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Mastering the construction budget: A contractors guide

Abstraction of a budget breakdown (materials, labor, equipment, subs, misc.) | Budgeting 101 | Knowify

One of the greatest military minds in all of history, Sun Tzu famously said, “Every battle is won before it’s ever fought.” The outcomes of battles are determined by the preparations and strategies put in place before fighting ever starts. While Sun Tzu was referring to logistics and troop deployment, there is a surprising amount of wisdom in those words that contractors can apply to their trade, especially when building a construction budget. 

A carefully crafted budget will greatly increase the chances of a profitable and efficient job. Of course, you’ll still need to execute, but Sun Tzu tells us that success is not just a result of the physical effort you put into something but the quality of preparation you put in before you ever hit the job site. 

While annual company-wide budgets will include overhead, administrative, and other indirect costs, this guide will focus on the main components of project budgets (i.e., materials, labor, equipment, subcontractor fees, and miscellaneous project costs). 

In this construction budget guide, we’ll explain construction budgeting and why it’s essential to the success of your contracting business. From there, we’ll detail how to build a budget, what to include to ensure you have an effective and competitive budget. Finally, we’ll close things out with some helpful strategies you can use to ensure your budget process is as efficient and profit-enhancing as possible.

What is a construction budget?

A construction budget is a financial plan that estimates the expected costs and all relevant expenses involved in a construction project. This is done by placing a spending cap on each major cost category: labor, materials, equipment, and miscellaneous costs. 

A well-crafted construction budget is an invaluable planning and project execution tool. By carefully allocating the costs of each task, you’ll have a blueprint that can dictate nearly every decision you make on the job. However, you shouldn’t think of budgets as restricting or limiting your ability to perform the job. Instead, they provide freedom to execute a job with precision and efficiency. 

Most, if not all, stakeholders, investors, and project owners will require a detailed budget before approving a project. Moreover, it’s a tool that everyone can use to gauge their own ROI.

Why is construction budgeting important?

Construction budgets are essential as they serve as a primary tool for contractors to meet financial objectives. If done consistently, budgeting will likely dictate every decision you make pre-construction. It will determine scheduling, the quality, type, and quantity of the materials you purchase, what equipment you use, and your overall approach to the project.

Here are a few reasons why construction budgets are so crucial to project success:

  • Provides an overall financial plan for each project
  • Assists in securing funding and ensures sufficient resources are available
  • Helps ensure the appropriate distribution of materials, labor, and equipment
  • Serves as a reference point for decision-making
  • Allows for accurate cost estimation and facilitates fair and transparent negotiations
  • Helps avoid financial disputes by giving all stakeholders a clear financial end goal

At the start of a project, a budget serves as a clear launching point. At the end of the project, it turns into a valuable performance review. But during a project, your budget should serve as a constant gauge for project performance. You don’t have to wait until the end of a project to know if you came out profitable. 

When you need to get somewhere new, you don’t look at a map once and then do your best to get there by memory or only refer to it once you’ve realized you’re already lost. It’s best to refer back to the map as often as you need to ensure you stay in the right direction. The same applies to your budget. Refer to it as often as possible to ensure you don’t get lost in cost overruns. 

Budgets provide a framework and single source of truth through which you can stay on track for every project phase. And if you aren’t on track, a budget can help you pinpoint why. While creating a detailed budget takes considerable effort, it will save you an extraordinary amount of admin time in the long run. Placing a continued emphasis on generating strict budgets and sticking to those spending constraints will result in a compounding effect over time.

Control costs and plan for profitability

Just like an unattended campfire, spending can quickly become uncontrollable if left unchecked. You don’t want to get caught in a situation where it’s too late to put out the fire that is cost overruns. 

An effective budget ensures that you’re starting with the end in mind. Well-begun is half-done, as the saying goes. With a solid budget, you’ll have a framework you can rely on all the way through project closeout. However, contractors are only human, and you’ll likely go over budget despite your best efforts.

In this case, the added benefit of a budget is the wealth of data it gives you to evaluate after the fact. This is where job costing shines through as a powerful business improvement tool. Job costing works by tracking and comparing all associated costs against your budget. 

In this way, you can start to piece together the financial story of a particular job. If you went over budget in labor costs, for example–why? Did you underspend on materials? Why? By answering these questions, you’ll unlock invaluable insights for improving your business where it matters most–efficiency and profitability. 

With all that said, a budget is not just useful for the beginning and end of construction projects; you can and should reference your budget during a job. Real-time tracking of actual costs will give you an instant snapshot of how you’re pacing against your budget. This is where the power of a budget comes through. 

You’ll know when something isn’t right because you’ll be able to see that construction costs aren’t where they should be. Instead of constantly worrying about how you’ll come out after a job, you’ll be able to constantly gauge your profitability through every phase of a project. This allows you to evaluate and address any issues before it digs into your bottom line.

Consistent budgeting means long-term improvements

Budgeting isn’t meant to be a one-time benefit. Consistent budgeting practices can be a powerful tool for making real and long-lasting improvements for your business. Meticulous budgeting with regular analysis will shine a light on where you’re chronically over or under-estimating. 

Uncovering this information will obviously help you improve your estimates, but doing so will also improve your ability to win more bids since you’ll have an estimate with pinpoint accuracy. 

If you can pair these efforts with some standardized procedures like cost codes and phase names that remain consistent, you can create an extremely efficient process for reviewing and evaluating actual costs against budget expectations. We can’t understate how impactful this is for your long-term financial growth.

Helps establish good relationships

Building a reputation as someone that can consistently execute while staying under budget will go a long way in establishing yourself as a trusted contractor. It’s a good look anytime you can fill the coffers of your client (while still filling yours). 

Coming in under budget shows you pay attention to the small details and bring pragmatic solutions to the table. It also demonstrates that you’re approaching a project with forethought–which is always a good look. 

Creating a construction budget will require a lot of communication between you, the project owner, and your GC. This back-and-forth is needed to ensure you have an accurate account of the scope, tasks, materials, and overall build plan. This constant communication will provide a valuable opportunity to improve working relationships with your suppliers and project owners.

Better job costing for better productivity

Job costing is most effective when you start with a detailed budget. Capturing costs at the job level is essential, but it won’t actually tell you anything about your productivity or efficiency on its own. To dig deeper, you’ll need to start with a detailed budget that you can use to compare actual cost totals against. 

This gives you a nice frame of reference to see just how well you’re doing against expectations. The budget will hold you and your finances accountable. It provides a framework through which you can base your decisions on. Without it, you’re shooting in the dark. 

In addition, consistently tracking project costs will allow you to build a historical data set that you can reference when budgeting for future projects. For example, looking at this data over time, you may see that certain jobs consistently overrun on costs.

Looking deeper, you may find the culprit is labor costs that have gone over budget every time you’ve tackled this type of job. Starting with a budget tells you that you are over budget and where and why you’re over budget. 

From here, you can adjust your estimates or change your approach on how you schedule or execute this type of job–improving your bidding process or optimizing the efficiency of your processes. 

Again, it’s about starting with and working toward a clear goal. Instead of spending sleepless nights in the office trying to recalculate costs and stressing about unexpected costs, you’ll have already planned for and avoided these pitfalls. Predicting costs allows you to efficiently allocate materials and schedule crews while working toward a clear and achievable profitability goal.

Construction budget breakdown: what’s included in a construction project budget?

Labor costs

Labor will include the hourly wages of all the workers needed to complete a job. But labor costing goes far beyond just hourly wages. Your budget must account for labor burden, including taxes, benefits, workers comp, etc. For example, if you plan on assigning a foreman and two laborers on a five-day day job (40 hours total), you might have a budget that reflects the following:

Foreman: $40/hr * 40 = $1,600

Laborer 1: $20/hr * 40 = $800

Laborer 2: $20/hr * 40 = $800

Total = $3,200

At first glance, you’ll need to budget $3,200 on labor costs for this job. However, this budget is missing some critical pieces of information. If you’re paying for health insurance and workers comp, you can expect to add an additional $5 to $15/hr on top of wages depending on benefits offered. In this example, let’s assume health insurance and workers comp results in an additional $8/hr to each employee. 

Foreman’s fully burdened labor rate:

State unemployment insurance$0.27
Workes comp$3.00
Health insurance$2.92

After taking into account labor burden costs, your foreman’s actual cost to your company is a full $8/hr more than you had originally estimated.

Over time, with multiple employees, failure to account for labor burden can cause your estimates to be off by as much as 50%! Compounding from project to project missing labor burden will wreak havoc on your long-term financial health. 

Hopefully, this demonstrates the importance of labor burden and why you should always factor it into your budgets, bids, and estimates (more on this later). 

Material costs

Project budgets should include a full breakdown of the cost of materials needed for each stage or phase of the job. Do your best to think of every possible material needed for the job. Capture everything you can think of so your budget includes these costs. 

Material costs are impacted by quality, market rates, and supply chain costs, so be sure to factor in these while budgeting. That said, it’ll be no surprise if material costs differ from your initial estimate once you’ve placed your first purchase order.

Since you can’t generalize material costs across all your jobs, you should reference job costing data from past jobs. This will let you see what you actually spent in materials costs on similar projects, which should help you narrow in on a more accurate budget for the upcoming job.

Equipment costs

Take into account any special equipment or machinery needed for the job. To do this, look at ownership, operational, and equipment leasing costs for every piece of equipment you’ll use on the job. 

Ownership costs will include things like depreciation, insurance, and licenses, while operational costs will include things like fuel and repair costs. Finally, leasing costs will include the costs of any leased equipment you’ll be using.

Subcontractor fees

Take into consideration any fees associated with additional subcontractors needed for the job. For example, you may need another team to work drywall or electrical. Put together a clear subcontractor agreement outlining the scope of work and price.

Bringing in additional subcontractors can reduce costs by allowing you to focus on what you do best instead of trying to tackle an aspect of a job that you’re not equipped to handle. But, you need to ensure that other subs are truly needed to complete the job on schedule. If you so, review bids carefully to and ensure these costs are factored into your basic budget considerations.

Miscellaneous costs

These are all other associated costs for a job that fall outside of labor, materials, equipment, and subcontractor fees. These indirect costs may seem tedious to track, and while they won’t have the cost impact as labor or materials, they’re just as important as direct costs (i.e., labor, materials, equipment, subcontractor fees). Unchecked, these costs can quickly add up, being more than enough to break what would otherwise be a profitable job. 

Miscellaneous costs: 

  • Permits
  • Bonds 
  • Insurance 
  • Financing fees (loans/interest)
  • Contingency funds

How to Create a Construction Budget

Looking at the overall job, you’ll want to create a line item-by-line item budget for labor costs, materials costs, equipment costs, subcontractor costs, and any other random costs that fall outside those categories. 

With these major cost categories in mind, break the job down into phases or stages. For example, a kitchen remodel might be broken down into eight different phases:

Construction budget example

1. Tear down and disposal$1,500$300$200$0$250$2,250
2. Structural repairs$1.000$500$300$2,000$0$3,800
3. Assess the electrical and mechanical systems$350$50$0$0$0$400
4. Assess the plumbing$350$50$0$0$0$400
5. Flooring installation$5,500$3,000$200$0$150$8,850
6. Install counters$3,500$1,100$250$0$200$5,050
7. Backsplash installation$850$250$0$0$75$1,175
8. Appliance installation$650$50$0$0$0$700

Note that you shouldn’t provide a general lump sum for any phase. Instead, you should break down each phase into the major cost categories and have a specific cost estimate in mind for every category in every phase.

So, instead of estimating a blanket $2,250 for the first phase (tear down and disposal), break it down so you know exactly how much you plan on spending in labor, materials, equipment, sub fees, and miscellaneous costs for that specific phase. 

After breaking the job down into phases or stages with categories, you can start to obtain quotes from suppliers (and subcontractors, if applicable). Analyze market prices and use historical data from past jobs or similar projects to help you. Remember that you must track every single cost that goes into your project.

Outside of the basic structure above, there are some vital concepts to keep in mind and steps to take to ensure you’re budget is as comprehensive as possible. These are:

Understand the scope of work

The scope of work is there to help provide additional guidance. The beauty of the scope is that it’s signed off by all stakeholders, so it works as a single source of truth should you run into snags in your planning or budgeting. 

By understanding the goals, objectives, and specifications laid out in the scope, you can craft your budget around your client’s requirements while at the same time meeting your own business needs. 

Review past job costing data

History often repeats itself, but it doesn’t have to. Taking the time to study past performances on similar jobs will reveal the insights you need to be better at the next job. It’s a step you can’t afford to forget when putting together a new project budget. It’s worth the time to sift through the data to find nuggets of information that can make your next budget more accurate. 

The goal here is to see how your previous budget performed. Did you come in exactly on budget, or did you completely miss the mark? It seems tedious, and it can be tough to go back and relive mistakes or issues that caused cost overruns. But this is all about getting better. It’s the only way to understand where can improve and catch common mistakes early in the process. 

Go in with a plan

Remember Sun Tzu? Win the battle before it starts. After reviewing your performance on past jobs, it’s essential to make sure you have a new plan in place to dial in your costs for the upcoming project. 

For example, if you run into cash flow issues on your last job because you were spending more than you thought you would on labor costs, consider securing financing or reevaluating your scheduling or processes. Make a list of all the resources, processes, materials, crew schedules, and logistics for each phase and ensure they align with objectives from the scope of work. 

Spend time before hitting the job site, forming the procedures, processes, and resource allocation to ensure the project doesn’t run into the same problems as last time and conforms to your client’s requirements. 

Establish cost codes

Cost codes are valuable for contractors who wish to standardize and report across jobs. Consistency in phase naming using cost codes could be very valuable, depending on your trade. Not every job broken down at the phase level will have cost codes. However, you can choose to use them to get more granular or cost out similar phases across jobs.   

Cost codes are a particular way to conduct phase-based job costing in which you always use the same numerical code for a certain phase. For example, using the official CSI codes, plumbing piping insulation will always be identified with a code of 22 07 19. You will rarely find companies using their own custom cost codes outside the official CSI codes, so if you use them, stick with construction industry standard codes.

How to ensure you build a competitive budget

To start, don’t assume anything. Leave nothing to chance. This is especially true for your client’s expectations. Understand what is important to them and do everything you can to ensure you see the project from your client’s perspective. 

In this way, you can create your budget and then show it to them, explaining your thought process behind each number. This is a crucial step to work through issues and level set expectations and realistic outcomes. 

If there are objections or things they want to change, have these discussions openly and honestly and back everything up with data and facts. Handling these discussions and crafting a budget around their priorities is the key to developing a project plan and budget that works for everyone.

Seek expert advice

Don’t be afraid to run your budget by a financial or accounting professional who can provide insight into your budget structure and details. We recommend doing this for any large or complex projects as another way to ensure you have a solid plan in place. 

Expert advice can make all the difference, and the second set of eyes, and expert eyes at that, can do wonders to improve your budget to ensure you have an even better plan. They can help you think about the project from another perspective and help you structure a budget. This can also help you if you feel stuck or unsure when putting together your budget. 

Always account for labor burden 

Labor burden is the full cost that an employee has on your business. This includes much more than just their wage. For example, employee benefits such as paid time off, retirement, and health insurance are consistent costs per employee on top of their hourly wage. 

Examples of additional costs that account for labor burden:

  • Payroll taxes
    • FICA
    • Medicare
    • Social security
  • Health insurance
    • Dental
    • Vision
  • Workers’ comp/liability insurance
  • Retirement contribution
  • Bonuses
  • PTO/Vacation

Failing to account for labor burden can be enough to completely render your budget useless. It could cause your labor estimates to be off by as much as 50%. For this reason, you should take the time to calculate the labor burden for every employee and ensure you are applying this number to your labor estimates and budgets. 

Miscalculation of labor burden can lead to budget overruns, project delays, or a poor quality of work. For this reason, we recommend you recalculate labor burden percentages every 6-months or so to ensure your numbers are up-to-date and accurate. 

(Burdened labor costs + Additional costs) / Wage * 100% = Labor burden percentage for that employee

With this rate in hand, you can apply a fixed rate on top of employee wages when estimating your next job. Even better, we recommend getting as specific as possible using construction accounting software that automatically applies labor burden for every employee. 

Stay consistent & review often

Just because a job has closed out doesn’t mean you should forget about it. Keep old budgets filed away and organized. When a similar job pops up, go back and analyze the old budget to see where things went wrong or right. 

Study the past job to get an idea of the actual cost totals for materials, labor, and equipment. Were you under budget for the last job? Did you end up going over budget on labor? Take the time to reflect on these questions so you can better prepare for the upcoming job. Through careful comparison and analysis of past budgets, going line-by-line you’ll have the insights you need to create a realistic and achievable budget. 

Staying consistent with your budgeting practices with things like phase names and cost codes can help improve this review process even more. This will allow you to see where you’ve been systematically over or under estimating costs, allowing you to quickly and effectively adjust budgets. 

Consistent budgeting practices can be a powerful tool for improving your estimating, and vice versa! This symbiotic relationship will help you nail down accurate cost numbers that will either win more bids (because you’re no longer overestimating costs) or improve profitability because you’ve stopped underestimating costs. 

Get on the same page with your client

After you craft your initial budget, meet with your client and all relevant stakeholders and run through the budget. Take initiative in this meeting and be ready to defend your cost numbers. Historical data can be of huge benefit here since you’ll be able to back up your estimates with hard data. 

Talk through any objections from your client and have them go back through their needs and requirements. This is to ensure your budget is accurately reflecting their requirements. This is also time to discuss if any client requests will impact your budget or finances. 

If they want to change anything in the scope that will cause your budget to problems, be transparent about this and don’t shy away from explaining why this will cause you cash flow problems or hurt other aspects of the job like timelines or quality. Remember that they need you, and most times, they will be willing to work with you as long as you can back up your claims with historical examples and real cost data. 

Be transparent with your team

Your field team and project management team must be on the same page regarding your budget constraints. The theory behind this concept is called cost control

If your employees aren’t working off the budget you’ve painstakingly created, then it doesn’t matter how airtight of a plan you’ve created. Your budget can only work if it’s performed as intended. Ensure everyone is on the same page when it comes to your budget. There is no reason to keep this information just to leadership. 

Call a team meeting if you have to, and run through the budget as a team. This way, everyone can march in the same direction. If anyone has questions or objections, keep your ears open. Remember that your team may have intel or experience that you don’t have. 

Ensure foreman and managers understand the numbers and make their day-to-day decisions with that budget in mind. If they go against it, ensure they’re running it by you first and coming to the table with a good reason. 

Napoleon said it best when he exclaimed, “An army’s effectiveness depends on its size, training, experience, and morale, and morale is worth more than any of the other factors combined.” 

Transparency boosts morale by allowing you and your team to openly collaborate on how to improve projects. This keeps all team members in the know and increases involvement. A successful project plan that is under budget benefits everyone. Make sure you’re team knows that a rising tide lifts all boats.

Construction budgeting tips

Estimate with budgets in mind

Budgets can hinge on the effectiveness of your estimating process. If you’re putting effort into a precise estimate to help win a job, don’t let those numbers fall to the wayside once the job starts. Take the time to compare your estimates to actual costs to help you craft a more realistic budget for future projects. 

This one seems obvious, but it’s a common mistake that even the most experienced contractors make. You’re only human, and no one can craft a perfect budget for every job.

However, you must ensure you’re backing up your estimates with hard data. Don’t guess. Pull from past jobs or intel from the project owner, supplier, or general contractor. You’re estimates must have solid legs to stand on. 

Consistent budgeting practices can be a powerful tool for improving your estimating, and vice versa! This symbiotic relationship will help you nail down accurate cost numbers that will either win more bids (because you’re no longer overestimating costs) or improve profitability because you’ve stopped underestimating costs.

Change orders, change budgets

Change orders can wreak havoc on your budgets. For this reason, do everything you can to reduce the amount of change orders throughout the construction process. This starts by having a comprehensive budget.

If you’ve accounted for every possible cost, you may be able to catch a cost before it becomes a problem on the field. Address change orders quickly and communicate your reasoning for issuing these orders effectively. If your general contractor or project owner initiated the change order, communicate how this change will impact your budgetary or cash flow needs.

Don’t stay silent here. Bring up these concerns as soon as you identify them so you can find creative solutions to keep projects on track. In addition, utilize construction-specific software designed to track, issue, and organize change orders.

Track costs and progress in real-time using construction management software

Construction management software helps subcontractors optimize their project budgets in several meaningful ways. Using construction management software allows you to not only craft accurate budgets but also lets you track everything in real-time. If you’re tortured by sleepless nights worrying about the uncertainty of projects, construction management software is for you.

Budgeting tools will allow you to track budgets in real-time, letting you see where money is going. You’ll be able to see how every dollar spent is affecting your bottom line. The additional organization, tracking, and reporting of tools like Knowify help you optimize budgets, ensuring you make the most efficient use of your money for every project.

Communicate and manage external risk factors

Bad communication is the bane to all successful construction projects. You can’t foresee everything as unexpected costs will inevitably happen but you should still try to.

Assess anything that could go wrong and have something in place to address it. Communicate this to your team so that when something does go wrong, everyone is ready to spring into action instead of standing idly wondering what to do next.

Budgeting with Knowify

Getting the most bang for your buck is central to the construction industry. This all starts with creating a construction budget that works for you, not against you.

If you’re a specialty contractor looking for the most streamlined way to better manage your project budgets, then Knowify is here to help. With a centralized platform, you can easily organize budget items and track budget-related documentation such as invoices, payment schedules, and contracts.

Not only that, Knowify offers powerful insights and alerts to help you quickly identify potential budget risks and prevent unforeseen costs. In addition, contractors can easily compare and adjust different budget scenarios to make the most efficient use of financial resources.

To learn more about how project management software like Knowify can help you with cost control and budgeting, schedule a demo with a Knowify expert, or start your free trial today!