Construction Business Best Practices Series, Step 5: Accurate Estimating Systems

Editor’s Note: This article is the fifth in a series of twelve to lead you toward entrepreneurial excellence by our regular contributor George Hedley, owner of Hedley Construction and Hardhat Presentations. 

Has this ever happened to you? You negotiate an easy project to build with a great customer who trusts you, doesn’t question your costs and awards you the job at your price. Then, seven months later, you discover your estimator didn’t put enough in the labor budget to complete all the work required. The time and energy building a trusted customer relationship has been wasted because of a poor estimate. This is a contractor’s worst nightmare!So, you ask your estimator what happened. He blames it on the project manager, the superintendent, the weather, the architect, the engineer, bad plans or his bad childhood. What do you do? You can’t fire him. You need to bid lots of work to keep the pipeline full. Plus, you don’t have enough time to find and train another estimator. Now what?

Construction is Not Easy!

Building an excellent construction business is tough. Most successful construction companies were founded by entrepreneurs who are excellent cost estimators. Building projects is important, but calculating accurate costs are necessary to make a profit. To get a signed contract, you find a sales lead or customer who needs what you offer, then, you prove your company is qualified to do the work. You pick up plans, do the take-off, secure subcontractor and supplier bids, prepare your final estimate, mark it up and then submit your bid. Next, you wait for the bid results. They call and ask you to revise your bid to include more items. You call the customer to review your inclusions and exclusions. You cut your price again to get the job. Finally, you sign the contract and hope you’ll make some money.

As I built my business, estimating systems were the foundation to my overall business success. When you know costs going into a project, you can manage jobs better and make more profit. But as your business grows, you have to delegate estimating to others. To do this, you need to create and maintain accurate estimating systems and controls. As you develop systems, remember your goals are to replace yourself with systems and produce the same results every time.

Know Your Job Costs!

The first goal of accurate estimating and bidding systems is to insure you know and track job labor, equipment, material and subcontractor costs. Ask yourself these questions as you think about preparing your next bid:

• Do you know and track job costs?
• Do you recap final costs versus the estimate?
• Do your field timecards reflect the real costs per work item?
• Does your accounting system give timely job cost reports?
• Will your estimate produce accurate costs?
• Do you keep track of labor costs?
• Do you have a cost history library?
• Do you feel confident in your costs?
• Are your general conditions costs accurate?
• Is your labor burden rate correct?
• Is your crew bidding rate accurate?
• Are your equipment rates accurate?
• Is your overhead markup sufficient to recover your overhead?
• Is your profit markup enough to give you a proper return?

What’s your estimator’s No. 1 priority? When I speak at conferences or conventions, I get many responses to this question. They include the following:

• Bid lots of jobs
• Get lots of work
• Maximize sub-bid coverage
• Be competitive
• Know what things cost
• Make a profit

The top priority for my estimator is to arrive at accurate job costs. I don’t want our bid to be an estimate of what a job might cost, plus or minus 10 percent. Estimating accuracy is a key to long-term construction business success. The only variable on any bid should be the profit mark-up. Excellent and experienced estimators know what things cost. In my opinion, their estimating goal must be to prepare bid estimates within 1 or 2 percent of the final actual cost on every job. Good estimators continually compare their past bids to the final job cost results to see how accurate they were. Then they make adjustments accordingly for their next bids. They are in constant contact with the field superintendents and foremen to review how they arrive at estimated costs. They continually review labor, material, equipment, subcontractor and supplier costs to insure they know every possibility for differences in the jobs they bid.

Accurate Estimating Rules

1. Every estimate covers your job costs.

Your estimating goal is to calculate the ACCURATE final cost of building each project you bid. Estimates should not include any “fat,” “fudge factor” or “slop” to cover unknowns. A perfect estimate equals your actual cost of doing the work. Can you cut your costs? No, unless your crew leaves something out or gets creative during the installation process.

2. Your estimate is the total cost.

Estimating is arriving at the total job cost. To arrive at accurate costs, the estimator is responsible for knowing what things cost. They must review final job costs and update their cost history library on an ongoing basis.

3. Your bid is the total contract amount.

A bid is the sum of accurate estimated job costs, plus your overhead recovery markup, plus your profit markup to hit your company goals. You job costs shouldn’t vary from the estimate. Your overhead is the amount required to recover the cost of doing business. Can you cut your costs or overhead? Both job and overhead costs can’t be cut when you are preparing bids as these are fixed amounts. The only bid variable is profit. Profit is the reward for taking business risks and should be adjusted based on project risks.

4. Contracts are opportunities!

When you are awarded a job you have an opportunity to get paid for job costs to cover labor, equipment, material and subcontractors. Then you have an additional opportunity to make some money, only and after you recover your overhead. Your overhead is a set amount determined by your fixed cost of doing business. Your overhead includes all of your general and administrative costs and goes on with or without any jobs under construction. Each job must pay its pro-rata share of your annual overhead budget.

Many times I listen to construction business owners lament over how they can’t get enough markup to make a profit, or they complain they bid work and it comes in costing more than they figured, or they never have enough money to pay themselves a good salary. The problem is simple. Basic business math must be understood.

Volume – Job Cost – Overhead = Profit

You can cover your job costs on every job, but not have enough left over to recover your overhead or make a profit. This usually happens to contractors who don’t understand business fundamentals. You don’t make a profit until all of your annual job costs are paid for plus you pay back all of your overhead costs for the year. Most companies don’t cover their overhead costs until October or November and don’t make a profit until December. Just because you have money in the bank doesn’t mean you are profitable.

When you increase overhead by hiring an estimator or bookkeeper, your choices are simple: raise markup or increase sales volume. If your volume or markup decreases in a softening market, your only choice is to cut overhead or increase sales. When job costs increase, you’re in trouble as your only choice is more sales. Most owners mistakenly focus on cutting costs instead of increasing revenue when things go bad.

Risk is a Five Letter Word

What is the most risky thing you do? Think of your profit markup as a risk factor to cover the variables of building the project. For most, labor is the most risky thing you do. What is your second most risky factor? It is probably equipment or materials. The least risky factor is subcontracting work as you have lump sum fixed price contracts for these trades.

To compensate for risk factors, excellent estimators keep track of labor in production hours or crew-hours per work task. I call this the “man-hour” method of estimating. For example, it might take two man-hours per cubic yard of concrete to pour footings. These man-hours shouldn’t vary from job-to-job or from year-to-year. But they will vary for different job types. A good estimator tracks job costs by job type, job difficulty, job size, job location, crew size and customer.

To track job labor or equipment costs by work task, set up your timecards to track the tasks you perform and want to use in your estimates. For example, a concrete contractor would keep track of labor costs to pour building slabs in man-hour per work task as follows:

Is Your Bid a Mystery?

Job cost overruns also occur when contractors use unit prices to bid their work. Site concrete contractors bid curb work by dollars per lineal foot of curb, fence contractors bid dollars per lineal foot of fence and painting contractors bid dollars per square foot of wall painted. Over time, these simple unit prices become their standards. And as prices rise for labor or equipment, these contractors don’t make proper adjustments accordingly and are guessing the real costs. I call this the “mystery” method of estimating.

At a fencing contractors’ association meeting, I asked 100 contractors how much a six foot chain link fence costs. Everyone answered the same: $9 to $11 per lineal foot. I then asked if it mattered how big the job was, how difficult the job was, if the access was easy or if the footings were to be placed in rock or in an asphalt parking lot. They didn’t know how to calculate the different conditions to vary their bids accurately. They didn’t keep job costs in man-hours per work task based on differing jobsite and project conditions.

A good accounting software package tracks labor time by cost code work category and then gives tracking reports on the man-hours expended by category of work performed. Make it your priority to acquire an excellent job cost accounting software package as a tool to build your company. Always recap the estimate versus actual project costs. Compare these actual costs versus the man-hour costs you used to bid each project. Then keep these results in binders by job type so you can refer to them when a similar job comes along to bid.

Markup Based On Risk

Most contractors bid every job using the same markup for overhead and profit. But isn’t your project risk different for labor versus subcontracts? Yes! Subcontracted work items have significantly less risk than labor. Vary your markup accordingly. Look at the bid example below:

• Which job takes more overhead to run?
• Which job takes longer to build?
• Which job has more risk?
• Should the overhead and profit markup be the same markup for both jobs?

When you calculate the overhead and profit markup the same on every project type you bid, you’re not getting compensated for the risk you take. And then you land difficult jobs too cheap and don’t get the easy jobs. This causes your company to stay busy doing the wrong kind of jobs. You must vary your profit markup based on the risk factor. Labor needs a higher markup than subcontracts. A better way to bid job # 2 is a follows:

Yes, your price is higher. But this reflects a more accurate bid based on the risk factor you’ll encounter on the jobsite.

Accurate Estimating Checklist

1. Accurate Time Cards-Excellent estimators know accurate estimating starts with accurate information from the crews who actually do the work. Step one is to insist your timecard is divided into the cost codes you want to estimate with. Then, it’s the estimator’s responsibility to insure field workers are filling out timecards correctly.

2. Accurate Labor Burden Rate-Do you know how your labor burden rate is calculated? Is it accurate or an approximation of what your accounting department thinks it should be? An accurate labor burden rate is essential for accurate estimating. If your rate is padded, you are too expensive, and if it’s not complete you’ll bid too cheap. Review it for accuracy and include taxes, workers’ compensation, medical, liability insurance, vacation, union dues, safety training, small tools, overtime and down-time.

3. Accurate Crew Bid Rate-Excellent estimators use different crew rates to bid different projects based on what the job needs. A crew on a difficult job needs more experienced people, while a larger simple project can use less trained crew members. Figure different crew sizes and make-ups to determine your accurate man-hour crew bid rate.  I like to calculate bid rates for two-, three-, five-, ten-, and twenty-men crews. You will find your bid rate varies considerably for different crews.

4. Accurate Equipment Rates-Excellent estimators know what equipment really costs. Calculate the cost for each piece of equipment your company uses. Total the purchase price, interest, maintenance, gas and insurance over the life of the equipment. Divide this total cost by the expected number of billable hours to arrive at you accurate cost per hour.

5. Accurate General Conditions-Most estimators either guess at the actual costs of job start-up, managing, supervising, temporary facilities and closing out projects, or they use a percentage to figure general conditions. And, the unit prices they use are often outdated and inaccurate. I find on a typical eight month project, our general conditions can vary from $10,000 to $25,000 per month. Accurate estimating must include a review of what your general conditions really cost and then a budget based on input from the field.

6. Accurate Overhead-Your company overhead is a fixed (not a percentage) amount. Divide your total projected annual overhead by your total projected annual job costs (not sales volume). This percentage will equal the actual overhead recovery markup to use. Example: $800,000 projected annual overhead divided by $5,000,000 projected annual job costs equals 16 percent markup for overhead recovery. Don’t get trapped into thinking you can use an industry average such as 10 percent or 15 percent to cover your overhead costs.

7. Accurate Profit MarkUp-Profit markup is not determined by what you can get. It is a fixed amount of what you want. To determine the profit markup required to hit your goal, divide your total annual projected costs by your annual profit goal to determine markup. Example: $400,000 annual profit goal divided by $5 million projected annual job costs equals 8 percent markup to hit your profit goal. If you can’t achieve 8 percent profit markup in your market, your only solution is to adjust your volume up and your markup down until you hit your $400,000 profit target.

Want to make lots of money? Make your bid more than a “guestimate.” Make each estimate an exact prediction of what it will take to build every project. Install accurate estimating systems and controls and watch your bottom-line results improve significantly.

Construction Business Owner, May 2006