The construction industry is a risky business. Consider a simple example: What’s the possibility of losing 50% of your expected profit on a project? Now, what are the odds of making an extra 50%? The chances of losing your shirt are far greater than the chances of a profit windfall.
Given these odds, the typical contractor has no choice but to assume risks. Knowing how to allow for that risk before you sell the job might be the difference between making a profit and losing your shirt.
To handle risk, create an estimate. Do not account for risk in this estimate — it should only include typical anticipated costs. Next, review the estimate and create two more estimates: a “perfect world” estimate, where everything goes exactly as planned; and a “catastrophic” estimate, where everything goes wrong. These estimates should include all standard risks that each job faces.
Look objectively at factors such as estimated hours, jobsite accessibility, subcontractor reliability, and the time line. Once you’ve created these two additional estimates, assign each estimate a subjective probability percentage. Next, create a weighted-average estimate by multiplying your probability factor by each estimate’s cost figure. Last, use this as a basis for an additional markup for risk in your proposal.
Once you have roughly quantified the risk, you can add those additional “risk” dollars to your estimated costs. Then, add overhead and profit to come up with a sale price that includes the risk calculated for the job.
—Leslie Shiner, owner of The ShinerGroup, and Melanie Hodgdon, president of Business Systems Management, provide management consulting and coaching for contractors. They co-authored A Simple Guide to Turning a Profit as a Contractor.