Every business wants to maximize profitability.
For general contractors and specialty trade contractors, a great financial tool to analyze job performance and find ways to boost the bottom line is a gain-fade analysis.
Most construction companies prepare work in progress (WIP) schedules, which help determine where a project currently stands on profitability. But for a more in-depth analysis of your profitability over time, a gain-fade analysis is a critical tool.
A gain-fade analysis evaluates trends of gross profit on construction projects over multiple periods. Generally, it focuses on the differences from year to year in total estimated and actual gross profit on each job. The report allows construction executives to determine if there are any consequential patterns.
Using a WIP report to evaluate the estimated costs versus the total actual costs doesn’t provide all the financial information construction companies really need. Seeing the change in gross margin from year to year adds an additional level of analysis.
Gain-fade analysis reports also are important in maintaining project financing. A fade – or downward trend – of 10% or more often results in a call from a bonding agent seeking more information about the cause of the fade.
The more variability in your contract over time, the riskier you appear to be to your bonding agent. A higher profit fade also diminishes confidence in a contractor’s ability to estimate and manage jobs.
But gain-fade analysis reports have far more benefits than just satisfying bonding agent requirements. Gain-fade analysis reports can teach construction executives a lot about their strengths and weaknesses. Performing the analysis multiple times over the course of a job can help construction executives spot operational issues, estimating problems or both.
There can be many reasons for a construction job to have a gain or a fade. Some of the most common factors are your estimators, your project managers, your crew, change orders, and weather. Here’s where things can go wrong:
- Estimators: Job estimators can be the source of profit fade if they’re too optimistic or bid too aggressively just to get the work. It’s worth looking into whether low bids may be the reason for the lack of acceptable profit level on contracts.
- Change orders: Change orders might cause profit fade if they’re unprofitable or haven’t been properly recorded. Evaluate whether the change order is creating a sufficient amount of additional margin on the job.
- Project managers: If a project manager isn’t effective at managing the costs and people on the job, that may result in profit fade. Gain-fade analysis reports are a great way to see which of your teams work most efficiently – and therefore profitably.
- Expertise gaps: Work outside your company’s wheelhouse can cause learning curves, resulting in extra cost or work delays. Before taking a job, consider whether it is work your company can handle profitably with the available knowledge base and skill sets.
- The accounting department: Your accounting department may be a source of profit fade if job costs are not coded to the correct job. To help in this area, have a project manager and estimator review and improve final job costs.
At Concannon Miller, we perform regular gain-fade analyses for many construction companies. We’ve developed a comprehensive gain-fade calculator that can benefit any construction company seeking to get a better understanding of their job costs and ways to improve profitability.
Download a free calculator today to improve financial analysis of your construction jobs. Or contact Andy Kahn, CPA, MBA, CFP, head of Concannon Miller’s construction team, at akahn@concannonmiller.com or 610-433-5501 for personal assistance.
