No job ever goes perfectly. The longer you’re in business, the more war stories you’ll accumulate about how a project fell apart due to inclement weather, power losses, forest fires, loss of your most responsible carpenter, or the homeowners who morphed into the customers from hell as soon as the contract’s ink was dry.
You may not be able to predict the nature and timing of the next disaster, but you can draw on your experience to smooth out some of the inevitable ups and downs of your business.
There are three categories of risk:
1. Financial–Factors such as the amount of cash reserves, the timing of your billing, and the likelihood that the customer will pay you on time.
2. Contractual–Factors such as the clarity of the scope of work and change order process, and how accurate and current your legal documents are.
3. Operational–Factors such as how familiar is the work to be performed, the quality of the crew and project manager, availability of the appropriate equipment, insured status of subcontractors, and the likelihood that required materials will be available on time
Once you’ve considered a prospective job’s risk factor, how can you quantify this in a useful way? Obviously, if a job’s risk factor is too high, you should walk away from it.
Where does the acceptable risk level lie? Pricing can help you out here. If you price a risky job accurately enough, you are more likely to (a) still make a profit or (b) scare them off.
Here’s how to do it.
First, come up with an estimate for the job, unadjusted for risk. Let's say the estimated cost of the project is $100,000.
Next, come up with a “Perfect World” and “Catastrophic” estimates for the same job. This is where your gut and years of experience come in, and where you can consider the likelihood of weather, crew loss, sour customers, and so forth. Then assign a probability for each scenario. For example, you may feel that there’s a 40% chance that the job will run as usual, 25% that conditions will be perfect, and 35% chance that the job will be a disaster. This is where your gut and years of experience come in!
This is how the risk table should look:
Complete the Weighted Average column by multiplying the estimated cost by the probability for each of the three conditions. The total of the Weighted Average column reflects the estimated cost including risk. In this example, 4.4% was added to the estimated cost of the job. The final step, of course, will be to add a markup suitable for your company’s overhead and its target profit, based on the total estimated cost adjusted for risk.
While none of us has a crystal ball, it is possible to provide a cushion against the inevitable!
