The cost control on any construction project is the heart and soul of the project. Proper financial management, from the onset of the project, is a necessary requisite of any successful construction project. Although there are many contractors that would disagree, a successful project, is a project that allows all parties to make money, and the owner, architect are satisfied with the result.
Those of you who have experience and knowledge in the construction industry, are probably hysterically laughing, when I make a statement that all parties should make money. I realize that there are many individuals, as well as companies within the industry, that only care about their own financial well being. However, from experience, problems, conflicts and negative results will occur, when there exists two entities on the construction project, the haves and the have nots.
As an owner or a general contractor, it is important to financially control the project. The difficulties encountered on any construction project are due to the number of different entities that are required to successfully complete the work. There will be multiple subcontractors, multiple material vendors, various equipment rental agencies as well as miscellaneous services such as porta johns, utilities, office supplies, etc. Due to the complexities of a construction project, and the various financial needs of each involved entity, the control of cost and financial distribution is critical.
General financial parameters of the typical construction project;
1.) In most circumstances the owner or financial institution supporting the project will attempt to purchase the project for the lowest initial value possible. This will involve procedures such as bid package distribution and competitive bidding. The final result is, in theory, the lowest responsible value for the project. Although this is the popular belief, a brief look at the description of different types of construction contracts, located within this website, would be helpful.
2.) Although intentions are good, and the objective is to obtain the lowest responsible value for the project, in many instances the low bidder, has either figured out an angle, missed a portion of the scope of the work, or simply decided to take the chance of bidding so low, that no one can beat them. In many instances I have known companies to take a project for less than the estimated total cost, just to have the opportunities afforded by being awarded the construction project.
3.) All possible attempts by all parties will be made, to make money on the project. All subcontractors will be maneuvering their forces on the project to enhance the possibilities of additional work, or change orders, due to out of sequence work, or added scope. Foreman on the project will be instructed to find all possible avenues to make money by addressing extras. The financial stress of making money on a low bid project will be in full gear by all players.
4.) The general contractor will attempt to front load the requisitions to the owner. This means that the initial items of work, required at the beginning of the project, will have a value on the schedule of values that is highly inflated. This technique is used, to allow the general contractor, to obtain as much of the contract value, early on in the project. Each sub will also attempt to front load their schedule of values to achieve the same goal. Once all schedule of values are formally presented, the intent of both the general contractor and the subcontractors will be to obtain more of the owner’s money than the work completed, actually represents. This technique is called front loading a project.
5.) Normally, the owner or financial institution supporting the project, is not aware that the project is being front loaded. Therefore, the money paid to the general contractor is normally more than the work completed actually represents. The intent of this procedure is for the general contractor to have substantial additional money, to circumvent any problematic financial issues, as the project nears completion. The greater percentage of the contract value that the owner has paid, the less leverage the owner has on the general contractor to perform the final work. Money will tip the scale to the owner or the contractor depending upon how the financial balance sheet is weighted.
6.) The general contractor will discourage the front loading of subcontractor requisition. What is good for the goose is NOT good for the gander in this case. Although the general contractor is focused on receiving more money than the work represents, they are also focused on distributing less money to the subcontractors. In this manner the general contractor has leverage on the subs to complete the work. This is not a two way street and never will be. However, this attitude and methodology causes problems and stresses on the construction project as the work progresses. Subcontractors become irritated with the general contractor and desperate to obtain some money for their work.
7.) The general contractor will try every tactic in the book, to delay the payments to the subcontractors for as long as possible. Although the owner has paid the general contractor this does not mean that the subcontractors have been paid. Again, the intent of the general contractor is to hold onto as much of the money as possible, for as long as possible. If the general contractor can hold substantial money from the subs and is successful in front loading the entire requisition, the general contractor has increased their control on the owner as well as the subcontractors.
8.) The owner, in most cases, will not be aware of this scenario on the project. In most situations, the owner is not educated nor experienced with this type of behavior, and will not realize the situation until it is too late. This is what the contractors are anticipating and hoping for. An uneducated owner is an owner that the contractors can and will make money on.
These are the general financial situations that create the financial environment of the construction project that has been bid and awarded based on the lowest competitive bid, which is the majority of construction contracts.
Considering these financial circumstances, the following is a summary of how the owner or financial institution can control the financial climate on the construction project.
1.) The owner or financial institution financing the project, must understand the complexities of the construction industry. The following very briefly summarizes these complexities.
a.) By soliciting the lowest competitive bid value for the work, this will create a financial challenge for the successful bidder. In most cases the successful bidder is not smarter than the other bidders, they just missed some scope of work, made an error on their subcontractor selection, or simply low balled the project to make sure they obtained the opportunity to construct the project.
b.) Once the low bidder has been awarded the project, this bidder will be researching methods of creating financial profit, beyond the original contract value. This will cause change order frenzy as the project advances. Change order frenzy is preached within the industry, the project manager that can create the most additional work change orders, wins!
c.) The contractor will attempt to substantially front load the schedule of values for the project. The owner or financial institution must be aware that efforts will be made to collect as much money as possible on the project, as early in the project as possible. This attempt must be met with educated and detailed understanding of the scope or work within the contract.
d.) The contractor will demand or request a down-payment prior to starting work. This down-payment should be negotiated at the time of contract signing and not after the work has commenced. The owner should try to eliminate any down-payment requirements due to the fact that in most cases, this down-payment goes to financially support or pay for another bill on another project.
e.) The contractor will attempt to collect as much money as possible, and will try to avoid having to pay out any of that money to subcontractors or other vendors. General contractors are notorious for holding the subcontractors money for ridiculous periods of time. There is always a reason why the check did not arrive at the subcontractor. The hypocrisy of this payment procedure is inherent in almost all of the general contractor, subcontractor relationships.
f.) The contractor will attempt to delay work on the project, create change orders, or pursue any other avenue of financial gain possible to stimulate profit on the project. The owner or financial institution cannot limit the creativity of a general contractor when it comes to obtaining the owner’s money.
2.) Once the owner or financial institution understands the atmosphere of the construction project, the following financial procedures should be strictly followed.
3.) The owner should not provide a down payment for the project. If the down-payment is insisted upon, the owner must demand receipts and invoices for the money that totaled the down-payment. Down-payments are strongly not recommended. They have a tendency to never be for the financial support of the project that the down-payment originated from. In many cases, this down-payment is to fund the remaining bills on the general contractors last project.
4.) The owner must carefully dissect the original schedule of values that the contractor has submitted to the owner. The schedule must accurately reflect the money required to complete each work activity. The best method to accurately evaluate a schedule of values is to look at the initial scheduled work items. In most cases these values, such as mobilization, general conditions, site prep and excavation will be initially inflated by at least 25%. This is a given, in most cases. The owner and financial institution should evaluate the initial submission of the schedule of values, with this percentage in mind. Once the contractor understands that there standard procedure of presenting an inflated schedule of values has been discovered, the more intelligent contractors will attempt to reconcile the schedule of values to be more accurate.
5.) Once the contractor presents the first requisition, the owner should analyze this invoice with a fine tooth comb. The owner and or financial institution should clearly indicate to the contractor that all billing will be checked and rechecked. The contractor must be made aware, that financially, this will not be an easy project and the owner is looking at all the billing, very closely.
6.) Once the owner pays the first requisition to the contractor, every other requisition MUST be accompanied by lien waivers. A lien waiver, is a waiver signed by the subcontractor, that indicates their last invoice was paid, and that they will not lien the project for this amount. What must occur to make the lien waiver legitimate is that the owner must contact the suppliers of material to this particular vendor, to make sure that this vendor has been paid. In some cases, a second and third tier vendor should submit a lien waiver for the period of time, as the subcontractors requisition states.
7.) Cost control of change orders is an entirely different issue. The change order procedure on a competitively bid project can become very involved and intense. In many cases, the contractor and subcontractors have competitively bid the project, therefore the value of the contract is normally lower than the contractors comfort level. Based upon this level of anxiety, the contractor and subcontractors will attempt to solicit change orders to make up the profit deficiency. Cost control relative to change orders is always difficult, time consuming and tedious.
It is especially important that the owner understand the following;
a.) The scope of work as described within the initial contract documents. This is important due to the fact that all the contractors and subcontractors will inherently try to claim additional work, even if the scope of the work is clearly identified, and included within the original agreement. Therefore it is extremely important that the scope of work is clearly understood by the owner or the financial institution.
b.) There should be NO additional work performed or identified as approved, until there is a signed document issued by the owner. Again, this is important due to the fact that the contractors and subs will claim to have performed additional work, without approval. They will then submit invoices for this additional work, even though they have NO agreement. It is important that it is clearly indicated that NO additional work will be paid for, unless it is accompanied by a signed formal agreement. Be ready for the crying and the agonizing over the alleged schedule delays due to lack of signed change orders.
c.) NO change order work that has not been approved and accompanied by the issuance of a formal signed change order, will be accepted, on the monthly requisitions by the subcontractors. This must be adhered to by the owner or the financial institution. The contractors will make up all sorts of stories and reasons why they had to perform the additional work for the betterment of the project. Do not listen to them. No signed document, no payment!
d.) The contractor and subcontractors will attempt to set the stage for the following;
- Attempt to intimidate the party paying the bill, into thinking that they are doing the owner a favor performing the work. This is incorrect and the owner must reverse the psychology onto the backs of the contractors.
- Attempt to over bill in hopes of being overpaid.
- Attempt to not pay their bills on a timely basis to remain ahead of the project financially, no matter how low the actual contract value may have been bid.
- Threaten to leave the project if change orders are not paid for. The owner must remain vigilant in their demands that a signed and approved change order is required prior to the work being performed and paid for.
e.) The owner or financial institution must understand the contract scope of work as well as the legal and formal financial clauses within the contract. A good construction contract will be set up to allow the owner full authority when paying the contractors, as well as full protection from any contractor threatening to boycott the project, or slow it down.
f.) The owner is in charge and the entity with the money is the strong and dominant party ,despite the attempts by the contractors to reverse this situation.
Once the owner or financial institution understands the full intent of the contractors, as well as their contractual rights, they need to develop their own spreadsheet to clearly and analytically record all transactions and financial obligations and payments on the project.
An excel spreadsheet should be formatted, to accumulate the change orders and their effect on the total contract value. For example if the initial contract is for $1,000,000.00 and ten change orders of $100,000.00 each are approved, then the spreadsheet must show a total financial obligation of $2,000,000.00 In addition the payments to the contractor as well as any retainage held from these payments, must be analytically recorded, to financially keep a record of all transactions and balances.
The importance of lien waivers cannot be overstressed. The contractor must identify the subcontractors involved with the project, as well as the major suppliers on the project. All of these important entities must be financially supported by lien waivers for all payments on the project. Although lien waivers can be modified and forged, it is an important document to record.
The financial control of a construction project is a difficult and necessary activity. Unfortunately unless there is a professional construction manager or consultant to represent the owner or financial institution, the financial control becomes extremely difficult. The expense to incorporate a professional entity to guide the project financially can almost be guaranteed to be worth the expense. One mistake or incorrect change order approval can be the total cost of incorporating a professional entity on your construction project.
The best financial control is based on experience and knowledge within the industry.