The Price of Not Understanding Cost to Complete
Published on by Dan Holthaus in Construction
The construction industry has a unique form of recognizing revenue based around the concept of Cost to Complete (CTC). Contracts for construction projects can often stretch from months to years. The CTC model allows construction firms to recognize revenue over the life of the contract based on how much of the project is complete. This process inherently provides the possibility of error in determining profitability until a project is complete.
The CTC process can often cause problems, because vital personnel don’t completely grasp the concept and the impact that it can have on an organization. In order to establish a baseline CTC, estimators initially bid a project setting the standards that need to be achieved in order to reach a goal level of profitability. Variables that are unique to a project and may come in to play must be accounted for by Project Managers throughout the project. This is often where a disconnect occurs between the budgeting and forecasting process. As more cost is incurred that was not initially forecasted by the estimators, the project is shown as closer to completion than it truly is. As these scenarios accumulate over the course of a project, the CTC becomes an inaccurate model of where the job stands.
Inaccurate CTC schedules may result in:
- Profitability fluctuation due to inaccurate revenue recognized: banks and surety companies frown upon inaccurate financial statements that show inconsistencies in revenue and profit margin.
- Negative impact on your line of credit, negotiating debt, and surety bond rates as a result of banks and surety companies reduced confidence in your ability to report consistently
- Inaccurate strategic decision making by management based on incorrect information: without accurate data, you can’t identify weak points and as a result, projects experience margin fade near completion.
It is common practice for Project Managers to break down jobs into segments to track cost. By assigning cost to each of these segments you can get a sense of how the project is performing at the macro level. The most common mistake is forecasting this segment onto the project without considering the variables, such as weather, unforeseen delays, and equipment issues. A strong Project Manager will be able to understand how the impact of these issues has affected the budget and the necessary adjustments that will need to be applied to the CTC.
Take time to invest in your team’s understanding of the CTC process and the impact it can have upon your organization. Being able to report cost and forecast accurately will have rippling effects. Estimators will be able to more accurately bid jobs as they have a greater sense of the cost and capabilities under different circumstances. Your financial reporting will become more reliable and you will be able to place greater faith in your strategy going forward.