Ways To Insulate Your Construction Company Against Rising Costs
The construction industry continues to face supply chain slowdowns, labor shortages and inflation — though the latter of the three has generally moderated a bit as of late. To monitor and optimally respond to rising contract costs and market changes, contractors need a plan. Here are eight ways you can insulate your company against the higher cost of doing business in today’s environment:
1. Double down on accurate estimates and timely financial reporting. Generating precise estimates and tracking project expenses in real-time are key to staying within budget. Make sure estimated costs have been updated to reflect inflation, wage increases or other factors.
From there, leverage the right software tools and your company’s historical data to create feasible project budgets and forecast future costs. Use the latest job cost accounting and reporting methods to help identify cost increases before they become problematic.
It’s also important to regularly compare estimated costs to actual costs, as well as to review the likelihood of profitability for all jobs at least once a month. Include both direct and indirect cost allocations and, as appropriate, use the percentage of completion accounting method to recognize revenue.
2. Include a contingency reserve in project budgets. Setting aside a portion of the job budget for unforeseen expenses can cushion the financial blow that all too often comes from surprise cost increases or project delays. Don’t overlook risk management. Identify and assess potential threats early on and have a plan in place to mitigate them.
3. Build flexibility into contracts. Consider price-acceleration clauses or cost-plus contracts that allow you to adjust the contract price and pass unexpected costs on to the owner. Also, when negotiating a contract, look into the possibility of asking for a deposit to buy and store materials before construction starts.
In addition, clearly integrate change order terms and procedures into the contract. Don’t wait until a job ends to pursue this additional compensation. Process change orders immediately so you can get approval and bill for added costs as soon as possible. Timely cost allocation and revenue recognition, along with supporting documentation, will also make it easier to make a claim under a price-acceleration clause — or defend against a customer’s refusal to pay.
4. Negotiate with suppliers. Let suppliers know you’re comparison shopping to encourage them to offer the best deal possible. If feasible, take advantage of bulk purchasing or just-in-time delivery options to reduce the cost of materials and minimize the risk of price fluctuations. Unless you receive a steep discount for payment in full, use manageable financing for your purchases. Although you’ll likely incur interest charges, spreading out payments should help free up cash flow.
5. Incentivize project managers to meet profitability goals. Whether through compensation or bonuses, when project managers have a clear stake in meeting profitability goals, they tend to be more proactive in managing job costs.
That includes tracking labor hours, staying on schedule, double-checking shipments of materials, and making sure subcontractors arrive on time and fully prepared to work. Project managers should also closely review job-specific financial reports and be empowered to make adjustments as needed. That said, put controls in place to minimize the risk of project managers taking unwanted shortcuts, such as shifting costs from one job to another.
6. Bill and collect proactively. When drafting contracts, include payment amounts and stipulate:
- When they’re due,
- How to submit payments, and
- What penalties may be triggered by late payments.
Include any other pertinent information related to paying invoices as well.
From there, ensure invoices are detailed and include all supporting documentation showing proof of work. Diligently follow the invoice schedule outlined in the contract and regularly follow up about unpaid invoices.
If you’re not already using it, accounts receivable software — which is likely built in as a module within your accounting system — can greatly help ensure that invoices are accurate and sent out in a timely manner. Set up automated reminders to bill owners, remind them of due dates and, again, don’t hesitate to inquire about past-due invoices.
7. Explore tax credits. In the hustle and bustle of winning and performing work, contractors often overlook tax credits. These are particularly valuable because they lower your tax liability dollar for dollar, freeing up that money to cover costs or build a cash reserve.
For example, though the pandemic-related employee retention tax credit expired in 2021, eligible employers that haven’t yet claimed it may still do so for up to three years retroactively. Eligible companies can claim up to $7,000 per employee per quarter for the first three quarters of 2021, and up to $5,000 per employee for all of 2020. We can help you determine whether your construction company qualifies for this tax credit or other tax breaks.
8. Improve your overall accounting function. Having personnel who truly understand construction accounting and job costing is critical. You may need to invest in additional training or upskilling to ensure that both your in-office and on-site employees are up to the task of optimally managing costs. You can also count on us to help you assess your financial reporting and cost management processes and technology — and identify difference-making improvements.
Contact us with questions.