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 is a multi-billion dollar industry comprising sub industries of residential, commercial, office, civil, site development, roads and more. The layman often thinks of your residential contractors when hearing the term.
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.
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.
Estimates are a controlling tool to guide the construction management team towards improved profitability. Estimates by themselves do not generate profits; actual performance creates profitability for the contractor. Estimates act as the technical manual for the project. Once the project is completed, the contractor must compare the actual results against the estimate’s values. In effect, the financial outcomes are evaluated against the originally estimated hard costs. The information gleamed from this evaluation educates the construction management team with what works and any failures. Then end goal, identify poor performance. It is then up to the management team as to how to properly address this issue eliminating this type of mistake in future work. The long-term results are improved profits, higher quality performance, improved customer satisfaction and most importantly, the esprit de corps that comes with team success.
To grasp this concept the reader must first understand some history associated with mark-up. Next, a modern approach is adopted which requires an understanding of hard and soft costs. Once the two types of construction costs are incorporated, the contractor will learn how to read and interpret a basic profit and loss statement. With this knowledge and given the various margins for the respective type of contractor they then can calculate the mark-up needed to achieve financial success. It all begins with a little historical perspective.
Success in construction requires control at both the organizational and field operations level. The owner must set the culture; put into place a structure, create policies, implement systems and use procedures to control the end result. Control the outcome and the contractor will earn a good profit and achieve success.
A tool used by a developer, contractor or homeowner to keep the primary party committed to getting the project completed is called ‘retainage’. In effect, retainage means to withhold a small percentage of all payments made until all the work is done. The idea is prevent the contractor, subcontractor or vendor from earning their respective profit until they have completed their agreed upon service.