Cost overruns have become commonplace in the construction industry. However, as competition grows, standing out with higher standards represents a crucial opportunity to retain and grow your client base. Construction cost overruns happen for many reasons, but implementing cost management best practices can prevent or mitigate the most common causes of projects running over budget. If you’re tired of financial surprises, this guide will help you understand why they happen and what strategies you can implement to keep your costs in line with project budgets.
A cost overrun is when your construction project’s costs run higher than indicated in the budget you’ve agreed with your client because of unexpected or underestimated expenses. Most construction projects experience cost overruns, with one global study reporting overruns in 92% of projects. The typical extent of overruns depends on the project type, with average construction project cost overruns ranging from 20% to 50% in several sectors. Although large overruns are common, their consequences for construction companies are serious, often including:
Construction projects can stretch over months or years, even without delays, and involve extensive collaboration while managing various resources. With so many moving parts, effective cost management for construction projects requires anticipating the potential causes of cost overruns.
Once you and your client have agreed on project plans and specifications, it’s important to rely on an experienced, competent estimator. Construction project cost estimation must account for many independent data points with varying degrees of uncertainty. If you start with a poor estimate, your project is almost guaranteed to overrun its budget. Estimates can go wrong because of factors like:
If you’re bidding on a project, accurate and thorough tender documents are crucial for you to form a precise view of the project’s costs. Inadequate tender documents can paint a misleading picture of a project’s cost as a result of:
Errors or gaps in the initial design can lead to construction overruns because of rework and delays. The longer it takes to spot these errors, the more expensive they are likely to be. The costly consequences of design errors include rework, change orders, cascading delays and compliance issues.
When the project starts based on a design that changes along the way, the rework tends to increase costs. Most construction projects will revise the design along the way, even if the initial design is impeccable. After all their financial models and budgets are finalized, a construction company may end up making a change order because of:
Even with precise planning, a dependable team executing the project is essential to cost management. Subcontractors and employees lacking the necessary skills and experience can cause costly errors, leading to budget overruns.
Construction is unlike many other industries in that you do costly, extensive portions of work before receiving payment for it. This balance can become tricky, especially when working on multiple projects, each with its own budget. It takes meticulous planning to ensure cash reserves will cover materials, subcontractor fees and payroll for a cost-efficient timeline.
Cash flow challenges are common in construction, as many companies operate with limited cash reserves. If one client is late in paying you, this can make it difficult for you to pay all your subcontractors and suppliers on time. The result is often a vicious cycle of delays where parties slow or stop work pending payment, introducing extra logistical costs and wasted labor hours.
When planning errors result in not having the necessary materials on-site in time or not knowing what materials are on hand, the unexpected lead times can cause costly productivity losses and require extra spending on labor and transport.
Besides material management, several other aspects of poor site management can contribute to cost overruns, including:
As the construction industry advances, projects become more complex, requiring more experience. Everyone starts somewhere, but a newer contractor is less equipped to anticipate the many ways unforeseen expenses can creep into projects. As a contractor completes more projects and learns from industry resources, their ability to prepare reliable budgets and manage contingencies will improve.
Once you understand the common causes of cost overruns, you can take steps to reduce the risks. Here are 10 cost management strategies to help you keep projects on track and protect your profits.
A skilled accountant can support effective cost management in several ways, including:
The more realistic and comprehensive the initial estimate is, the less likely a well-managed project is to run over budget. Appoint experienced estimators and engage multiple stakeholders in the estimation process to minimize the risk of blind spots. The estimate should account for historical data, current market conditions and the project specs. For the most efficient, accurate estimates, your estimator should leverage construction project estimating software and support regular reviews to adjust the working estimate for market shifts and unexpected on-site developments. Most quotes are only valid for a limited time.
A project estimate should be specific enough to inform the cost breakdown in your budget. For example, your construction project budget should be able to draw from the estimate to populate categories like:
Give your estimator your budget template beforehand so they can break their estimate down into the categories most helpful to you and point out any gaps in your budget structure. Ensure they understand that you want the estimate to include both construction costs and project costs. Construction costs — or hard costs — are expenses involved in the building process itself, like labor, materials and equipment, while project costs — or soft costs — are the other expenses necessary to facilitate construction, including design, engineering and legal fees.
Schedule weekly, monthly and quarterly budget reviews to compare costs to the budget and take swift corrective actions where necessary. The monthly and quarterly reviews should engage senior staff and tackle any questions concerning the project’s scope, objectives and financial outlook.
The most financially stable construction companies are those that expect the unexpected through contingency plans. Contingency planning involves:
Optimizing your resource allocation can improve cost efficiency, reducing the risk of overruns. Resource optimization starts with a comprehensive resource allocation plan aligned to the project objectives and involves regular reviews to realign allocation with the updated budget.
If you know the marks of a project likely to see overruns, you can act swiftly to prevent or mitigate overspending. Common warning signs of construction cost overruns include:
Hire professionals you can trust to execute project plans with precision, and promptly resolve any design or logistical issues they encounter with leadership. Beyond recruitment, it’s vital to provide sufficient training for laborers and professional development opportunities for all permanent staff. These opportunities are especially crucial for strategic roles like project managers and site supervisors, who have the greatest impact on whether your project stays within its budget.
Develop a close relationship with a reputable lender in the construction industry for dependable support when you run into cash flow bottlenecks. However, prevention is better than cure with cost overruns, so use the other tips in this guide to limit lending to situations where the need is urgent and you have a feasible, timely repayment plan. If you take out financing to fund a project from the outset, check whether your loan agreement includes a cost overrun guarantee clarifying who is responsible for covering cost overruns during the financed project. This clause is crucial to avoid costly misunderstandings. Your construction contract should include a similar guarantee.
Collaborate with your accountant, project managers, estimators, subcontractors and other relevant parties to create a comprehensive financial forecast for your project’s long-term outlook. This collaboration ensures everyone involved understands the parameters they have to work within and provides an opportunity to communicate about potential issues before they lead to costly reworks down the line.
Whenever you complete a project, whether that project stayed within its budget or overran it, conducting an end-of-project assessment will help your team learn and improve. If overruns occur, analyze the root causes and collaborate on processes to prevent or mitigate similar problems in future projects. Documenting these insights and sharing them throughout your company can help improve cost management on every subsequent project.
Polston Tax Resolution & Accounting was founded in 2001 and has grown to serve construction businesses nationwide. Our skilled construction accountants and tax attorneys have saved thousands of clients millions of dollars through record-keeping, tax planning and tax resolution services. Through this extensive experience, our team has gained a deep comprehension of construction cost management practices and financial compliance requirements.
Our approach to construction accounting combines adherence to generally accepted accounting principles (GAAP) with adaptation to the evolving complexities of the construction industry and the needs of individual projects across sites. Consistent application of this approach over more than two decades has positioned our award-winning firm to provide cost management insights applicable to diverse construction projects.
Keeping a construction project within budget can be challenging, but by applying the information in this guide, you’ll be well-equipped to anticipate and prevent cost overruns. If you want the assurance of knowing your project’s finances are in order so you can focus on the strategic decisions that drive a cost-efficient operation, partner with Polston Tax Resolution & Accounting.
Our construction accounting and tax professionals will:
Schedule a free consultation today to discover how we can streamline cost management for your construction project.
