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Offering a fair price for quality workmanship lies at the heart of every contractor’s long-term success. Finding this critical balance begins with the estimating process.
Over time, however, even the most sound approach to estimating can slip a little bit and require recalibration. The good news is that the tools for the job lie right within your construction company’s financial statements.
A good place to start is gross profit. Get out your income statement and determine just how much gross profit you’ve generated from each of your projects during the last two years. (You can go back even further if you want a larger sample size.)
Although an income statement primarily shows broad categories of income and expenses, your financial statements as a whole should include a contract schedule with gross profit totals that you can reconcile to your income statement’s gross profit amount. Gross profit includes only direct and allocated construction costs, not administrative overhead.
Use your contract schedule to determine each job’s billings and costs (based on the same rates used in the estimating process), as well as each job’s gross profit — both as originally projected and as actually realized to date. Then adjust your contract schedule for jobs in progress at year-end, carryover amounts from jobs started in the previous year and revenue earned, but not billed.
Compare the costs you just calculated using your contract schedule to the actual amount of gross profit on your income statement. If you’re accurately recording job costs, little disparity should exist between the amounts — except for excessive or insufficient allocation rates.
The most common cause of discrepancies between these two costs is charging inaccurate rates while estimating jobs and updating your contract schedule. If you’re misapplying job costs by using inaccurate rates, scrutinize your income statement and contract schedule to determine which cost types are listed with incorrect rates.
Another tool you can wield to your advantage is your balance sheet. First look for overbillings — that is, billings that exceed costs and estimated earnings (in other words, billings that are more than the revenue earned on the job), creating current liabilities (or deferred revenue).
Also investigate underbillings. These are costs and estimated earnings that exceed what has been billed up to a point in time, creating a current asset. Such projects usually have estimating problems, because line items that can be billed earlier have to be beefed up to create cash flows early in the project. It may be due to the timing of the project manager’s billings doesn’t match the work completed to date. If late billing caused the problem, find out why the project manager failed to send out a timely bill.
Of course, just as you need to learn from past mistakes, you also must repeat your successes. Identify — and celebrate — successfully estimated jobs. You might even create an incentive program for your estimators to hit certain job profitability targets.
As construction markets change and the prices of materials and labor fluctuate, the task of estimating can go through its own alterations. No contractor can afford to get too comfortable with his or her estimators’ work. Review it regularly for accuracy and don’t hesitate to make adjustments.
Need help recalibrating your estimates? Doeren Mayhew’s construction CPAs can help. Contact us today!
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