When contractors think about the big business they’re going to build—and all of the money they’re going to make—unfortunately, they seem to neglect estimating and cost analysis.
In fact, estimating and cost analysis is what’s going to make your construction business profitable… and isn’t that what you’re going for? Profit?
We hope so. That’s why—in this lesson—we’re going to cover everything you need to know regarding estimating and cost analysis—including understanding the project scope, quantifying project costs, calculating overhead and profit, risk, and more.
Understanding the Project Scope
When it comes to accurate estimating and cost analysis, a thorough understanding of the project scope is essential.
What exactly is the project scope? Well, the project scope refers to the specific tasks, deliverables, and outcomes that are required to complete the project successfully.
It’s crucial that you review the project scope carefully to ensure that you are accounting for all of the necessary costs.
Here are some tips to consider while you review the project scope document:
- Read the document carefully—highlighting anything that is unclear or confusing that will need clarification.
- Ask questions. Considering the parts of the document that were unclear to you—you can reach out to the project owner for answers. Believe me, it’s better to ask questions in the beginning than to make assumptions that could lead to inaccurate estimates.
- Identify any potential discrepancies—comparing the document with other project-related documents—such as the architectural or engineering plans.
- Consider the project schedule. Understanding the project schedule is essential to determine the resources required to complete the project on time. Be sure and identify any tasks that may require additional resources or time.
Quantifying Project Costs
“Quantifying” the project costs involves identifying and accounting for all of the costs associated with the projects—including labor, material, equipment, and any other necessary expenses.
While quantifying the project costs, here are some tips to consider:
- Break down the project into smaller, more manageable tasks. This will help to identify the specific resources required for each task and allow for more accurate cost estimates. For example—if you’re doing a complete home renovation—it would be a good idea to break the plumbing work and electrical work into different categories or tasks.
- Identify material costs and estimate the quantity needed. This will allow you to calculate the total cost of materials by multiplying the quantity by the unit cost. For example—using the home renovation example again—if you need 2,000 square feet of hardwood flooring at $5 per square foot, the total cost of hardwood flooring would be $10,000.
- Estimate labor costs required for each task and estimate the number of hours or days needed to complete the task. You can then calculate the total labor cost by multiplying the hours or days by the hourly or daily labor rate. Using plumbing work as an example—if you need three workers for two days for piping installation at a daily rate of $250, the total labor cost for piping installation would be $1,500.
- Consider equipment costs—identifying any equipment needed for each activity and estimating the duration and cost of equipment rental or ownership. Using a concrete driveway as an example—if you need a concrete mixer for three days at a rental rate of $100 per day, the total equipment cost for concrete work would be $300.
- Account for other expenses—such as permits, insurance, and any potential subcontractor costs.
Once you have estimated the costs for each task and accounted for all other expenses, you can calculate the total project cost by adding all of the individual costs together.
Calculating Overhead and Profit
The costs associated with a construction projects aren’t just related to material, labor, and equipment. You must also consider overhead and profit when developing a cost estimate.
Overhead costs are the indirect expenses associated with running a business—such as rent, utilities, office expenses, legal and accounting services, travel, and other related expenses.
Profit is the amount that the contractor adds to the total cost estimate to make a profit on the project.
Here are the key steps to calculating overhead and profit on a construction project:
- Identify overhead costs. To calculate overhead costs, you need to identify all of the indirect expenses associated with operating your business, which we mentioned earlier. You can then estimate the total overhead cost for the project by multiplying the total direct cost—including material, labor, and equipment—by a percentage that represents your overhead expenses. For example, if the total direct cost for a construction project is $50,000 and your overhead percentage is 20%, then the estimated overhead cost would be $10,000.
- Determine the profit margin. How much do you want to make on the project? The profit margin is generally expressed as a percentage of the total project cost. For example, if the total cost estimate for a construction project is $100,000—and you want to make a 15% profit margin—you would add $15,000 to the cost estimate as your desired profit.
- Calculate overhead and profit. Once you have determined the total overhead cost and the desired profit margin, you can then calculate the total overhead and profit for the project. To do this—multiply the total direct cost by the percentage that represents your overhead expenses, then add the desired profit margin as a percentage of the total cost.
For example, let’s assume the total direct cost for your project is $100,000. If your overhead expenses are estimated at 10% of the total direct cost, the overhead cost would be $10,000 (10% x $100,000). If your desired profit margin is 20% of the total cost, the profit would be $24,000 (20% x ($100,000 + $10,000)). The total cost estimate—including overhead and profit—would be $134,000 ($100,000 + $10,000 + $24,000).
We know—this can be confusing to some contractors out there. But, don’t worry—you can easily find a bookkeeper on Upwork.com to help you with calculations and other financials. There’s also software available, which we’re going to cover later in this lesson.
Just remember that calculating overhead and profit should not be overlooked. This information ensures contractors that they’re making a profit on the project, while also covering their indirect expenses—which is essential to running a successful construction business.
Dealing with Uncertainty and Risk
Of course, construction projects don’t always go to plan. There are many unpredictable factors that can impact the cost and timeline of the project. For this reason, it’s crucial for contractors to identify and manage any potential risks during their cost estimation process.
Here are the key steps to handling risk and uncertainty in construction cost estimation:
- Identify potential risks. Start by identifying potential risks and uncertainties that might impact the cost and timeline of the project. This could be anything from weather delays, to labor shortages, to supply chain disruptions. You never know.
- Estimate the impact of each risk. For each potential risk, estimate the potential impact on the project timeline and cost. This will help you prioritize which risks you should develop mitigation strategies for.
- Develop risk mitigation strategies. Once you have identified the potential risks and estimated their impact, you should develop strategies to mitigate each risk. This may include developing contingency plans, securing backup suppliers, or hiring additional employees to mitigate potential labor shortages.
- Include contingency funds. When developing the cost estimate, include a contingency fund to account for potential risks and uncertainties. In other words, have money set aside for rainy days.
- Update the cost estimate as needed. As the project progresses, monitor any potential risks and update the cost estimate as needed to reflect any changes. This will help to ensure that the project remains on track and within budget.
What is the project scope in construction, and why is it crucial for estimating and cost analysis?
The project scope in construction refers to specific tasks and deliverables needed to complete a project, and understanding it is crucial for accurate estimating and cost analysis to ensure all necessary costs are accounted for.
How do contractors calculate overhead and profit in construction projects, and why are these factors essential in cost estimation?
Contractors calculate overhead by identifying indirect expenses and profit by determining a desired profit margin percentage, adding both to the total cost estimate to cover business expenses and ensure profitability in construction projects.