Budgets are a necessary tool in any contractor’s toolbox. They help contractors know where you are in a project, how your production is going, and whether you’ll make any money. Not having a construction budget is like flying blindfolded — there’s no guarantee you’ll get where you need to go. Here’s what to include in a construction budget, and tips for making it work for your bottom line.
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Types of costs in a construction budget
When calculating a construction budget, there are two types of costs to factor in: hard costs and soft costs.
Hard costs are directly related to the physical construction of the project or building. They include materials, labor, supervision, and equipment costs. Any cost for something that gets installed during the project or helps with installation is considered a hard cost.
Examples of hard costs include drywall, nails, equipment rental fees, subcontractor labor costs, and site work equipment. The easy test to determine if a cost is a hard cost is to ask “Does this up in the physical building, or does it help install something in the physical building?” If the answer is yes, that means it’s a hard cost.
Soft costs are not directly related to the construction of a project or building. However, they are needed in order to complete the project.
Also known as indirect costs, soft costs include design fees, insurance, bonds, legal fees, and accounting costs. Anything that helps support the construction activities is considered a soft cost.
Types of construction budgets
Construction budgets come in two main types: annual budgets and project budgets.
Every construction company should have an annual budget for the business. This budget includes proposed amounts for anticipated income, project costs, payroll, and business expenses.
Companies can use their past history and trends in their financial statements as a guide to determine these amounts. An annual budget also helps you know how much profit your company will need to make on projects to cover your expenses.
A project budget is an estimate of costs that will be incurred when working on a particular job. It includes costs for labor, materials, equipment rental, temporary services, project management, supervision, and other project-related expenses.
A construction project budget is often developed when putting together a project bid, as you have to know what it will cost you before you price the project.
What to include in an annual construction budget
It’s important that all construction companies develop an annual budget for their business expenses. Developing an annual construction budget requires analyzing the previous years’ expenses and projecting those costs into the future. Without a plan, management has no way to gauge how well the company is doing as the year progresses.
There are some company expenses that could be incorporated into project budgets. These include overhead and administration expenses and costs for disputes. Overhead and administration can be considered an indirect project expense, in that these expenses wouldn’t be necessary if there were no projects. So, every project budget needs to include a line item for these services.
If the company doesn’t know how much it will spend on them, it’s more difficult to allocate those expenses to each project. With a budget for the year, management can allocate a percentage of the costs to each project based on its size and duration.
Dispute costs should also be distributed to each project’s budget, even though not every project will have a dispute. For example, if you know you had two disputes last year and know their total cost, you can apply that cost to this year’s annual budget, distributing it among the upcoming projects.
Added line items in the project budget for lien filing fees, notice creation and postage, and legal fees can help spread these costs out. Again, even though not every project will face disputes, knowing these costs and being able to account for their possibility can help you stay on track.
What to include in a construction project budget
Developing a project budget is probably something you are more familiar with. It involves looking at the plans and bid documents for a project and determining how much it will cost to perform the work. This is usually done during the bidding stage of a project.
Once the costs for the project are determined, an allowance for overhead expenses is added, as well as the desired profit. This total is presented in a proposal to the owner or general contractor.
Depending on your company’s role on a project (whether it’s as a general contractor or a subcontractor), there are several types of costs that you’ll want to include in your budget. Those costs include:
- Design fees
- Interest and other loan fees
Permit fees may be paid by the owner or the general contractor, depending on how the contract reads. Trade contractors, like plumbing, HVAC, electrical, low voltage, and fire sprinkler, may pull their own permits or these costs may be covered in the building permit package.
Make sure you know who is responsible for paying for them and how much the fees will be when determining your costs.
Bonds and insurance costs
Costs for bonds and insurance will be carried by all contractors on the project who are required to provide them. Most contractors, at any level, are required to carry a certain amount of insurance in order to be licensed. The costs for this coverage can be included in every job as part of the budget. Bonding may be more project-specific, as it’s only required on certain projects depending on the requirements and the type of work being performed.
Design fees may be carried by either the project owner or the general contractor in their budget. These will include fees for architects, engineers, interior designers, surveyors, and other consultants that help create the plans and specifications for the project. The cost of design fees is often based on a percentage of the total project cost.
Loan interest and fees
If a project will be financed by a loan, the owner will need to include costs for loan interest and any fees associated with borrowing money. Fees for construction progress inspections, budget review, draw administration, closing costs, and other loan services should be included as well.
Labor and materials
Any materials that go into the project and the labor required to install them should be included in a construction project budget.
This includes not only the hourly wages for workers, but employer taxes, benefits, and amenities such as cell phones and vehicles as well. Fees for shipping, packaging, and expedited delivery can also be included as material costs.
A contingency is a pool of money set aside for any unforeseen circumstances that may arise during the project. In most cases, the owner will carry a line item for this in their overall project budget. Sometimes general contractors may carry it as well.
The contingency can generally be used for changes in the scope of work as well as unforeseen site issues. Lenders may stipulate how and when the contingency can be used if it is part of the original loan package for the project. Most projects should carry a 5-7% contingency.
6 tips for staying on budget
A contractor’s profit is directly tied to their ability to create a budget — and stick to it.
1. Estimate accurately
Many construction budgets are made or broken in the estimating phase of a project. If you can’t accurately estimate your business costs before you submit a bid, there’s no way you will be able to stick to your budget.
If your estimates are far from the actual expenses you incur on a job, you will want to take a close look at the reasons why.
2. Create a schedule
Creating a project schedule before beginning work is a great way to help keep the project on budget. Using your schedule, you can predict when costs will occur and when you’ll be able to bill for those costs. This helps you predict your cash flow needs and prevents overspending.
Developing a schedule also helps you identify your critical path tasks, so you know which items may cause a delay if they don’t happen on time.
3. Double-check your material takeoffs
Having accurate material takeoffs is also important for staying on budget. If you don’t know how much material you need to install, you can’t accurately determine how long it will take you to complete the project or how much it will cost. You can use software and other electronic tools to help improve your takeoffs.
4. Regularly review your reports
Regularly reviewing your financial reports, like project job cost reports, can help you spot trends and budget overages before they happen. If you notice that project expenses are above where they should be, you can investigate why that’s happening and adjust the budget if needed.
If you’re working on a commercial project, and your costs are higher than the average cost per square foot of commercial buildings in your area, you may need to make adjustments.
5. Communicate clearly
Keep an open line of communication with the project owner or GC. Let them know as soon as you spot differing conditions onsite or have a potential price increase. The project team may be able to mitigate the cost of the change if everyone works collaboratively to reach a solution. You’ll also want to let them know as soon as possible so you can maintain your claim rights as per the contract.
6. Protect your payments
Sticking to your project budget doesn’t mean anything if you aren’t getting paid. Protecting your payments will help keep your cash flow moving according to schedule.
Sending preliminary notices and monthly notices can help speed up payment. When you’re paid on time, you don’t incur additional costs like finance charges and late fees, keeping your project on budget.