The construction industry uses three distinct terms to offer their services to customers. Estimates, bids and proposals are terms used to present a dollar value associated with construction work. For the less sophisticated contractors, the terms are interchangeable. The reality is far different. Each term has an historical context and legal meaning. Thus, it is prudent for any contractor to understand the differences and use the correct term when offering their respective services. This article will explain and elaborate the differences between estimates, bids and proposals. In addition, some legal issues are explained; specifically, as they relate to contact law. As a contractor, it is your responsibility to understand the respective terms and when and how to use them. This knowledge greatly reduces your risks, especially risks associated with lawsuits.
Construction Industry Standards
Average Net Profits Are 9.4%,
Net of Income Taxes!
A $750 Billion industry encompassing home construction to industrial development. The construction industry section of the website has over 60 articles related to proper administration and accounting for construction. Learn the nuances that create success in construction.
The national average sales for residential roofing contractors are slightly greater than $3 Million per year. A typical small roofing contractor will have a couple of crews working various projects and frequently sub out jobs. In addition, the owner acts as a project manager and there are one to two estimators depending on the volume of work.
Take-off or takeoff in construction is a term used to refer to the process of detailing units and costs with a job estimate. Take-off is in essence the work papers supporting the final values for both numerical count and dollar amounts of the respective elements of an estimate. Take-offs are not restricted to just materials; take-off includes a separate set of documents to support labor hours and costs; equipment usage, and other types of costs (debris removal, permits, compliance, jobsite facilities, utilities and safety gear). Each industry within the construction sector of the economy uses their own process to create take-offs. At the individual contractor level, take-offs can be performed with pencil and paper or at the other end of the contractor spectrum, reach the sophisticated level of customized industry software. Every estimator must decide for themselves what they are comfortable with as the tool to create take-offs.
Backlog and the associated pipeline of work is the second group of key performance indicators for a contractor. With construction, understanding the volume of existing contracts, i.e. backlog, aids the management team in setting production goals in the near term. In conjunction with pipeline information, a contractor can quickly ascertain future financial performance. In order to do this, the contractor must create a set of key performance indicators that identify existing dollar value of signed contracts not yet started along with their respective time constraints. Furthermore, the pipeline of potential work is stratified in groups and historical performance guides the management team with what to expect for future work beyond the near term.
This is the second part of a three part series explaining the various key performance indicators used by contractors. Backlog of work refers to existing signed contracts, their corresponding dollar value and timeline for completion. Whereas the pipeline KPI is broader in scope. The pipeline of work refers to funnel effect whereby the final outcome is a signed contract. At the very top of the funnel, the widest point, sits all potential contracts that are considered leads. As the report steps into the funnel, not all leads turn into requests for estimates. The goal is have estimates turn into negotiations tied to the dollar value and time frame. The final part of this pipeline is of course final negotiations related to terms and conditions within the contract; e.g. there is a letter of intention by the customer to sign a contract given some reasonable terms and conditions.
Construction accounting exists to provide two key financial points of information to contractors and the management team of a construction company. The first and most important financial point is field production profit. This particular profit measurement is commonly referred to as job profits. It is essential contract revenue less direct (hard) costs of construction. The secondary and almost as important as the primary key financial point is the company’s net profit after taxes. This particular key financial point is the customary financial profit of the company. The first financial point is tied to job costing and therefore, construction accounting is comprised of two different accounting systems. The two systems are job costing and traditional financial GAAP (Generally Accepted Accounting Principles) reporting.
The primary key performance indicator with construction is the annual financial income statement (profit and loss statement). For most traditional contractors, the bottom line, net profit after taxes should be no less than 7% with an average of 9.4%. If the contractor desires to be in the upper 10% of the industry, net profit must be greater than 12%. For those involved in the trades, minimum net profit should be greater than 10%, with the average being 14% and the upper tenth percentile bracket having greater than 18% net profit. Again, after income taxes are paid. However, a year is a long time to wait to review performance. In the interim there are other key performance indicators to identify trends and provide feedback to the management team. They consist of three distinct groups of indicators: 1) Production Reports, 2) Backlog/Pipeline Information, and 3) Interim Financial Outcomes.
The residential construction industry’s average net profit after taxes equals 9.4% during 2019. The top four companies in the United States built and sold 151,366 homes with an average sales price of $376,703. Each home netted after income taxes $35,464 of profit. This equates to an average net profit of 9.4% in the residential construction industry.
There is no preset national standard for markup on materials. The Internal Revenue Service’s Construction Industry Audit Technique Guide (May 2009) states that from the Means Contractor’s Pricing Guide include a standard 10% markup on material for profit. However, profit is only one portion of total markup; therefore, markup on materials starts at a minimum 10%. In some cases markup on materials can exceed 100%. This article provides guidance to the contractor, estimator or project manager with setting the markup rates on materials.
Labor burden in construction is a value added on to the respective hourly labor base wage to to determine the total cost per hour for a particular trade or employee. Labor burden rates are used extensively with estimating and recording actual results. The key to labor burden is that the rate is NOT universal. The value is different per company and in some cases per trade/employee. The rate is highly dependent on the various employee benefits provided and the structure of the organization.
The core tenet of an estimate is that each is unique. This uniqueness is driven by hard costs of construction. There are five distinct hard cost drivers in every estimate. Each cost driver has different application principles (introduced in this lesson), different sources of value and final markup formulas to determine the final estimated hard cost. The five distinct cost drivers are 1) materials, 2) subcontracted services, 3) equipment application, 4) labor and 5) intangible expenditures. Each type of cost (driver) has principles of application, i.e. thought processes an estimator must consider. Some of the principles are common among all five types of costs. Others may be unique to just that particular cost driver. This lesson introduces these five cost drivers and the various application principles involved with each driver.