Risk Management in Estimating
By Leslie C. Shiner, MBA

When creating an estimate for a job, it’s just that, an estimate. Some contractors refer to it as an educated guess, others joke that it’s an uneducated guess. But creating an estimate may be necessary to get the job.

Estimators must create bids with an eye toward profitability. A key way to increase profitability is to analyze and include risk factors in your estimate by understanding the three types of risk inherent in each job—contractual, financial, and operational.

Each job contains many risk sources that the estimator should consider. The first is contractual—have you actually read the contract, reviewed the plans, and digested the specifications? While it can seem that there are no laws protecting contractors, there are provisions inherent in most contracts that can help the contractor during disputes. Each contract should have a precedence clause, outlining which will take precedence in case of conflicting information. For example, if the specs, plans, shop drawings, or contract all specify different materials or dimensions, what should the contractor do? That’s where reading the contact with a fine tooth comb becomes a must.

I heard about an architect who specifically wrote a clause in his specifications that read something like this: “Unless rejected in writing in the bid, any contractor submitting a bid must purchase for the architect a new pair of Timberland Pro-Series Workboots, (size specified).” You would be surprised at the number of boots he had in his closet—more than he could ever possibly use. Too many contractors do not carefully read the contact only to skate by on most jobs. But it’s that one job that ends up in court that can seriously hurt you or put you out of business. And with today’s litigious society, the question is not “if,” but “when” and “am I protected?”

To mitigate contractual risk, analyze the contract to see if you can include a price escalation clause. Review the retention requirements and see if you can release retention at completion of milestones instead of waiting until the end of the job.

The second type of risk to consider when creating an estimate is the financial risk. What are the odds of not getting paid? Can your cash flow handle this job? Many contractors who work on public jobs are assured of getting paid, but the question then is when? They may not be able to float payroll for 60, 90 or 120 days waiting to receive payment. Have you ever wondered how much your credit line should be? The industry standard credit line should be at least 10% of your gross revenues, or three times the amount of your average accounts receivable balance.

When working on residential jobs, particularly large remodels, it is important to determine if the client can actually pay for the work. Design-Build work often suffers from “scope creep” where the scope of the job continues to increase as the client gets more excited about the possibilities. Then, however, reality sets in, and the scale of the job is significantly cut for budgetary reasons. You don’t want to waste hours and hours working on estimates for jobs that the client can’t pay for.

The final type of risk to consider is operational risk—what can go wrong during the job. Often the estimator and project manager are the same person, and he or she will consider these risks when creating the bid. As companies grow, though, this function usually becomes split between two different employees. The estimator may say that operational risk isn’t his or her problem, but that’s not the case! Since labor is often the most risky part of any estimate, it is important for the estimator to have a clear understanding of both 1) how long it takes to do a task and 2) what are the true labor costs. Too many estimators create the bid as if the “A” team was doing all the work, but then, if the company grows and the crews get busy, there may be new employees on the job. Estimators must create the bid as if the “B” team did all the work.

Creating a schedule during the estimating process can help mitigate operational risks. This sets time expectations for the crew and subcontractors. It also can provide a cash flow schedule to manage the job. Many contractors create a schedule at the start of the job, but not many contractors update this schedule during the job. Consistently updating the schedule will keep the job on track and help the job finish on time and on budget.

Estimating is actually not a guessing game, it is a science. And including risk factors in each estimate can help manage that risk and create more profitable jobs.

Finally, when a job has been bid, performed, and completed, don’t forget the final step—to analyze, analyze, analyze. While all jobs are different, use each job to become a better estimator and help your company be more profitable.

For more than 20 years Leslie Shiner has provided business and financial management assistance to contractors. She also speaks to local, regional, and national construction groups and associations, and is the author of Health Checkup for Your Construction Business and other titles available at www.profitpress.com.

Copyright © 2006 Profit Press, Inc. Reprinted with permission.