In construction, accurate estimation is critical. Contractors depend on it to prepare bids that are both competitive and profitable.
In fact, they have contractual protections in the form of cost-recovery clauses.
This approach has an advantage over the simple PPP model in that it is multilateral, thereby imposing global consistency. However, this added level of complexity introduces greater uncertainty into the estimates it generates.
Profit Margin
Profit margins in construction are important for businesses to maintain to ensure they can meet financial goals and continue operating efficiently. They also help to protect against the risks associated with low profit margins, including cash flow problems, reduced reputation, and limited ability to win new business. By understanding and monitoring profit margins, businesses can take steps to improve them.
Generally, profit margin is calculated as the difference between a company’s revenue and its total costs. This includes direct project costs and overhead expenses. The amount of profit earned by the project is then divided by the total cost and multiplied by 100 to find the percentage of profit that has been made. This is known as a gross margin and is a useful way to compare the profitability of projects between different construction companies.
Various factors impact profit margins in construction, including type of project, project risk, and overhead costs. In addition, it is essential to accurately estimate the sales price of a project and add a contingency amount. This will ensure that the sales price is high enough to cover all project costs, including indirect field expenses, overhead costs, and contingency, while still leaving room for a healthy profit. This is the first step to ensuring that your construction business is profitable. It’s also a good idea to avoid using manual calculations, as they can be time-consuming and leave room for errors.
Contingency
Contingency is an important part of the construction estimation process, and can help you keep your project on budget. It is money set aside to cover unforeseen costs or risks that might impact the project’s final cost. It is usually calculated as a percentage of the base estimate.
The amount of contingency in an estimate is a matter of opinion, and may vary between contractors and owners based on their risk tolerances. It also depends on the type of procurement method used, such as lump sum (LS), guaranteed maximum price (GMP), or a combination of both. Regardless of the methods used, contingencies should be carefully planned and managed.
In the case of foreign-funded construction projects, currency fluctuations can have a significant impact on a contractor’s input costs. These include materials, equipment, labour, sub-contractors, insurances and bonds. Because these costs are often negotiated in local currency, they can be affected by changes in the market price of the respective currencies.
Contingency should not be used as an excuse for poor estimating, however. It is important to have a thorough cost-estimating system in place, and a contingency should only be used to cover any unanticipated expenses that cannot be covered by the existing scope of work. It is also essential to determine how any unspent contingency will be handled from the beginning of a project.
Overheads
It’s important for estimators to accurately calculate indirect project costs, as well as total overhead costs. These are the behind-the-scenes expenses that can’t be easily attributed to one specific job, such as office supplies, cell phones, vehicle costs, equipment maintenance, inventory management, uniforms and shop rent or mortgage.
These expenses are necessary to run the business whether or not there is work, so it’s critical for contractors to track and control them. A firm grasp of indirect and overhead costs enables a contractor to run a financially sound construction business, streamline their estimating processes with job costing software, protect payments through accounts payable workflows, and submit accurate bids for projects that are both competitive and profitable.
Indirect costs in particular can be difficult to estimate accurately. They’re often tied to business trends such as labor scarcity, the economy at large and the market demand for certain building materials and supplies. During times of scarcity, fewer specialty contractors can work on the same projects and they may need to increase their bid prices or expand into new segments or geographic locations to compete for available work.
This expansion also increases their exposure to currency fluctuations, particularly if the contracts are valued and paid in different currencies. This is known as forex risk, and there are several ways that it can impact a company’s profits.
Pricing
Exchange rates can significantly affect pricing in construction estimation. Contractors that sell to foreign markets and source materials from other countries can be exposed to a wide range of fluctuations. These fluctuations can have an impact on their operating profit. Consequently, they need to be aware of these fluctuations and adjust their unit prices accordingly. They can also use currency forward contracts to hedge against these fluctuations.
In the long run, nominal dollar-foreign currency exchange rate changes tend to be offset by differences in inflation rates. This phenomenon is known as purchasing power parity. The idea is that the price level of identical goods in different countries should be the same. In practice, however, this is often not the case. For example, a German car manufacturer may have to raise its prices in dollars in order to match the price of the same car produced in the United States.
On the short-run, changes in exchange rates can have a major impact on competitiveness. A change in the relative cost of imports, for example, can lower domestic consumption and cause substitution away from exports. In contrast, an increase in the price of domestic goods may boost demand and increase exports.
Exact models of these effects are not available. For example, a company that sources its equipment from Germany and Japan may have to pay higher shipping costs in dollars than it would in euros. These differences in operational exposure can have a big effect on the company’s operating performance and budget.