One of the most powerful financial tools a construction professional can utilize is a profit fade schedule. What is profit fade? It occurs when profit from a given job gradually decreases over time from the original cost estimate. The result is a job that seemed to be successful in the beginning turns out to be a loser in the end.
The culprit lies in increased costs. The reason naturally ranges from any number of causes or frequently is a combination of many factors. Common causes of profit fade are:
- Ineffective overhead allocation or inaccurate job costing
- An underperforming project manager
- Aggressive or sloppy bidding practices that don’t accurately capture cost
- Costly change orders
- Poor subcontractor or supplier performance
- Inadequate job training or supervision
- Unplanned delays such as adverse weather
- Fraud or cost-shifting
How do you calculate profit fade? Take the difference between estimated gross profit on a given date and compare it to the actual gross profit for that job once complete. Or better yet, do a running trend analysis as work progresses from the initial bid. The end result should be expressed in dollar amounts as well as in percentages.
After the analysis is performed, a trend should begin to emerge. This trend could vary based on estimator, project manager, or region, just to name a few. It’s a powerful internal monitoring tool, and if regularly performed it can lead to cost intervention before a job goes entirely south, or additional education can be provided for estimators or project managers who are consistently off.
It should be noted that profit doesn’t just fade—there’s also the concept of profit gain, which occurs when profit from a given job gradually increases over time from the original cost estimate. Successful general contractors typically exhibit this management technique as they frequently operate on thinner margins than subcontractors.
Lastly, profit fade or gain analysis is a frequent tool used by bonding agents, who run the analysis based on job schedules from year to year. They use this to understand how aggressive or conservative management is with their cost estimates, or more directly stated, bonding agents use it to understand how accurate cost estimates are, which ultimately factor into the decision of bonding capacity.
Wouldn’t it be wonderful to implement the powerful tool of profit fade or gain analysis into each month-end close? Jones & Roth can help you get there and can provide templates to guide the calculation.
Sarah Shaw-Stahlke, CPA is a member leader of the Jones & Roth Construction Team. She has expert knowledge in the construction industry and assists clients with financial reporting for bonding and banking purposes, job costing, financial ratios and benchmarking and tax planning.