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Ask the Advisors: IRS Audit Triggers & How to Avoid Them
As a construction business owner, you’ve probably started a job with high hopes only to find that the anticipated profit had somehow evaporated. That is, the total cost of performing the work exceeded your initial estimated costs.
This “profit fade” can result from a number of factors. To keep your business on track, you need to learn to play the numbers game that keeps your margins intact and your bottom line strong.
Sometimes, the desire to win a bid can lead to underestimating materials or labor costs. A hasty or careless estimate may omit items for which you’ll later have to unexpectedly pay. For this reason, it’s always wise to have a second set of eyes — preferably a manager or owner — review bids to ensure accuracy and that a reasonable profit margin has been built in.
Remember to include some contingency costs to allow for delays because of inclement weather and other unpredictable developments. Periodically review past jobs that represent a cross-section of profitability, comparing estimated and actual costs to help determine where unprofitable projects went awry.
Closely tracking costs as the project is underway can help you recognize problems and take action early — before they whittle away at profits. Document a budget for each job that’s broken out into project phases, including quantities of materials for each phase.
The project manager should compare the budget against labor time cards and materials invoices to assess progress and whether costs are in line with estimates. Quantifying the work as it’s performed will help you and your management team to make adjustments in the field if expenses are getting out of control.
It’s hard to avoid cost overruns and time delays when the client can too freely make changes to the project while work is in progress. Before beginning a job, make sure you and the client agree on the scope and nature of the work you’re expecting to do — and that this understanding is clearly indicated in the contract.
From there, establish a clear process for handling change orders. As you’re no doubt aware, waiting until completion to bill for changes will likely leave you with an uphill battle to collect those additional amounts.
After each job is completed, compare estimated costs to actual ones. Talk with your foremen and project managers about what went well or poorly, which factors helped or hindered their work, and whether the estimate was reasonable or ill-conceived.
Take what you learn from these discussions and use it to improve future estimates and projects. If certain types of work, clients, locations or conditions regularly seem to increase your costs, adjust your bids accordingly or perhaps even avoid certain types of jobs. On the other hand, if you can identify factors that routinely lead to higher profit margins, focus on that kind of work.
Fighting profit fade is important to every construction company’s financial health. Don’t wait until it’s too late! Doeren Mayhew’s construction CPAs can help provide your company with strategies to go on the offensive to keep costs down and profits high.
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