growing.
Scenario #3:
- A general contractor’s project managers and superintendents did not have good systems for tracking subcontractor or general conditions budgets when variances occured. On large projects, wild million-dollar gross profit swings became normal.
- Underlying Causes: The vice president of operations never adjusted his hands-on management style to accommodate a larger company, an increase in projects and more employees, which led to a breakdown in control. There was no delegation and project managers were not properly trained. Changes were made to take project photos to identify project progress, but visual production lags were overlooked. Project manager accountability was built into projects to manage tasks, but tasks were performed without quality.
- Final Result: The company conducted a turnaround consulting project to develop action plans to grow profits in every facet of the business, set high-performance standards, and to reclaim its bonding capacity. Outgrowth of these turnaround efforts revealed a lack of job cost knowledge and a lack of familiarity with the field. The company made it mandatory to produce every estimate with operations oversight. Turnaround efforts also led to a new incentive plan for all employees. As a result, the company flourished with record revenues and profits.
Best-In-Class ApproachThe best approach construction firms can take to manage the variability in percent-complete projections is to negotiate a schedule of billings within their original contract. These guaranteed payments are made without an emphasis on specific job progress as long as reasonable, visual progress is being made on the project. This encourages companies to be more aggressive in accelerating the construction schedule because additional monies are built into monthly payments.
Companies can verify percent-complete even without a contractual schedule of billings. First, review direct cost dollars spent and combine them with committed dollars; then compare this number to the original budget for any significant variance. If the overall direct costs are projected to stay in line with the original budget, divide the actual dollars spent and accrued by month-end by the original. This yields the percent complete.
An example would be a job with an $800,000 original budget of a $1 million revenue contract, and actual costs of $200,000 recorded on the job cost reports. At this point, the company would calculate a 25 percent complete job and the billings-to-date would be $250,000.
Two things can change the percent-complete, including accrued items. If there are $100,000 worth of accrued (put-in-place but not paid) items, the month-end direct costs will total $300,000. This produces a 37.5 percent complete job, not 25 percent. The billings-to-date would be $375,000, a difference of $125,000. Accurate direct costs matter because they affect cash flow.
The second item that impacts percent-complete is when the overall budget changes to exceed $800,000. If the budget increases another $100,000 to reach $900,000, but the job costs remain at $200,000, the percent-complete is reduced to 22.2 percent (from 25 percent), the company is not as far along as it thought. The original contract stayed the same at $1 million. The net cumulative billings-to-date impact is a $28,000 reduction.
By verifying the percent-complete, walking the jobsite, taking project photos and performing independent reviews of job cost forecasts, monthly swings in gross profits and billings can be minimized or eliminated. This places construction firms in a stronger position when discussing the project status with customers, architects, engineers, suppliers and other contractors, which solidifies cash flow continuity.