Key Performance Indicators With Construction – Backlog and Pipeline of Work (Part 2 of 3)

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

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.

Key Performance Indicators With Construction – Production Reports (Part 1 of 3)

Key Performance Indicator

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.

Residential Construction: Average Net Profit After Taxes Equals 9.4%

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. 

Markup on Materials – Setting the Proper Rate

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 – Proper Rate Formula

Fixed Costs

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.

Estimating in Construction – Part V (Cost Drivers and Application Principles)

Estimating in Construction - Part V (Cost Drivers)

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.

Implement Job Cost Accounting in Construction

Implement Job Costing in Construction

Financial success in construction is tied directly to job costing. Without job costing, financial wellness is likely a product of coincidence than authority within this industry. Implementing job costing in construction is the absolute best financial control a contractor can do to ensure success. Tie cost accounting to the estimating process, and prosperity is all but certain. Rarely does any contractor fail when they implement job cost accounting.

Estimating in Construction – Part IV (Concepts, Tenets, and Principles)

Well developed, accurate and timely estimates are the best tool ensuring profitability in the construction industry. No other internal control mechanism is as valuable to the contractor as the estimate. Good estimating systems in construction provide the management team with the necessary confidence to make long-term decisions benefiting all parties involved with the company. Customers receive a higher quality structure with less warranty requirements, employees get a sense of security with their tenure, and vendors/subcontractors acquire desirable relationships with their contractor assuring delivery of best practices for their respective trades. Simple put, good estimates deliver profits to the contractor.

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