By now, many construction businesses have at least outlined the parameters of their 2023 budgets, if not finished them entirely. No matter where you’re at in the process, it doesn’t hurt to double-check your methodology to ensure your spending plan for next year is built on a solid foundation.
Start with spending
Often, the budget-setting process begins with an estimate of total revenue for the year. A better strategy, however, is to start with projected spending because it’s something over which you can exert a little more control.
Divide your expenses between hard and soft costs. As with individual project budgets, hard costs are the “brick and mortar” expenses directly related to physically completing work — such as equipment, materials, and labor. Soft costs are indirect costs (such as insurance, fees, and certifications) and overhead costs (such as office rent and furniture).
When you divide your budget into these two categories, you’ll have a better sense of which line items are variable and can be adjusted and where to apply cost-control measures. Throughout the year, check back on hard and soft costs to see whether new or overlooked ones are threatening the budget.
Heed historical lessons
Taking last year’s budget and adjusting the numbers for inflation may be tempting, but it usually doesn’t work. You can and should, however, review your construction company’s historical data to better identify relevant trends that could likely affect the budget throughout the year.
For example, study your income statements from the past several years. Start with the most recent one and compare each line item to past statements. If you detect an upward or downward trend for a certain expense, adjust the line item accordingly.
Such a review presents the opportunity to determine where your operation has consistently spent above or below allotted budget constraints. It could also reveal whether you need to readjust spending, cut back operations or look for ways to raise capital.
Calculate your gross margin, which is the difference between net sales revenue and the cost of goods sold (COGS). In construction, COGS typically refers to direct costs, such as materials and labor, as well as indirect costs or general conditions.
Compare your gross margins from previous years with the average gross margins for the industry segments in which you perform work. You should be able to locate this data through trade publications or industry associations. Knowing these numbers will help you refine your current budget and set prices for jobs as the year goes along.
When it comes to projecting gross margin, temper optimism with pragmatism. A 5% sales growth last year doesn’t automatically translate to 5% growth this year. Consider other qualifying factors such as staff turnover, current market costs of labor and materials, the need to buy or lease new equipment, local market demand, and the overall economy.
An objective review of your budget, as well as your budget-setting and -management process, can provide useful insights. Feel free to contact us for help identifying trends that may be hidden in your financial statements, as well as implementing strategies to leverage opportunities and guard against risk.