You make critical decisions every day in managing your projects and your people. But, do you have the time to control the bigger financial management issues facing your business? Many construction business owners spend their valuable time working in the business, but few are able to devote significant time and resources to work on the business.
Measuring profit fade is important for all construction companies. The profit calculated when bidding a job can fluctuate dramatically as the project develops. The information given during your evaluation of profit fade presents you with the ability to make corrections before it’s too late. This article addresses the following questions:
- What is profit fade?
- What are ways to fight off profit fade?
- What information can be used to avoid profit fade?
What is profit fade?
Many construction companies suffer from a condition called profit fade. It occurs when the profit from a job is less than anticipated – usually due to increased costs. Some causes of profit fade include:
- Aggressive bidding upfront which may lead to initial underestimates of cost, poor job execution and job delays.
- Early downward adjustments on cost estimates can be detrimental for a contractor. By taking the time to review costs for each project, you will be able to gain better control and achieve great consistency of your construction costs.
- Change orders which may not be profitable can be avoided if your client selects all features on their project first and eliminates change orders. Construction can suffer cost overruns and time delays by a contractor when your client decides to change some aspect of your project while work is in progress.
What are ways to fight off profit fade?
At Lewis & Knopf, we encourage all construction companies to establish a thorough review process to detect and manage profit fade. Doing so will help you not only assess your current finances, but also improve your business processes going forward. Below are a few steps to fight profit fade:
- Evaluate Estimating Procedures
Have another management level employee review bids to make sure all costs are included. It’s important to review your projection methods regularly to ensure you’re getting the best possible results.
- Assess Previous Jobs
Select several projects that represent a profitability cross-section of your company’s business. Review each project’s estimate by comparing its figures to the actual. Identify areas where the job didn’t meet the budget. It’s important to review previous jobs to make sure the proposed gross profit is attainable.
When reviewing your estimates, remember to include reasonable man hours and material amounts. In addition, consider allowances for inclement weather.
What tools can be used to avoid profit fade?
Bonding companies look at job schedules to determine, among other things, a contractor’s ability to estimate, consistency in job profitability, profit fade and overtime.
Before your company goes out to bid, review the following list of questions to help you eliminate profit fade:
- What are the causes of any delays in jobs?
- What are the methods used in allocating overhead to jobs?
- Is there good communication between project managers and accounting?
- Are job costs being assigned accurately to jobs?
- Are there certain problems in jobs which seem to happen consistently?
- What were the effects of change orders on the jobs’ overall profitability?
- Is the appropriate amount of time being spent in reviewing estimates?
- Are the underlying assumptions being questioned?
- Are the actual results being compared to preliminary estimates?
- Are the causes of profit being less than originally anticipated analyzed?
By determining the answers to these questions, you will be able to conclude the cause of any profit fade you could have prevented. Based on any weaknesses within your company, you can create and implement procedures to increase your efficiencies.