Prevent Profit Fade On Your Projects
Kirsch CPA Group
May 13, 2021
Have you ever completed a job only to realize that the cost of performing the work equals or exceeds the revenue that the project brought in? This phenomenon is called “profit fade” and, if it occurs repeatedly, it can prove fatal to your business.
Although profit fade could threaten any construction business, it’s a particular concern for contractors who undertake long, complex projects. Calculating costs and predicting revenue for these jobs can be difficult because materials costs can rise during the project and unforeseen conditions — such as bad weather — can affect project schedules.
Estimate Accurately
The first step to curtailing profit fade is to produce accurate project estimates. Does that sound easier said than done? Most project losses can be traced back to bid errors, so focus on eliminating them.
Your estimates should be detailed so that they don’t underestimate materials, labor or indirect costs associated with a job. Also, consider reserving at least 5% of the project budget for surprise costs, such as delays due to weather or site issues or to problems such as poor subcontractor performance.
And, if you don’t already, adopt the practice of job costing — coding and calculating the cost of specific activities or tasks — to identify which tasks are making money, and which aren’t. This way you can say “no” to jobs that won’t pay the bills.
Define Contract Terms
Well-defined contract terms and conditions are another way to minimize the incidence of profit fade. For example, contracts with subcontractors should include provisions outlining your rights to:
- Supplement work and be reasonably reimbursed if the sub performs inadequately,
- Suspend the sub’s performance, and
- Terminate the contract.
In some cases, contracts should also require subs to buy surety bonds or subcontractor default insurance.
As for contracts with owners, the language should first and foremost clearly define the agreed-upon scope and nature of the work you’ll perform. Include a clause that limits how much (if anything) an owner can change while work is in progress before paying additional compensation. From there, establish a clear process for change orders and approvals that allows you to bill an owner for approved changes as soon as possible.
To better manage materials costs, consider including a price acceleration provision in contracts with owners that allows you to adjust the contract price if materials prices increase over the course of the project. Some contractors also add contract language asking for a deposit to buy and store materials before work begins.
Manage Costs
Managing materials costs can get tricky — especially as the COVID-19 pandemic continues to disrupt supply chains. So, when bidding on a project, include a backup plan of two or more alternative suppliers. Try to include at least one that’s local. If feasible, build up inventory levels with critical materials and long-lead items to insulate your business against supply chain problems.
Of course, the best way to prevent profit fade is to closely monitor costs throughout the entire construction process. Tracking costs in real-time enables you to recognize problems early so you can act immediately to correct course.
Doing so must be a team effort. Train your project managers to compare labor time cards and materials invoices against a job’s budget to assess progress. Monitoring project costs in this manner bring you back full circle to the estimating process. Knowing and documenting the actual costs of current jobs should lead to more accurate estimates for future ones. Project managers should also communicate effectively with their crews to catch expenses that are starting to get out of hand. And, last but certainly not least, managers need to work well with their accounting team to fully understand the budget and use funds optimally.
Your Role
As a construction business owner or executive, your role is to see the big picture. As each job is completed, compare estimated costs to actual costs to determine what led to a healthy profit margin or, conversely, to cost overruns and profit fade. Once you identify areas for improvement, you can take steps to address shortcomings in your operations or avoid the types of jobs that will likely lead to losses.
Contact us to learn more about preventing profit fade
© Copyright 2021. All rights reserved.
About The Author
Kirsch CPA Group is a full service CPA and business advisory firm helping businesses and organizations with accounting,…
Tags
Sign Up for Email Updates
Related Articles
Tax Treatment of Debt Forgiveness: Watch Out for Tax Bills Delivered COD
- 01-18-23
- Kirsch CPA Group
Manufacturers: Be Aware of These 3 Business Tax Provisions Currently in Limbo
- 01-18-23
- Kirsch CPA Group
The Tax Deductible Mileage Rate for Business Driving Increases for 2023
- 01-04-23
- Kirsch CPA Group
Succession Planning Considerations for Construction Business Owners
- 12-14-22
- Kirsch CPA Group
Prevent Fraud at Your Construction Company With a Holistic Approach
- 11-30-22
- Kirsch CPA Group
Manufacturers Must Act Now to Maximize Depreciation-Related Tax Breaks for 2022
- 11-09-22
- Kirsch CPA Group
It’s Time for Businesses to Rethink Their Working Capital Practices
- 11-09-22
- Kirsch CPA Group
Social Security Wage Base and Earnings Test Amounts Increase in 2023
- 10-27-22
- Kirsch CPA Group
New Law Enhances Payroll Tax Break for Small Manufacturers’ Research Expenses
- 10-13-22
- Kirsch CPA Group
How Buy-Sell Agreements Factor into Business Owners’ Estate Plans
- 09-14-22
- Kirsch CPA Group
SALT Cap Workaround Law Could Save Ohio Business Owners Over $100 Million
- 08-31-22
- Kirsch CPA Group
How Manufacturing Companies Can Benefit from the Section 179 Expensing Deduction
- 08-04-22
- Kirsch CPA Group
Could the Work Opportunity Tax Credit Help Your Construction Company?
- 06-23-22
- Kirsch CPA Group
Good News: IRS Boosts Standard Mileage Rates for Second Half of 2022
- 06-23-22
- Kirsch CPA Group
Education Benefits Can Help You Recruit and Retain Smart Employees
- 05-26-22
- Kirsch CPA Group
Ensure Your Construction Accounting System Has the Right Features
- 05-12-22
- Kirsch CPA Group
John Kirsch Named to Greater Butler and Warren Counties Business Hall of Fame
- 03-25-22
- Diane Glover
Manufacturers Need to Act Soon to Take Advantage of 100% First-year Bonus Depreciation
- 03-17-22
- Kirsch CPA Group
Commission Fraud: Salespeople Getting Paid More Than They’ve Earned
- 02-04-22
- Kirsch CPA Group
Consider a New Approach to Meeting Your Business Real Estate Need
- 09-17-21
- Kirsch CPA Group
Beware: Teleworking Arrangements May Cause State Tax Withholding Issues
- 08-18-21
- Kirsch CPA Group
5 Common Construction Accounting Risks — and How to Address Them
- 07-07-21
- Kirsch CPA Group
Supreme Court Finds No Standing to Challenge a Provision of the ACA
- 06-24-21
- Kirsch CPA Group
Labor Shortage: Unlock Solutions by Evaluating Your Employment Value Proposition
- 06-09-21
- Kirsch CPA Group
Material Participation Standard is the Key to Unlocking LLC Tax Losses
- 05-27-21
- Kirsch CPA Group
Know Your Legal Obligations Under the Americans with Disabilities Act
- 05-13-21
- Kirsch CPA Group
PPP Loan Not Forgiven? There’s a Safe Harbor for Deducting Expenses
- 12-03-20
- Kirsch CPA Group
What You Need to Know About the Deferral of Payroll Tax Obligations
- 09-15-20
- Kirsch CPA Group
PPP Loan Forgiveness – Significant Borrower Friendly Changes on the Horizon
- 06-04-20
- John Kirsch
Tax Filing Deadline Remains April 15 – Payment Due Extended to July 15
- 03-19-20
- John Kirsch
Prepare to Receive a Social Security Administration No-Match Letter
- 10-15-19
- Kirsch CPA Group
IRS Announces Changes for Personal Use of Employer-Provided Vehicles
- 06-10-19
- Diane Glover
Watch Out for these Tax Issues When Planning for Your Business in 2018
- 06-26-18
- Diane Glover
What Image Does Your Organization Present to Large Contributors?
- 03-15-18
- Kirsch CPA Group
8 strategies to help you adapt to economic down turn without layoffs
- 02-24-18
- Diane Glover
Remember To Take Required Minimum Distributions at Age 70 1/2 Or Face Penalties
- 02-17-17
- Sue Schloemer
Time is Money: Don’t Spend Valuable Time Inputting Data into QuickBooks
- 06-18-22
- Diane Glover