Project Cost Controls and Processes for Construction Contractors
March 27, 2017
Despite the strong real estate market which is making most contractors very, very busy, it is more important than ever for contractors to control their projects to achieve their target project profits. Many contractors enter projects with slim margins and take on significant execution risk. When the industry is busy, it is more important than ever to carefully manage projects in order and avoid costly errors that will erode your projected profits. In order to manage this risk, contractors must have strong processes for identifying, projecting, managing and reporting costs on their projects. This has always been fundamental for any well-run construction company. Sharpening processes to control project costs will help ensure that projected margins will ultimately be realized.
Cost control starts immediately upon contract execution and continues until the project closeout. Managing costs throughout the life of a project requires effective foresight, expertise, organizational communication, accurate and organized reporting, and a reliable accounting system. Most importantly, it requires effective teamwork among all project personnel. It is important to develop procedures for detailed recording and forecasting of costs, as well as for the evaluation, approval, and processing of company commitments and invoices.
Controlling Scope Creep
In preparing bids or prior to entering contract negotiations, contractors must gain an understanding of the scope of the project and identify indirect construction-related issues that need to be factored in the initial estimates. These indirect issues include phasing, logistics, schedule, and the availability of qualified labor. Foreseeing all of the costs, not just direct costs, will allow the contractor to negotiate and settle claims for extras from a position of strength.
Subsequent to the award of the project and frequently prior to the contract being executed, the project design and requirements evolve. The contractor must monitor the developing scope against the original scope and estimated costs for this inevitable “scope creep” and communicate these items, their costs and the schedule impact with their clients.
Effective procurement is the best opportunity to reduce the cost and increase the profitability on a project. It not only establishes the initial buyout of the job, but also sets the stage for controlling costs claims throughout construction. Contractors should have a strategic purchasing plan that packages the various components of work to maximize competitive pricing. Unit prices, labor rates, and pre-determined alternates should be identified and incorporated into each purchase.
The Cost Worksheet
Contractors should utilize a standard cost worksheet for every project. Depending on the size of the contractor and the sophistication of each project, it is helpful to utilize an Enterprise Resource System (ERP) system to track the cost reporting, change management, and commitment management. Real-time links from accounts payable and payroll for actual costs will enable better estimates of costs to complete.
Consistent project cost reporting and using standard cost codes are necessary for effective accounting control. The cost worksheets should be organized in a manner that allows easy evaluation against the schedule of values and original cost estimates, and accounts for the latest view of financial status at the project completion.
Lead project personnel should be responsible for the accuracy of the cost report. The accounting staff should provide valuable assistance and monitor the control process, but overall responsibility for the cost reports should rest with key project management staff.
Systemic controls over entering invoices against approved contract commitments should be established in the accounting software. The system should include policies that prohibit payments to vendors or contractors without the proper organizational authority.
Contractors should review and evaluate the project cost worksheets at least monthly for clerical accuracy as well as analytically evaluate line item variances. It is important to determine the latest view of projected aggregate project costs against projected aggregate project revenue. Inadequate contingencies and projected shortfalls should be clearly communicated and alternative strategies should be determined.
The cost worksheet should be one of the primary tools that project management uses to prepare the monthly project status report, which provides senior management a high-level view of the project, including profit estimates. Other relevant information to be communicated monthly is an updated project schedule, a list of unprocured trades, outstanding billings, and critical client and subcontractor issues.
Controlling Changes that Affect Cost
Contractors should establish processes that require immediate written notification to clients of potential scope changes, along with the impact of the change on both the budget and the schedule. Cost estimates should include detailed breakdowns of costs submitted by subcontractors plus additional general condition costs, insurance and bond costs, plus overhead and profit. Ideally, work should not begin on this work unless it is specifically authorized, in writing, by the client.
During a project, it may be necessary to incur additional costs as a result of subcontractor deficiencies. Examples would be contract defaults, supplementing crews due to insufficient manpower, supplementing for required cleanup or rework. Written notice must be provided to the subcontractor with the required cure period so that the backcharge can be enforced so these costs can be recouped.
Project managers should evaluate each subcontractor requisition for work completed in relation to the established schedule of values for each category of work. No payments should be allowed on unapproved change orders. No should extra payments be allowed on base contract amounts to compensate for unapproved change orders.
Everyone can improve
Most contractors have most or all of the above noted processes in place, or they wouldn’t stay in business long; but how well are the processes working? Hopefully project profit fade is rare and major project losses never occur. When they happen, it is common to focus on process changes to correct or prevent the last problem encountered. It is important that all aspects of the cost control processes are objectively assessed and steps taken to improve the weak areas. Most of the time, a series of written expectations of each project position with steps for monitoring and communication is all that is necessary. Improvements to control processes do not always require costly technology investments. Clear processes, clear accountability, and training are the essential elements.