Most business owners would tell you that the only thing harder than setting a company budget is sticking to it. Contractors face the added stress of managing multiple project budgets while still handling their overall business expenses.
To keep your construction company’s cash flow healthy and your business on course for a profitable year, you’ve got to do the legwork necessary to create an accurate, reasonable budget and then employ smart budgeting practices all year long.
Calculate spending before revenue
You may be tempted to begin the budget-setting process by estimating total revenue for the year. A better strategy, however, is to start with projected spending. After all, spending is something over which you can exert a little more control.
Divide your expenses between hard and soft costs. As with individual project budgets, hard costs are the “brick and mortar” expenses directly related to physically completing work — such as equipment, materials and labor. Soft costs are indirect costs (such as insurance, fees and certifications) and overhead costs (such as office rent and furniture).
When you divide your budget into these two categories, you’ll have a better sense of which line items are variable and can be adjusted and where to apply cost control measures. Throughout the year, check back on hard and soft costs to see whether new or overlooked ones are threatening the budget. You may also be able to cut some items as circumstances allow.
Evaluate historical trends, data
Taking last year’s budget and adjusting the numbers for inflation is another enticing shortcut, but doing so is typically ill advised. You can and perhaps should, however, review your construction company’s historical data to better identify relevant trends that may affect your budget throughout the year.
For example, study your company’s income statements from the past several years. Start with the most recent one and compare each line item to past statements. If you detect an upward or downward trend for a certain expense, adjust the line item accordingly.
Such a review also presents the opportunity to determine where your operation has consistently spent above or below allotted budget constraints and whether you need to readjust spending, cut back operations or look for ways to raise capital.
An additional helpful tip: To uncover a trend for a line item, divide the current number by the previous year’s number and subtract 1. The answer is the growth rate. Repeat for other years’ income statements and chart the results to visualize the trend.
Be realistic about gross margin
Calculate your gross margin, which is the difference between net sales revenue and the cost of goods sold (COGS). In construction, COGS typically refers to direct costs, such as materials and labor, as well as indirect costs or general conditions.
Compare your gross margins from previous years with the average gross margins for the industry segments in which you perform work. You should be able to locate this data through trade publications or industry associations. Knowing these numbers will help you refine your current budget and set prices for jobs as the year goes along.
When it comes to projecting gross margin, temper optimism with pragmatism. A 5% sales growth last year doesn’t automatically translate to 5% growth this year. Consider other qualifying factors such as staff turnover, current market costs of labor and materials, and the need to buy or lease new equipment.
Also contemplate external factors, such as the overall economy and local market demand. The COVID-19 pandemic has had varying effects on construction. In some cases, projects have been shut down or put on hold. However, an increased demand for single-family housing and home renovations may create more work in other areas, depending on your specialty.
Make it a habit
Without regularly revisiting the budget, you’ll be left to guess whether your construction business is on the right track as the year rolls along.
Set dates in your calendar, at least quarterly, to sit down with your fellow business owners (if any) and top managers to look over the budget. These periodic reviews will help you adjust as necessary to adapt to emerging trends and challenges — and to remain competitive and, one hopes, profitable.
Last, but not least, involve your CPA in the budget-setting and management process. He or she can help you identify and analyze financial trends, as well as implement strategies to guard against risk and leverage opportunities.
A different animal: Project budgets
They may be the same species as an overall business budget, but project budgets are a different animal. Here are a few strategies to consider when creating a feasible project budget:
Factor inflation for indirect costs in bids. While indirect costs can be tricky to identify and calculate, their impact on a project is very real. When preparing a bid, estimators typically allocate a percentage of the total cost for insurance, fleet maintenance and other indirect costs. Be sure to periodically update these costs in your estimating system to ensure you’re not forgetting any and that they reflect current inflation rates.
Include a buffer for unexpected expenses. Every contractor is vulnerable to cost overruns. Unforeseen circumstances, such as bad weather or substandard site conditions, can delay projects and hurt budgets. A good course of action is to reserve at least 5% of the project budget for surprise costs.
Research project financing. Make sure a project owner will likely be securely financed before submitting a bid. By the same token, take care that your construction company can accept the contract and remain financially stable until you receive payment.
The content featured in this article originates from our bi-monthly Contractor Newsletter. Subscribe below and stay in the know.
