By Andy Knutson, CPA
In 2017, we worked with a construction subcontractor that had struggled with profitability in recent years despite many project successes. The company’s bonding agent, who was concerned about the situation, had requested a reviewed financial statement and referred us to provide it. During our initial meeting with the owners and their team, it became clear that a lack of communication had contributed to the crisis.
The Issue
After reviewing the construction company’s financials, we realized it had been consistently underestimating projects. The owners and their team were securing plenty of work but leaving money on the table.
The project estimator was doing the best he could with the information he had, which unfortunately wasn’t much. He knew direct expenses, such as labor and materials, and had a rough idea of the sum of payroll taxes, insurance costs, etc. But he didn’t have a clear understanding of equipment charges. What’s more, the estimator was in the dark on overhead costs such as rent, office staff salaries, equipment leases, and technology. He was estimating an amount for these, but it wasn’t enough.
The Solution
With access to information the estimator didn’t have, such as the company’s income statement, we calculated an estimated hourly overhead charge. Then, we gave the estimator this number so he could accurately reflect the company’s overhead costs on future bids.
Next, we helped the accounting department understand what information the estimator needed to do his job. We explained that it wasn’t necessary to share the full income statement, but that the estimator needed some visibility, especially around fuel, insurance, and equipment depreciation costs. We helped the bookkeeper understand how to calculate and reevaluate the hourly overhead charge each year, so the estimator would always have an up-to-date number.
The Result
With a better picture of the construction company’s overhead costs, the estimator knew what his margins needed to be, as well as the point in the year at which the company would break even. This allowed him to be more strategic with his estimates, depending on the time of the year.
We started our work during the winter of 2017, which meant we were looking at 2016 financials. The company had a deep backlog of projects, so it took roughly 12 months to see results. Finally, in 2018, the new estimating process paid off: the company was consistently profitable throughout the year.
The Takeaway for the Construction Subcontractor
Although inaccurate numbers were to blame for the low estimates, it was a lack of communication that caused the system to break down. The accounting department simply didn’t know what the estimator really needed.
Don’t let a knowledge gap stifle your business, especially when it comes to your profitability.
If you’d like to start 2020 by getting a good handle on your indirect and direct costs, we can help. Contact us today.