A Guide to Profitability in the Construction Industry

Why is the guide made?

I have had in-depth discussions with more than 1,000 construction entrepreneurs in just over five years. Very quickly it dawned on me that very few companies know how to value things that have a direct impact on profitability, cost awareness and the avoidance of a cash crisis. The situation in the construction sector in Finland therefore requires a radical change of attitude.

In this guide, I want to open up things that I feel are really useful to many construction companies. If you want to improve profitability for your projects, read the guide to the end.

Profitability

It is often thought that the profitability of a company is influenced by the market situation, supplier prices, as well as chance and own making have only a limited impact on the final result. However, I firmly believe that by correcting cost accounting, bidding and project tracking, a large number of construction companies in Finland will be able to operate profitably regardless of the industry.

Profitability of project level in contracting

The issue can be approached very simply at first:

Know your costs
Make a budget
Define the desired result on the bottom line
Follow the plan

However, things are not always this simple. When starting to create a budget, questions arise as to what costs are allocated to the project, what are the fixed costs, and so on. The world situation also affects many things in other respects. Therefore, special attention should be paid to profitability factors.

Cost accounting

Many construction companies have approached cost accounting on a light basis. It may be that the calculation does not take into account, for example, the breakdown of a more precise level, leaving the company's learning gap. However, cost accounting establishes the basis for the profitability of the enterprise, as will become clear in the following.

Use the litterbox structure in the calculation

The most reasonable way is to first structure the calculation structures in cost accounting into main liters and sub-liters (depending on the size, duration of projects, and the operation of the company). The litter structure should reflect the costs accrued to the project chronologically - aware that the projects are not similar to each other.

Why is the litterbox structure important? Both for calculation and for monitoring purposes. It is good to transcribe the calculation according to the activities of the company, so that each aspect is taken into account with certainty.

Use product packages in the calculation

In cost accounting, you should prepare so-called product packages under different transcripts, which can be used for calculation and monitoring. In some systems, product packages are as terminology stakes and in this case we do wagers.

The product packages used in the calculation are important because you get to know the costs of your business and get the planned margin from the project instead of surprises.

What does the product package include?

A product package, as its name implies, is a package that aggregates all the costs under one package of products, what is the cost of making a particular product.

The product package may include

Labor costs
Material costs
Subcontracting costs
Other Costs

Cost of product packages

What is important to consider in the costs associated with the product package?

Labor costs

Hourly wage to be paid to the person or group of persons working in question
Employer page expenses calculated on top of salary (employer page expenses have increased significantly over the years, which is not taken into account in many companies)
Time spent on that work performance in hours per unit of work performance

Material costs

Unit cost of material (e.g. lumber cost for one metre)
Material consumption per unit of product package
Material waste percentage (this is important to consider already at the calculation stage)

Subcontracting costs

Cost of subcontracting work or materials from subcontractors

Other Costs

Machinery and equipment
Fuels
Meal allowances, daily allowances, mileage allowances
Other costs other than labor, materials, or subcontracting

At this stage, it is important to note that there may be several product packages such as these, if the number of square meters to be installed is large (the duration of the working time is smaller relative to the squares) or other variable factors.

Did you know that? With current technology, you can import text structures and product packages into the system in bulk using Excel, so you do not have to spend time on the monthly cycle as it used to be.

Product Packages vs. Cost Per Square

Why is it important to make product packages, and not just estimate the cost per square?

In short: without this, you will not learn to know the costs that are part of your projects, since you will not receive a budget for cost tracking, to which you will go to compare the costs realized at a later stage. Of course, you can get the budget up to the litter level for cost tracking, even if you enter it manually.

If the costs are not based on actual costs during the calculation phase, how can you get the information that:

whether the hours worked exceeded the budget
whether the hourly cost is sufficient, for which the working time is calculated
whether the expenditure of the material exceeded the budgeted expenditure
whether the unit cost of the material exceeded the budgeted unit cost
whether the realisation of subcontracting or other costs exceeded the budgeted costs

In short: you will not be able to access the vital information why the project was not profitable and you can easily draw the wrong conclusions, which will further increase the possible plight of your business.

Importance of monitoring

Once a contract has been established on costing, it is clear that active monitoring of the implementation is of utmost importance. Therefore, the accuracy of monitoring, its scope and the positive user experience for employees are not in vain emphasized. Monitoring teaches, creates real-time cost and invoicing data and makes understanding the overall picture of the business effortless. However, I'll go through a couple of different types of contractors first, and the benefits of being an informed contractor.

“Mid-price contractor” vs. informed contractor

A lot of times I talk about a “mid-price contractor”. By this I mean a company that, based on averages, estimates costs in different areas with Excel and offers its products based on this. In addition, the “average price contractor” often monitors the profitability of a project only at the project level, not at the litter level.

Also, I'm comparing the difference between a supervised contractor and a “mid-price contractor”. An informed contractor calculates based on actual costs and monitors the profitability of projects at the litter level. An informed contractor is able to take into account the calculation if the project is in some respects easier or more difficult. The “average price contractor” defines the squares and uses a certain average price.

If an easy project is offered, the bid of the “mid-price contractor” exceeds that of the notified contractor and thus loses the competitive situation to the notified contractor. Similarly, in a more difficult project, the “average price contractor” will beat the notified contractor with a lower contract price, but will not receive the desired margin.

This inherently directs the awakened contractor to do easier projects and the “mid-price contractor” to do more difficult projects, because the “mid-price contractor” has not been able to calculate all the necessary costs, resulting in a lower contract price offered.

In so-called normal projects, both do equally well. The problem comes in the long run when the pressures of the “average price” contractor increase in many respects as profitability remains lower than that of a vigilant contractor. This can be reflected in an attempt to obtain a high margin for additional work or to start shorting at the site, as the budget may have been exceeded even before the end of the work. This can be reflected in conflicts with the customer, for which there is no need for an informed contractor.

Litter-level cost tracking as part of everyday life

Until a few years ago, litter-level cost tracking received a negative reception in many companies. I understand these entrepreneurs very well, because many of the proponents of litter-level monitoring began to want really accurate monitoring, where there were far too many transcripts.

The routines of people in different roles involved in monitoring in one way or another should be remembered in each situation:

First of all, I want to raise the workers who work on the site. If at the site you have to think too much about what kind of litter or subterfuge today's work belongs to, the workers will consume unnecessary time and energy and, in the worst case, get tired of monitoring altogether.

The second group of employees are those who audit purchase invoices and allocate costs to litters. There is a risk that monitoring will soon be completely missed, as monitoring takes too much time and energy from a large part of the organisation.

I support such a litter-level monitoring that is equivalent to

daily activities of the company
the company gets a good enough picture of the profitability level of the projects by sector
monitoring does not employ very many staff
the monitoring is clear and every person in the organization understands why the monitoring is being done (not for policing, but for a profitable business)

What is the correct accuracy for monitoring the level of litter?

This, in my opinion, is a completely company-specific issue. It depends entirely on how long the projects are, what steps are included in the project, and what size the work amount is.

If the projects are hours/day gigs, there is no need for a litter-monitoring. In this case, I recommend project type-specific monitoring, in which projects are divided into, for example, certain service gigs, warranty gigs or whatever the company has. If the duration of the projects is one week long, the follow-up should be divided into at least 2-3 litters. For longer projects, respectively, to a more precise level.

Sum summarum: The monitoring of the level of litter is determined by the activities of the company. The most important objective is to have an adequate understanding of whether the calculated costs correspond to the actual costs. And in such a way that monitoring does not overwork the company's employees in their daily activities.

Benefits of litter-level monitoring for the company

Especially for projects lasting a week or longer, littering monitoring is extremely important. If monitoring is carried out only at the project level, it will be seen when the project is completed whether the project went well or poorly financially.

There is a saying, “like looking for a needle in a haystack”. This describes a situation where you go through a project and spend a lot of time trying to find out what went wrong with the project. In addition, a lot of valuable time is lost if the company's finances are tight or there is a need to otherwise make changes to financial planning. Because the situation will be sorted out with a long delay.

Similarly, monitoring of the litter level and the preceding calculation based on actual costs provide the company with valuable information on whether changes need to be made to the calculation and to what extent changes should be made.

Let's take an example; At the beginning of the project, the company notices that the costs realized with the litter of earthworks increased above the budgeted costs.

It is very easy to look at the following things:

whether the hours worked were exceeded - that is, whether the hours worked were calculated too little relative to what was achieved
whether the cost of the work was exceeded - whether the factors used too small an hourly cost in the calculation
whether the quantities of materials were exceeded in relation to the calculation - whether there were too few materials counted
whether the unit cost of materials was exceeded in relation to the calculation
whether the cost of subcontracting was exceeded in relation to the calculation
whether the proportion of other costs was exceeded in relation to the calculation
was there anything missing from the calculation that had to be done and there were additional costs

In each situation, the change can be made as soon as the error is detected in the calculation library of the bid calculation program, so that the same error is not made a second time (the changes must be effective immediately in the next calculation). And the change can be made immediately during the project, as long as the company has real-time, litter-level monitoring.

It is extremely important to make repairs to the calculation library immediately, because typically companies have several projects to calculate, so the damage does not have time to recoup in future projects. In companies that carry out backcounting, this problem is unfortunately common.

Real-time

It is often thought that you will have time for tomorrow, but for the company tomorrow may be too late. That is why I emphasize the importance of real-time monitoring in ensuring business profitability. Here are some of the main points regarding real-time:

From post-calculation to real-time monitoring

Many trainings and textbooks talk about the importance of postcalculus. Of course, backtracking is better than a situation where there is no follow-up of any kind. However, I'm all for real-time cost tracking, because people might misremember things later on when you set out to go through which part of the project succeeded and which part of the project failed.

There is another aspect of real time in larger projects: additional work. I've heard a lot of stories about how, after finishing a project, the entire project was backcounted at the litter level. Such calculations reveal, among other things, that more has been done than was actually included in the contract. Additional work would always have to be approved in advance by the customer, but in these situations the work had been asked to be done orally by the people on the site during the project. And so the hours realized and material costs were higher than what was budgeted for the project. This same pattern was repeated with more litters.

With real-time monitoring, such issues are noticed already on the first letter, allowing you to take better control of the costs during the final project.

Real-time monitoring makes it possible to better detect many things. Do you have to be on target all the time from the beginning and do the things with the materials that are planned in the calculation phase?

Examination of the project mass of the enterprise from different “angles”

Have you ever wondered what the profitability level is for a particular client, for certain types of projects, when a particular foreman is pulling projects or in some other aspect. If you follow individual projects separately, you will not easily know what connects profitable projects and what connects unprofitable projects.

When your company has calculation and cost tracking in the same system at the litter level, and you can analyze from different “angles” to the profitability of the entire project mass at the litter level and different filters, you will gain significant added value compared to your competitors. You will be able to quickly make changes to various things, quickly and easily see which of the people in the organization should be hired as key people in your company based on good results, and with whom it is good to have a development discussion to improve the situation.

In addition, you will get an idea of whether additional work is worthwhile for your company. You can see the situation according to different contract formats, if you occasionally perform total price contracting or unit price contracting. In the current turbulent situation, the use of such data is extremely important for maintaining and developing competitiveness, profitability and operating conditions in general.

Summary

The profitable business of a construction company is actually based on a few important points, which are only carried out systematically and according to the same formula. So, remember the most important things about the mechanisms of profitability in the construction sector:

1. Take into account all expenses in the calculation and do it right!
2. Use easy product packages with all expenses embedded
3. Make a quotation or cost calculation at the litter level
4th. Monitor in real time and ensure employee experience
5. Learn from previous projects and develop operations, computation and monitoring
6. Use Fondion for operational management in the construction sector.

If you want to deepen your understanding or discuss the specific needs of your company, book a free consultation with a Fondion specialist. We are happy to help you find the best solution for your needs.