Construction and capital improvement projects can be complex financial expenditures for an organization, and present significant risks to the organization’s goals and objectives. Generally, organizations do not have construction cost experts on staff when they embark upon a major construction project. Frequently, this gap in internal knowledge is “patched” through the use of a construction management firm.
However, while a construction management firm can help with the logistics of a construction project, such as coordination of bidding, ensuring that construction is performed timely and safely, and that the specifications of the project are adhered to, a construction management firm rarely provides significant help in ensuring that the financials of the construction project are appropriate.
The risk undertaken by the owner organization during a construction project is heavily influenced by the type of contract that is used for the project. There are generally three types of contract used:
- Fixed price contract – Fixed price, or lump sum, contracts are most frequently used, especially on large projects. A fixed price contract transfers most, but not all, of the financial risk to the construction company. The owner of the project retains some financial risk through the change order process. As the number and value of change orders increases, so the risk that the original contract price was underbid increases, and may indicate that the construction company is attempting to pass the financial risk back to the owner. Management of change orders is essential in managing the project, and frequently the owner’s staff are not knowledgeable enough to provide effective financial oversight. Additionally, with a fixed price contract any cost savings accrue solely to the construction company.
- Guaranteed maximum price contract – A GMP contract is in essence a time and materials contract with a maximum price that will not be exceeded (unless it is increased through change orders). A GMP contract results in a sharing of financial risk between the construction company and the owner. Additionally, any cost savings identified during the project will generally accrue to both the construction company and the owner.
- Time and materials contract – Under a time and materials (or T&M) contract, the financial risk is almost entirely retained by the owner of the project. The construction company may retain some financial risk through warranties or similar contract provisions.
With a GMP or T&M contract, it is essential for the owner to ensure that costs being applied to the contract are appropriate and reasonable. An owner does not want to pay billings for costs unrelated to their project. Some costs can be easy to monitor, such as materials and labor allocated to the job, as the owner can monitor the materials delivered to the site and the construction personnel physically working on the project. However, many owners fail to perform any procedures to ensure that the amounts billed match the amounts delivered to the jobsite or the personnel that were observed working on the project. Additionally, there are other more ambiguous costs, such as insurance charges, maximums placed on rental charges, overhead and home office allocations, et cetera, that are frequently applied to contracts that an owner has little ability to fact check or verify.
It is essential for the organization to have construction financial experts available to perform procedures on billings received from construction companies to ensure that billings include only those costs allowed under the contract and that relate to the project.
If you are considering undertaking a construction or capital improvement project, or are currently going through a construction or capital improvement project, Dean Dorton professionals can work with you to enhance your existing controls and provide added value to your organization. Our comprehensive, customizable range of services can help you protect your financial interest in construction and capital improvement projects.
Contact Simon Keemer, Adam Shewmaker, or your Dean Dorton advisor for more information on how we can help you.