How Project Budgeting Affects Income and Profit

Published on
March 14, 2022

A project budget provides contractors with information not only on potential costs, but it also predicts the total income and profit expected on the project. Contractors who don’t track project budgets could be leaving money on the table.

Budgets can be used to predict cash flow, recognize potential problems, identify scope changes, recognize income, and provide data for more accurate estimates in the future. All of these benefits lead to increased income and profits for contractors.

1. Predict income and cash flow

Contractors can use their project budget and schedule to help them predict future income and cash flow over the duration of the project.By overlaying the schedule on the budget and anticipating how much of the work will be complete at each billing cycle, contractors can predict their income for each month.

Income is based on the percentage of costs complete as per the project schedule. This percentage is multiplied by the total contract to get the value that can be billed in each month. The difference between the costs and income is the net cash flow and profit for the project. This money can be used to expand operations or pay for administrative expenses.

For example, a concrete subcontractor is about to start a three-month project that is worth $100,000. Total costs for the project are expected to be $75,000. If production remains steady over the course of the project, the contractor can expect to bill $33,333 each month, and have costs of $25,000 each month. Based on these numbers, the contractor knows to expect$8,333 in profit each month. They can use this information to inform their business decisions over the next three months.

2. Spot potential problems early

With a project budget in place, contractors can compare the percentage of costs incurred to the progress on the job and spot budgetoverages before the end of the project. The more detailed the breakdown of budget line items, the more information a contractor has to help them determine if the project is on budget.

If a budget overage is found while the project is in progress, the contractor can adjust to offset potential losses. An overage may also be a sign that added work has been performed and the budget needs to be increased, along with the projected income.

In our concrete example, say the contractor noticed that in the first month they spent $30,000 in costs, instead of the budgeted $25,000.The project manager checks with the field and finds out that they had to do some extra work to repair a slab that was damaged. The PM will adjust the budget to reflect this change and look for ways to save money in the future to offset the loss. Since he found the overage early, there are still two months to make up the difference. Without a budget, he may have to wait until the end of the project to discover the cost overrun.

3. Identifying scope changes

If the contractor finds that a budget overage is due to added work in the field that was requested by the owner (a change order), the project manager can adjust the budget to add the additional costs and potential income from this work. This change is important because it affects the percentage of completion, which informs the amount of income that is recognized for the project.

If the damage from the example above was caused by something outside the contractor’s control or was requested by the owner, then it would be a change order to the owner and an increase in the overall budget. The slabre pour costs $5,000 and is being sold to the owner for $7,000. The new contract total would be $107,000 and budgeted costs are now $80,000. Due to this change,the overall profit on the project has increased from $25,000 to $27,000.

4. Income recognition

Most contractors use work in progress reporting for their income recognition. This means the amount of income they can claim is based on comparing the budget for each active project to the actual costs to date to determine the percent complete. The contractor is only allowed to recognize the amount of income based on the percent complete. For example, if 50% of the costs are in for a project, then the contractor could only recognize 50% of the overall income.

If a contractor has billed more than the amount of income they can recognize, then their income is reduced by the overage. This is called overbilling. If a contractor has billed less than the allowable income amount,then their income is increased by that amount. This is called underbilling.These adjustments are made on the income statement and have a direct effect on the amount of income and profit a contractor can claim for any time period.

In the first month of our concrete example, costs to dateare $30,000 and the adjusted budget is $80,000. The project is 37% complete according to the costs. The contractor can recognize $39,590 in income($107,000 multiplied by 37%). If the contractor billed the owner $45,000 for the work that was completed, he is overbilled by $5,410. The contractor’s income statement will show a reduction in income due to overbilling of $5,410.

5. Improved estimating accuracy

Reviewing project budgets and comparing them to the actual costs incurred on past projects allows contractors to improve the accuracy of their estimating. Analyzing several projects of similar scope allows contractors to refine their estimating, which improves their success rate and increases income.

With better estimates there is a reduced chance of costoverages on projects. Contractors get a better idea of their actual costs to perform the work, which they can use to better inform their budgets. With less cost overruns, there is increased profit for the company.

If the concrete contractor determined that the slab repour was due to a design issue that might come up on another project, they could adjust their estimate for this type of work to include the added costs. In a future project they will recognize the added income without the delay and added costs.

Automated budget reports with Theo Build

Without a project budget, contractors are flying blind. They need to know the potential costs on a project before they begin work, so they can spot overages and report the correct income on their financial statements.In addition, budgets help them predict future cash flow and income, allowing them to make better business decisions.

Using tools like Theo Build help contractors keep costs inline and track project budgets closely. Costs automatically go to the correct budget line, ensuring that reporting is accurate. If you’d like to see how budgeting works with Theo Build, contact us for a demo.