A construction company is not really a single business, but rather is a collection of projects that operate autonomously as their own profit and loss centers. If projects are successful, the construction business is successful. However, one unprofitable project could have immediate and long-term catastrophic effects on the business. This can happen due to the lack of visibility, governance and control of these projects because of outdated, over-simplistic or siloed IT systems.
Take accounting software for example. Every construction business has one, but often the project operational activities that determine whether the business is making or losing money reside outside of that system. Furthermore, the industry’s demand for IT solutions has been met by an inordinate number of point solutions for almost any function or process on a construction project. Even if implementing best of breed systems, companies will not realize full benefits due to their lack of integration and siloed data.
Most construction companies manage Excel spreadsheets for monthly project control reports. They typically have multiple tabs and perform simple functions such as tracking the project from estimate to a project budget and track performance against baseline. Perhaps the most important tab in that spreadsheet is the project forecast, which should give management visibility of the estimate to complete and estimate at completion for an end position of revenue, cost and margin.
So, what is wrong with running construction projects in Microsoft Excel or other disconnected IT solutions from the system of record? Excel and other systems outside of an enterprise software application such as enterprise resource planning (ERP) do not include preventive and detective controls against manipulation.
It is easy and may be too tempting for a project or commercial manager to “massage” the data to make their project look profitable, hiding land mines that may blow up in the controller’s face in later project phases. This is a real risk because lacking a single ERP system, and there is no way to reconcile the contents of the project forecast against any authoritative source.
There is also the problem of projects spanning multiple fiscal planning periods — ranging from one year to 10, and possibly beyond. Problems can spin out of control and potentially sink a project or even a construction company if cost and timeline overruns are severe enough. At the very least, these issues damage relationships with project owners and are a drain against margins.
To be in control of projects means ensuring the project plan and financial forecast are in an auditable, reliable and secure ERP application. This is applicable for organizations across the board. Some may run multi-year projects with hundreds of subcontractors, including the management of project variations that impact the client contract and linked subcontracts.
Requirements for Strong Financial Management
Comprehensive enterprise software must include integrated functionality to manage all the construction project cost drivers including procurement, subcontractors, external and internal equipment rental and finally, labor. This includes the ability to produce a forecast based on trusted data rather than on spreadsheets that can easily be massaged to serve the interests of individual contract or project managers or internal teams.
Each project change needs to revise the profit and loss forecast through the end of the project life — robust solutions are capable of handling changes efficiently while preserving margin and avoiding surprises. As change orders are issued, it will be impossible to miss or obscure the financial impact, which lets the engineer risk out of the construction operation.
While cost, revenue and margin are important, so is cash flow where businesses must have enough cash on hand to support project operations. A good deal of the risk involved in the project may result from imbalance between the inflow of cash resulting from payment milestones or payment applications and the outlay of cash for subcontractors, materials, equipment and labor. This is why ERP systems must be able to forecast the cash position of the organization over the project lifecycle.
During estimating and in the initial negotiations with the project owner, the business will be able to establish tie-ins between risk and opportunity. As the project scope changes, it can quickly place a value against risk in terms of cost, cash and impact on the expense and cash flow timeline.
Avoiding Risk – Spreadsheets Won’t Do
Businesses need to choose tools that enable them to manage other project risks with an embedded risk management module. Just like the project forecast, contractors often handle risk management in Excel, and that spreadsheet is often not consulted or altered once the project is underway.
Managing risk continuously ensures decision-makers can identify the necessary contingencies in the forecasting process and ensure that risks are consistent with the forecast. Most importantly, it allows actions to be assigned and tracked to mitigate the risks.
Most contractors think about cost in terms of cost code structures tied to account numbers in a general ledger. A cost breakdown structure (CBS) is fit for breaking down cost such as labor, equipment, materials and subcontractors in a granular fashion, without resulting in an overly complex general ledger.
A consistent CBS across projects means decision-makers can easily template costs from one project to the next, and most importantly, get a consistent management view and cost reporting coding structure to rollup project performance across the entire enterprise.
Meanwhile, a work breakdown structure (WBS) can be unique for each project according to the project owner’s requirements. Together, WBS and CBS enables businesses to meet unique customer expectations while preserving a consistent approach across multiple projects. When WBS is integrated with the project plan, the project timeline can be used to drive the financial forecasting as well.
Visibility Beats Volatility
Ensuring financial control of construction projects in the face of volatile economic conditions and complex business structures is key to keeping a competitive edge. Flexibility to adapt to changing financial circumstances cannot be underestimated. This means being able to manage the project budgeting and monthly project forecasting process at any level of the cost or work breakdown structure.
ERP must be able to run large projects using a top-down cost control methodology driven from a CBS, while ensuring smaller projects can be run using a bottom-up WBS methodology. When these requirements are met, business leaders in the construction sector can proactively manage risk and stay in control of operations that make a real difference to their bottom line.
Robert Bruscino is a solution architect for construction at IFS, and possesses a unique cross functional background derived from more than 35 years’ experience in the construction, real estate and property management industries, having served various roles in finance, accounting, sales, marketing, operations and information technology.
