Profit fade comes into play when a company’s profit is lower than expected or budgeted. It can happen in any industry, but it unfortunately happens quite often in construction. Profit fades are common to construction companies due to the complex nature and some unknown variables in the industry. Often the cause of profit fade can be external factors, like increasing material or labor prices, bad estimates, poor subcontractor performance, and unpredictable weather conditions – just to name a few.
Profit Fade Prevention
Based on history, what has been the main cause of a company’s recurring profit fade? Often the same conditions will show up in other projects or jobs. At the start of any project, provide a list and communicate those profit fade conditions to current team members so they are fully aware of these profit “eating” issues. Being aware of these conditions ahead of time, may help to prevent them from happening again.
Construction companies should determine which conditions are the most pressing threats to their revenue generating activities or operations. This is critical to determine how much time should be spent mitigating these threats, and is it a good allocation of time and effort (cost benefit analysis)? There are third party companies that are available to assist in evaluating these threats, if the company does not have the bandwidth or capabilities to evaluate it themselves. Keeping a history of prior profit fades, and the reasons for them, will only assist the company in attempting to reduce the profit fade.
Once the business knows their most pressing threats to profitability, as well as the damage they may cause, they are better positioned to deal with whatever issues may arise. When keeping profit fade in mind, a strategy construction business may use includes implementing more conservative guidelines for estimating revenues and costs. In the end, ways to mitigate pressing threats are specific to any given project and should be handled on a case by case basis.
Good Accounting Team or Third-Party Assistance
The accounting team should be able to assess the amount of profit fade or gain for each project or job based on how it finished. Some companies do not have a sophisticated enough accounting staff and require assistance from a third party. CPA’s, accountants and/or consultants with experience in the construction industry, could test and analyze the contract or job schedules to determine if there is profit fade or gain and determine the company’s ability to properly and consistently estimate profits or losses on a job by job basis.
Contact Larry Davidson, CPA at email@example.com for additional guidance in this area.