Construction Today

Managing Profits

Detailed and written documentation can be the difference between earning money and taking a loss in construction.

By Richard Fineman

To begin a construction project, a bid is submitted and accepted by the client. In a perfect world, this work would proceed exactly as outlined in the proposal and approved by the client. The reality is that most construction projects experience at least one change order – and usually more – to the original design.

Modifications to the original contract impact both the cost and the work schedule of the project. That can be good or bad news. If done correctly, change orders give construction companies opportunities to earn more profit. On the other hand, if they are not properly documented or executed, they can have a negative impact on the profitability of the job.

Change Orders – Necessary Evils?

Instead of viewing change orders as irritating, use them to the company’s advantage. A change in the design signifies clients are receiving what they really want, which, in turn, leads to satisfied clients. Secondly, change orders may present opportunities to enhance the profit margin because the owner is not required to be as competitive in pricing as he was with the original bid.

Additionally, change orders allow companies to include value-added merchandising, marketing and selling to the customer and thereby enhancing profitability, reducing the break-even point and allowing for employee incentives related to the documentation and execution of the change orders. Recognize, however, that change orders are not always due to a client’s request for adding or modifying some part of the construction. In some cases, contractors discover problems with the physical layout or ever-changing building codes, which require a change to the original contract.

Specified materials may suddenly be unavailable or discontinued. Or, natural disasters, labor and material delays/shortages or other unexpected issues may cause problems with the construction. In these instances, change orders may protect the company from future nuisance, lawsuits and decreased profit.

Write It Down

The main error companies make with change orders is failing to get written authorization for them. Without this documentation, the client may refuse to pay for services rendered via the change order. For example, after construction has started on a house addition, the client decides to add a skylight to the room. The client seeks out the foreman to discuss this change. The foreman then talks to other staff, such as the estimator, to determine what is entailed. A quote is generated, and the foreman seeks the OK on this change from the client by executing a change order on-site. This change order defines the additional work to be done, as well as the cost and scheduling related to this change, and the client signs off on this, indicating his or her approval.

Yet, many small construction businesses neglect the written approval step. This often happens when contractors are too nice and trusting. Instead, the owner might verbally agree to something, but nothing is written down. The remodel is finished later than originally anticipated. The construction company has nothing to back up the verbal agreements. The contractor is stuck and ends up incurring the cost. That’s why it is always better to document what the client wants, how long the process will take and the extra charges. Include an explanation of the additional work required, what type and how much labor and materials are required, and if the completion date will remain the same or be extended. Never begin the work until the client approves and signs the change order.

Change Order Oversights

Other change order mistakes include:

• Inaccurate pricing – To win jobs, companies bid at what they perceive the cost. They believe they will make up the profit from the change orders, especially jobs involving industrial sites, commercial buildings and government/municipalities. Yet, why should a company that didn’t bid the job correctly in the first place and is losing money expect anything different when computing the price of a change order? Just like bids and proposals, change orders must be priced accurately and thoroughly. Otherwise, small details are left out such as added electrical outlets or restocking fees for retuning unused materials. If these particulars are omitted, the client cannot be billed for them, and the company will lose money. If documented and billed correctly, owners can expect to cover overhead and make a reasonable profit with change orders.
• Not accounting for construction delays – Some change orders are simple and barely impact the completion of the construction project, while others call for major revisions to the contract, which ultimately delay completion of the project. Review each change order to determine the effect it has on the project’s anticipated completion date. If the change order will result in a lengthy delay, reschedule the completion of the project and have this new date approved by the client. Otherwise, a delayed completion could trigger penalty clauses and cost the company.
• Failure to track or follow-up change orders – Once a change orders has been executed, the company needs to ensure that this part of the project is billed and paid for by the client. Too often an absence of a tracking system means many change orders fall through the cracks and are never paid for by the clients. Plus, projects overwhelmed by a multitude of change orders may be hindered by a lack of organization. Tracking the status of each change order eliminates this confusion. Additionally, it may be interesting to determine how many change orders are written on average during a project. This information can help companies make crucial changes to the way future jobs are bid to save time and money. Also reviewing the information from change orders can increase profit by reducing future mistakes or including options in subsequent bids most requested by previous clients.

Review company policies and procedures related to change orders. Create specific steps for documenting, executing and tracking change orders and then train employees to reduce costly change order mistakes.

Best Practices

The foreman, supervisor or project manager should handle change orders at the job site, which means they need to have the proper paperwork. Additionally, they should have the ability to obtain a price relatively quickly on both labor and materials, so clients aren’t waiting for this information and re-evaluating their decision on this change. Much of this information is easily accessed with the use of today’s technology such as PDAs, cell phones or push-to-talk phones, laptop computers and wireless Internet. Previously, on-site staff would write down the information for the change orders in duplicate and send one back to the office where the pricing and scheduling would be investigated, sometimes taking several days to a week to obtain this information.

Today’s foreman e-mails the estimator, who determines the price and e-mails the foreman back immediately. Using technology to the company’s advantage speeds up the change order process and enables clients to make their decisions on moving forward with the requested change quickly. Also, the company can rework the construction schedule to incorporate this change, minimizing delays and maximizing opportunities for clients.

Richard Fineman is a consulting services director for International Profit Associates and Integrated Business Analysis (IPA-IBA). For more information, call 847-495-6786 or visit www.ipa-iba.com.