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Why you should keep a close eye on your estimates

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By Lance Trammell, CPA, Principal of Assurance Services

A strong foundation is key to a successful project. The foundation is the base on which everything is built, so it must be able to bear the burden.

In constructing the foundation, you have to consider many factors, ranging from the ground it is being built on to the load it must help support. A solid foundation will stand the test of time, whereas a poor foundation can lead to costly repairs. For contractors, a strong foundation is analogous to strong project estimates. Solid estimates on a project consider the scope of work to be performed and proper budgeting of costs. If we don’t properly consider the scope of the work and the costs (load) to take on the projects, then we could be headed down a path of a poorly designed foundation that can lead to costly overruns.

Not only is it important to develop solid estimates up front, it is also important to keep a close eye on the estimates throughout the project. If you aren’t careful, you might just find yourself cutting into your profits.

Fixed price or approximate estimates?

The first thing to review when looking at your estimates is how they’re being generated. Estimating methods tend to fall into two categories: fixed price and approximate.

Because they incorporate detailed information, fixed-price estimates are typically the most reliable method. However, the contractor bears a bigger portion of the risk than the owner does because the job is set at a fixed price, even if costs rise higher than expected.

Many contractors prepare fixed-price estimates on a lump-sum basis. Estimators will compile a job’s price after closely analyzing drawings, specifications and other bidding documents. They then calculate the costs of materials, labor, equipment, subcontractors, overhead and other job-related expenses before applying a markup to the total cost to obtain a lump-sum estimate.

You may also produce fixed-price estimates on a unit-price basis. Here, you submit the bid based on the individual line items. As with a lump-sum estimate, the result determines the total project cost. Your estimator, however, segregates expenses according to each line item’s unit price.

The second method, an approximate estimate, is a shortcut that gives you only a rough idea of a project’s cost. Estimators primarily look at expenses derived from previous jobs, refining their figures as they learn more project specifics.

Are your estimations accurate?

Estimates are just “guesstimates” unless you take the time to understand the scope of work and cost out the project realistically. There are multiple variables going into costing a project so the more complex the calculation, the more likely it will account for the many variables involved. Failing to apply an evolving profit margin calculation can reduce the value of jobs over time.

For example, if you estimate profitability on a flat 10 percent sales price across most projects, you could lose money as changes and delays occur. Breaking down costs more specifically can prevent such losses. To avoid this scenario, many contractors today rely on estimating software.

Construction-specific estimating applications reduce errors and create a historical database to help you refine procedures and generate more accurate data for future projects. They can also relieve much of the chore associated with routine, repetitive and time-consuming calculations. So make sure your software is up to date.

Other ways to keep an eye on things

Your first and last line of defense in generating accurate estimates is the people doing the job. When reviewing estimators’ performances or when hiring new ones, make sure you’re employing professionals who can visualize project phases in great detail. They should also have good organizational and communication skills, a thorough knowledge of construction materials, processes and software and the ability to understand today’s more detailed drawings and specification documents.

To help ensure accurate reviews of estimates, encourage estimators to work transparently; you must know how he or she arrived at the quoted job price. No matter how skilled your estimators or what methods they use to prepare bids, it doesn’t hurt to have another party occasionally check their work for accuracy. This person could be you, a project manager or even an outside consultant. Project managers are a great resource here. Because they are going to be accountable for the job performance, they should have some input on the estimate. When reviewing estimates, verify that the projected gross profit of each job is in line with your profitability objectives and the current bid market.

During the project, hold recurring performance meetings to monitor the job as it progresses. As part of these meetings, make sure notes are being taken on items identified as “misestimates” and make sure those are communicated to the estimator to avoid these from happening in the future. After you complete projects, go back and compare estimates with your actual job costs. Investigate projects that went under or over the original estimates to find out what went right or wrong and to learn from the process.

Over a selected period (one to three years) look at how your company’s estimates were generated. Are too many approximate estimates creeping in and hurting profitability? Are your fixed-price estimates using updated materials costs and realistic labor data?

Remember, the more accurately you estimate projects, the more precisely and profitably you can quote prices for quality workmanship.

Seek the services of a legal or tax adviser before implementing any ideas contained in this blog. To reach a financial adviser at Lane Gorman Trubitt PLLC, call (214) 871-7500 or email askus@lgt-cpa.com.