Managing Risk in Today’s Construction Market

By Tracy Allen, CPA, CCIFP®

The construction business has always been a challenging place to make a living. Business owners face heavy competition to secure new clients and contracts. Bids must be priced attractively yet account adequately for costs, profit, and the “unknowns” that might derail budgets and timelines. Skilled craft labor shortages and subcontractor default are key concerns in today’s market. Managing and mitigating risk must be a strategic priority.

High-Level Strategy

Successful firms have a clear strategy that enables them to concentrate their resources on the most attractive business opportunities.

They have their fingers on the pulse of the markets they serve. They’re in tune with developments in the local economy at a level that enables them to forecast demand for their services. They know what their clients expect, and they anticipate how those needs might change in the future. They understand the political, regulatory, and competitive landscapes in which they operate.

They have a clear understanding of the type of work in their organizational wheelhouse. Detailed financial assessments of past projects reveal the size, scope, project type, geography, and customer profiles on which they’re best able to generate accurate estimates and effective performance. This awareness helps focus energy on projects for which the firm is particularly well-suited. It also identifies bids on which they should pass.

They know their cost structures inside and out. With input from human resources, purchasing and equipment and accounting departments, a carefully constructed bid considers today’s fully loaded labor costs, material costs, equipment costs, and overhead. It also relies on an analysis of completed projects to reveal where and how their initial bids differed from final job costs. If gross margins have consistently fallen short of expectations, it may suggest the need for operational improvements to stem the cost overruns. If historical trends are showing jobs finish with much higher gross margins than anticipated, then cost estimates may be too high of a contingency factor or there may be a systemic problem within the estimating team. In either case, the firm looks beyond the numbers to see what’s really going on behind the scenes. They know a cause-and-effect analysis combined with an action plan is a powerful way to improve performance while lowering risk.

Operational Excellence

Successful firms know their profitability depends upon the ability to execute their contracts efficiently and effectively.

They hire the best people for the job. Then, they provide the necessary compensation, training, and support to make them productive, loyal members of the team. Access to skilled labor impacts their job costs, the quality of their work, and their ability to meet their contractual deadlines. They know a stable talent pool contributes to the strength of their business and their reputation.

They leverage best practices in their business processes and project methodologies. They define roles and responsibilities to clearly establish individual and team accountability. They make sure everyone understands activities each area have ripple effects on others. They institute end-to-end business processes to make sure all affected parties focus on the right outcomes. They follow quality assurance guidelines rigorously and address problems early and decisively.

They establish a culture of safety throughout the organization. They know safety and profitability go hand-in-hand. To that end, they conduct training on all of their safety protocols and apply the appropriate oversight and measurements to ensure compliance. They track and manage the claims process and associated costs. Their return-to-work program helps each affected individual become a full-fledged contributor to the team’s efforts.

They take the time to evaluate their performance at the conclusion of each project. They compare the initial estimate and scope of work with the final job costs and completed work, including all approved and unapproved change orders. They take note of variations in material costs and production rates and feed that information back to the estimators. They assess crew performance and identify opportunities for improvement in group or individual performance, and make changes in operational processes where indicated.

Infrastructure Support

Successful firms leverage third-party experts to help them manage and mitigate risk:

  • They leverage their insurance partners’ expertise to procure an appropriate level of coverage for their scope of operations and risk profiles.
  • They obtain surety bonds to cover performance by their subcontractors. In the course of their due diligence, the surety company examines the subcontractor’s capabilities, work-in-progress, and financial health. A favorable assessment suggests the subcontractor should be able to complete the assigned work.
  • They work with their bankers to secure the appropriate short- and long-term financing for their operations while paying close attention to their lending covenants. They recognize the importance of a healthy balance sheet to sustain operations and fund growth.

Risk management requires vigilance at all levels of the organization. When viewed in a positive light, it creates the opportunity for the firm to build organizational strengths that bolster financial performance and ensure durability in good and bad times.

Meet Tracy

Tracy provides financial and accounting services, cash-flow and internal control reviews, as well as tax planning and consultation to her clients. She speaks and teaches seminars for the Construction Financial Management Association (CFMA) and the Surety and Fidelity Association of America.

Connect with Tracy here.