What is a contingency?
A contingency offers businesses a backup or safety net in preparation for unexpected negative events. Contingencies range from procedural backups to account for unforeseen events to financial padding to protect margins in the event of price changes.
In residential construction, a contingency refers to a percentage or fixed amount of money set aside to cover unanticipated costs that may arise during a project. A contingency provides extra margin in the project budget so home builders and remodelers can keep their projects profitable when new or unexpected costs come up or prices change.
Why are construction contingencies important?
One of the biggest challenges facing builders and remodelers is balancing income and expenses on each project to ensure their overall business cash flow stays stable. Prior to putting boots on the ground, estimators put together a prediction of what materials, labor, and subcontractor work might cost then tack on a margin percentage to ensure money comes in. These cost predictions come from subcontractor bids and vendor quotes but typically land on the preliminary budget months before work begins. In the meantime, costs change and prices fluctuate making that solid prediction just a wildly good guess. Unless builders and remodelers lock in prices with subcontractors and vendors, they face the risk of eating into their margins. Builders and remodelers also face cost changes from clients on selections and allowances that could negatively impact their margins.
Construction contingency are important because they ensure that small, often overlooked, details or unexpected issues that arise during a project do not derail the financials of that project. Home builders and remodelers deal with numerous vital details throughout every build so occasionally a home builder or remodeler may overlook a hidden cost when writing up a budget. But thanks to construction contingencies these hidden or overlooked costs don’t have to sink a project. Instead, residential construction companies that use them in their financials have a competitive edge and can stay profitable when responding to new costs throughout a project.
What are the different types of construction contingencies?
There are three different types of construction contingencies: Contractor contingencies, owner contingencies, and design contingencies.
Contractor contingency
In a contractor contingency the builder takes financial responsibility for any additional money spent on a project. This type of contingency usually requires building firms to reduce their profit margins since they take on additional costs.
Owner contingency
In an owner contingency the client bears the brunt of additional costs beyond the project’s original scope. Owner contingencies are typically used in conjunction with fixed price contracts when a project’s scope and budget are clearly defined. In a fixed price contract, money cannot be spent beyond a defined threshold.
Design contingency
In a design contingency the client bears the burden of additional cost. This contingency is used for unforeseen costs during the design phase when changes in scope are often initiated by the client.
How do home builders and remodelers use construction contingencies?
Residential construction contractors implement contingencies into their projects using manual, software, or integrated software methods.
Manual methods
Home builders and remodelers usually allocate between 5% to 10% of a project budget for a construction contingency. This amount creates enough breathing room for unexpected costs. Anyone tracking estimates and costs manually calculates a contingency percentage on top of all costs, before profit margins are applied. Whether they’re done on paper or calculated by hand, these methods offer familiar and accessible estimating options that get budgets and proposals in the hands of clients. Any negotiations to price or recalculations, however, require careful tracking and risk human error.
Software methods
Spreadsheet software, like Google Sheets and Microsoft Excel, help contractors manage construction contingencies through formulas and digital files that reduce human error and automate calculations. These programs require a very hands-on approach, taking several iterations to get all elements working together. Home builders and remodelers also use accounting software, such as QuickBooks, for tracking project financials. These accounting systems excel at reporting on income and expenses going towards a pre-set contingency but are limited when it comes to applying markups. While these tools offer a digital experience that prevents the paper shuffle common with manual methods, they struggle to bring the full estimate to proposal to budget experience together.
Integrated construction project management software
Integrated construction project management software, such as CoConstruct, manage all project details, including financials, in one easily accessible online location. A home builder or remodeler lays out their e estimated costs, calculates what contingency suits the project or client, then tracks the project’s budget all from one convenient login. In just a few clicks, a contractor can select a contingency percentage of the total cost or choose a lump sum to serve as the construction contingency for the project. Tied to the project budget, these calculations transfer into real-time estimated versus actual reporting to clearly dictate where such funds get leveraged.
Construction contingency FAQs
How do you calculate construction contingency percentage?
To calculate your construction contingency percentage, divide the total contingency fee by the total estimated project cost to get your contingency percentage. Conversely you can multiply your contingency percentage by your total estimated project cost to find the project’s contingency fee in dollars.
What’s an example of a construction contingency?
Many residential projects use anywhere from 5% to 10% of the total estimated project cost for their construction contingencies.
What’s the difference between a construction contingency and an allowance?
A contingency is an additional fee or percentage tacked onto a project to help mitigate unforeseen financial risks, where an allowance is a preset amount given to clients to provide flexibility in the selections process.
