Most residential contractors aim for a net profit of around 10%. But, they typically land around 3% to 7%. Those margins are tight, making it incredibly important to track and control costs and make the best decisions possible. And, beyond simply making a profit, the way costs are managed can determine what cash flow looks like—good or bad.
This guide on construction cost management will break down the importance of this process, highlight some key components, and cover some tips on effectively managing your costs. After all, consider this: on a $500,000 project with a 10% profit margin, reducing costs by as little as 1% can increase the net profit by around 9%. The numbers don’t lie.
What is Construction Cost Management?
Construction cost management is the process of planning, estimating, budgeting, monitoring, and controlling the costs associated with a project throughout its life cycle. The goal of the process is to ensure the project is completed within budget and on time without sacrificing the quality or scope of the contract.
Regardless of the discipline, construction cost management is important. But, it’s especially critical for residential construction, where your margins and budgets are tighter and timelines are less flexible. Here are three benefits of cost management:
- Staying profitable: The effective allocation of resources based on actual costs allows you to maintain their planned profit margins.
- Improving decision-making: By tracking actual costs in real-time, you can make informed decisions when facing unexpected changes.
- Minimizing delays and rework: If you’re closely tracking costs, you’ll have no problem keeping your finger on the pulse of the project. Understanding what’s occurring in all facets minimizes the chances of delays. It’s simply a better way to do business.
Key Components of Construction Cost Management
Budgeting and Estimating
A project won’t get far without accurate budgeting and estimating. A solid, thorough estimate will account for everything from materials, labor, overhead, potential risks, direct costs, indirect costs, and of course, profit. This allows your team to set a realistic estimate from the start.
Pre-construction forecasting tools that use real data to predict costs are also a huge boost, even on smaller residential projects.
Cost Control
Construction management cost controls play an important role in cost management. This process involves monitoring and managing expenses throughout the project, ensuring they’re on budget. If not, the goal is to quickly identify the issues and adjust as needed. The team can stay nimble and deliver your client’s project while preventing project overruns.
Certain techniques can simplify the cost control process. Regularly monitoring the budget and any changes, utilizing detailed reporting with real-time data, and ongoing financial reviews will help keep costs where they need to be.
Cost Planning
Cost planning is an ongoing process that should occur throughout the entire project lifecycle. It ensures you’re allocating resources efficiently at every project milestone and that the project can adapt to changes as they arise—which they always do. Managing costs with milestone-based cost planning (managing project costs by aligning spending with specific project milestones or phases) helps keep things manageable and makes it easier to control costs when needed.
Cost Reporting and Regular Analysis
If there’s one thing commercial outfits typically have over residential builders, it’s effective cost reporting.
Cost reporting is an essential part of the cost management process and allows construction teams to get a true, real-time picture of where the project stands. Understanding key metrics such as actual costs vs. estimated costs allows your team to adjust now as well as estimate better on future projects. It also helps with balancing actual payments (cash) and accrued billables (commitments) and the cash flow implications the differences can cause.
Monitoring expenditure and budget variances enables the team to make necessary adjustments to stay on track. But cost reports aren’t helpful if you’re not analyzing them regularly. Weekly report reviews as well as bank reconciliations will help teams make better decisions and catch issues earlier.
Risk Management
Residential contractors need to perform risk management assessments and work with the data they provide. Teams should sit down and define potential risks as well as their impacts to the project, and use that information to develop plans to minimize the impact. For example, if a material shortage is a risk, and the team determines that its impact will be too severe, they can open up a second account with another supplier ahead of time. This provides a safety net to control the timeline and minimize the costs associated with delays.
If a construction team identifies all of the potential risks on a job and determines the appropriate response ahead of time, they’re able to work faster to address the issue (if it happens), saving wasted time and resources.
Who doesn’t love the sound of that?
And, software can help. We know there is always the potential for slow payments and cash flow pressure. However, you can minimize delays by identifying these issues early with project management software. Rather than letting cash flow back up, teams can recognize there is an issue and adjust invoicing, scheduling, and budgeting in order to stay cash flow positive and keep the project headed toward completion.
Best Practices for Managing Construction Costs
Early Cost Estimations and Contingency Planning
One of the best ways to manage costs is to estimate accurately, as solid estimates help avoid later budget issues. This often requires past data, predictive analysis, and risk management to set up a realistic financial framework. Also, setting up contingency budgets to provide a cushion against unexpected costs will help keep things on track when an issue does arise.
Regular Monitoring and Adjustments
We’ve mentioned monitoring several times already, and that’s because it’s critical for noticing when there are issues and preventing cost overruns. Analyzing accurate reports created by construction software with the latest data can prevent small issues from going unnoticed and compounding into bigger problems. Tracking those changes provides accountability but also a larger data set to use for planning future projects.
The challenge is this: Your monitoring and the subsequent adjustments are only as effective as the freshness of the data being analyzed. That’s a long-winded way of saying fresh data is key. Enter your cost data into the system ASAP for the best possible data-based decision-making scenarios.
Managing Scope Creep
Scope creep is a major challenge on residential projects, but scope changes are manageable without inflating your costs. Clear communication and explaining the change order process will ensure that project owners either avoid changes or recognize they will cost them. Giving your team access to a platform that empowers them to estimate and propose change orders allows them to track scope adjustments and maintain the budget (and profits) while delivering the project the owner truly wants—all before creep can actually occur.
Communication and Collaboration
Regardless of team size, communication and collaboration are critical safety nets against cost overruns. Teams can use construction management software to align their finance, management, and construction teams to promote the free flow of information. This ensures everyone understands the current state of the budget and that any potential risks are identified and shared early. Also, sharing real-time cost data allows teams to work together to make better decisions and keep the project on track.
Post-Project Evaluation
Teams should always be learning. Evaluating the budget and actual spending after project completion can identify inefficiencies, overspending, and other areas with room for improvement. Discuss lessons learned from the cost management process to improve future project estimates and preserve their profit margins.
Tools for Construction Cost Management
The right software can boost cost management tremendously. For example, Beam’s construction management software uses cost codes to masterfully collect and categorize data accurately to truly empower decision-making. Our software asks for cost code input directly from the cardholder, ensuring accuracy and real-time accounting for better cost management.
Maybe most important of all, Beam promotes communication. It acts as the platform needed to connect the different teams and ensure they’re all on the same page throughout the project’s lifecycle. For example, project managers can see both the real-time costs and daily logs from field crews, ensuring they’re always in the know about job process and budget status. The real-time reports give these teams the data they need to work together to make the best possible decisions for the project.
How To Improve Your Construction Cost Management
Construction cost management requires solid data, thorough risk management, dedicated analysis, and effective communication. When a company masters these areas, estimates become more accurate, contingency plans become more effective, and project timelines are easier to stick to. And, as a result, teams can better predict and maintain profitability.
With the right tools and techniques, you can easily improve cost management processes. Modern software solutions simplify all of the different aspects of cost management, including providing real-time reports and platforms for communication. Beam’s construction software is the ideal tool for better construction cost management. Book your demo today to learn more.