Forecasting Costs on Construction Projects

A few weeks ago, I wrote an article about the different types of costs that general contractors encounter on their projects.  In that article, I discussed how understanding costs was critical to running a profitable general contracting business. Once a contract is awarded, revenues are largely fixed and managing costs becomes of the key determining factors of the success of a project.

Forecasting costs is the act of looking into the crystal ball at a given point in the life of a project and making your best guess as to where costs will end up when everything is complete and the keys have been turned over to the owner.  

Why You Should Forecast Costs

The ability to accurately forecast costs is very important for any general contacting organization.  An accurate cost forecast not only informs how a given project is doing, but when aggregated across all projects, these forecasts provide incredibly useful insight into the short and medium term outlooks of the business.

As an individual project manager, the single biggest reason to regularly produce a cost forecast is to increase profits on your projects.  Profit is what's left over when we have collected all of the revenues and paid out all of the costs.  If revenue is fixed but costs are variable, then it stands to reason that by managing costs effectively the project will make higher profit.

Forecasting costs will highlight trends on your projects.  When completed regularly, cost forecasts can identify parts of the project that are heading for trouble, allowing for early intervention to minimize losses, and identify opportunities for underruns to maximize gains. With a cost forecast in hand, project managers are well positioned to create and update forward looking execution plans.

Aggregated cost forecasts help a larger organization understand the size and timing of backlog which can be used to inform decisions around working capital needs, manpower requirements, and the capacity to take on additional work.  

How to Forecast Costs

Forecasting costs is both an art and a science.  While there are mathematical calculations we can perform to create a reasonable guess (that’s the science), everything should still pass through the filter of a competent project manager to capture nuance that may exist in the actual project conditions (this is the art).

When it comes to calculating forward looking costs, the approach is slightly different depending on the nature of the cost itself.  The three main types of costs that a general contractor is likely to encounter are: time-based costs, unit-based costs, and subcontracted costs.  

Time Based Costs

Time based costs hit the job and accrue in regular intervals.

As an example – let’s say that the site fencing for a project is on a 28-day rental period.  This means that it will generate an invoice for the same amount every four weeks.  By looking at the past period costs per week for the fencing multiplied by the remaining number of weeks left on the project schedule, we can get an idea of the forecast costs to complete for the fencing rental.

But this alone might not be enough.  As a project manager, you should consider other factors such as – new phases of work where the quantity of fence panels will change (thus changing the weekly rate), possibility of damaged panels that will incur additional charges, and one-time tear down costs.  Every extrapolation should be validated… does the value you have calculated make sense?  If not, make reasonable adjustments prior to finalizing your forecast.

Unit Based Costs

Unit based costs are tied to the amount of something that will be installed or completed for a given activity.  When forecasting unit based costs, it is more accurate to look at the number of units left to complete than the number of days left on the calendar.

To calculate a forecast for unit based costs, we can extrapolate by multiplying our productivity to date with the number of remaining units (this implies that in order to forecast unit based costs accurately, we capturing installed quantities on site).

If the project hasn't started and field productivities aren't available, you can look to historical values from similar projects, the value carried in the estimate, or an educated guess, to get a reasonable rate of production of the crew.

However you must still validate your assumptions!  There are factors that can impact crew productivity rates including initial learning curve, weather impacts, changes to other major site activities, etc.  If you have a reasonable expectation that the future production rate will be different from the historical or to-date production rates, you should account for this in your projected final costs.

Subcontracted Costs

For major purchase orders and subcontracts – the best way to forecast is to establish and follow a procurement plan from the outset of the project and buyout as much scope as possible as early as possible.

If the full scope (on a given cost code) has been bought out as a lump sum, then the actual + committed costs are good assumption for the final costs.

For unit price contracts such as concrete supply, you can apply the same concepts as unit-based costs shown above… multiply the units left to complete by the negotiated rate.  Of course, be sure to consider things like pump primer and waste when calculating units remaining.

Accounting for Risk

Construction is a risky business and we need to consider financial risks when preparing our forecasts.  We do this by creating allowances for potential costs and releasing any unspent allowance when the risk has passed.

There are two categories of risk that show up on construction projects - project risks, and contract risks.  It is a good practice to account for both categories of risk in the same way: use dedicated cost codes for the risk item, and carry costs to complete on the code for potential overruns associated with the item.  As the project progresses, risk abates, and the smoke clears from the crystal ball, any remaining forecast allowances should be released as profit to the job.

Project Risk

Project risk items relate to the physical construction of the job and the associated activities on site.  Examples of project risk items are high value self-performed work, potential impacts from weather, and long lead time items.

For every major project risk, consider creating a cost code on the project to track and manage separately.  

I live in Canada where it gets cold in the winter... installing concrete in the winter vs summer is much more expensive because it requires temporary heating systems. If I have a project with a concrete scope that is scheduled to wrap up in the late fall, its reasonable to carry an allowance for winter heat in case the schedule runs long, or winter comes early.  When the concrete work is done, the risk is gone - regardless of what time of year the activity took place... at that point, any money that was unspent in the allowance can be released.

Contract Risk

Contract risk items are the things appear in the prime contract that carry potential negative cost repercussions – such as liquidated damages, owner move-in dates, or exposure to the ceiling of a guaranteed maximum price.

Similar to project risk items, you should always ensure that contract risk items are tracked in your forecast.  Contract risk items are sometimes forgotten as they are not as immediately obvious in the day-to-day of the project.  By including cost codes in your budget and forecasting against them (even if the forecast cost is zero!), contract risk items always stay in sight for the project team and can be better managed and mitigated.

Sandbagging

Sandbagging, padding, cushioning, being conservative... these are all ways of saying the same thing: deliberately underestimating or understating the projected costs of a project.  The term "sandbagging" comes from the idea of filling sandbags to create a barrier against flooding, and it can be very tempting to carry fictional costs in your forecasts to ensure you never exceed the budget.

The difference between allowing for risk and sandbagging is that sandbagging has no obvious risk tied to it. When we don’t release unspent allowances, or when we carry allowances for non-existent risks, we are sandbagging.  There is often a temptation to carry contingencies through to the end of a project and release all of the contingency right before the end of the project to ensure that forecast profit never drops.  However, this is a BAD practice.

On stipulated price projects sandbagging distorts company financials, profit is understated and if enough projects sandbag, then the corporate financial position becomes cloudy and it is more difficult to plan and grow the business effectively.

On cost plus projects, sandbagging can lead to a situation when you significantly underrun the project budget, and as a result actually earn LESS profit than you thought because the final revenue of the project doesn’t reach the value that was being forecast.

When forecasting, carry allowances when risk is present, and release it when risk is not present.  Accuracy is important.

A Note About Contract Types

A quick note about different types of construction contracts and how they relate to forecasting costs... Neither the delivery model of a project (traditional design-bid-build, construction management, integrated project delivery, ...) nor the owner's payment model (stipulated price, cost reimbursable, unit rate, ...) change the fundamentals of cost forecasting.  

The fundamental mechanics of cost forecasting remain the same, regardless of contract type.

Where to Go From Here...

Forecasting costs is an important activity for general contractors, and the nuance involved with producing an accurate cost forecast can make it tricky.  

The best way to get better at forecasting costs through practicing your skills in the real world... so get out there, put your binoculars on and try to see into the future!  

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