Contracting margins in the construction industry are smaller than ever which means that the cost of a project needs to be monitored meticulously. The scope adjustments and contractual changes, if unaccounted for, can easily eat into already tight budgets to put projects into the red. Kenny Ingram, Vice President of Engineering, Construction and Infrastructure, IFS, zeroes in on the key ways enterprise software solutions can help construction organizations protect their project’s bottom line.
Contractors now operate in a volatile industry in which profits are fragile—margins often fall under a worrying 1%. With profits hanging in the balance, controlling unexpected costs throughout a project is essential, it is rare for a construction project to be executed exactly as it is envisioned in the initial contract. Why? Because as these contracts are built on estimations, stakeholders are likely to add new requirements to the contract as the project progresses—all increasing the risk of a project. To ensure that their projects are financially viable from the outset – and remain that way throughout the construction process – contracting organizations rely on construction-optimized enterprise software. But these platforms must provide contractors with the structure, risk mitigation and visibility they need to perform profitable projects. Tools that address complex project financial controls also need to be at the heart of the software. Here, I explain how enterprise software solutions can help construction companies monitor contracts, control in-project costs and increase their margins.
Clarity from the very outset
All the details of the contract are outlined at the start of a project. At this stage, the project managers record indemnities, insurance, liquidated damages, guarantees and other requirements. It is important that both parties understand all terms of the contract because, regardless of the nature of the requirement, failure to address these contract terms will carry a financial penalty. Software helps contractors from the start-up process to clearly translate the terms of a contract into performable jobs to avoid fines.
At this stage of the project, the commercial manager will also determine the amount of contingency that is needed to cover the potential project risks. As the project progresses, the risks and contingency need to be continually assessed. In addition, project variations in scope need to be tracked and controlled to keep the budgeting margin on track. Enterprise software alerts managers of their exposure to such risk, as well as the cost and revenue from project variations so they can make informed decisions based on accurate and timely information.
Real-time project calculations – forewarned is forearmed
If there are disparities between the project estimate and actual costs incurred, they will create large financial problems for the project. Contractors need tools that take into consideration various procurement methodologies to create an accurate project estimate for contractors. This will in turn reduce the overall risk of a project. A well-developed risk register is also required to manage deviations from the originally calculated estimate when necessary.
Scope changes are a common occurrence in construction projects and therefore are the biggest risk to a project’s financial viability. At first, the risk register will contain an unattributed pot of money. As the project progresses, the sources of and exposure to risk are more clearly defined. The commercial manager must ensure project variances are dealt with and approved in well-documented change orders that amend the scope and budget. To do this, they require the ability to determine the true impact of a change on subsequent project phases. This is essential in order to avoid cost or timeline overruns caused by interdependencies.
The most important project financial control process is periodic project forecasting. This process involves reviewing the project financial status at the end of a period and forecasting the end margin position of the project. This typically covers the actual and forecast project cost, revenue and margin, project variation status, risks, forecasted cash position etc. This periodic project forecasting process should be tightly integrated with the financial accounting and other processes to ensure the information is based on a consistent set of accurate data. In most companies today, this process is still done in Excel which means that the numbers can easily be manipulated with the risk that the senior executives will not be seeing the true position. In addition to the periodic forecasting process, it is highly desirable to also be able to see the real-time status of the project in terms of cost, revenue, progress, contract changes, risks, payments etc. so that critical decisions can be made as early as possible—long before you get around to collecting actuals in the accounting system.
Software should give commercial managers a helping hand – not hinder
Applications that produce real-time calculations of labor, materials, internal and external equipment rental, subcontracts and other cost drivers relieve the burden put on commercial managers. Enterprise tools should be able to give visibility of project costs and manage risks as they become evident during the project. In addition, they must be capable of managing actual and forecast cash movements in order to mitigate cashflow bottlenecks. The number one focus for most contractors is managing the financial aspects of the project but it is also critical to manage the project deliverables using a properly integrated work breakdown structure. This will give the control to make sure projects are not only delivered to budget but also on time, with minimum defects and with minimum health and safety incidents.
Working towards higher margins
As the construction industry continues to execute potentially problematic jobs that produce low profit margins, enterprise software solutions that are optimized for construction present a golden opportunity for the industry. Managers need to be equipped with the right tools to identify and address deviations from the contract and adjust budgets accordingly, in real-time, to ensure the project remains profitable. Software has to assist commercial managers during project set-up with the translation of contracts into actionable scope of work and continue this support with tools that accommodate for changes during the project. Flexible enterprise solutions are therefore a key requirement to improve profits across the sector.