Unforeseen project circumstances cost Owners time and money. Learn more about project contingency to ensure you’re financially prepared for the unexpected.
The pressure to keep project costs as low as possible is often overwhelming for Owners. On one hand, you want to finish on budget and make your proforma. On the other hand, the numbers are tight and the margin is thin. So, when it comes to planning and establishing your construction budget, adding contingency can seem to inflate the budget. However, when unforeseen issues arise having a little cushion already built into the project budget can actually create safeguards to ensure the project is completed within budget.
Verity Commercial is often asked by Owners why adding project contingency is so important to cost estimates. In our experience, risk management strategies include project contingency because it offers allowances for any cost changes. Project contingency serves to pay for unknown conditions, account for errors and omissions in construction documents, changes to scope of work. If applied correctly, Owners can manage risk while keeping their construction project within budget.
Additionally, project contingency covers estimate accuracy and risk exposure, improves transparency, facilitates more realistic project cash flows, and discourages potentially harmful tradeoffs in schedule and/or scope.
Most construction budgets have contingencies that are either included within each cost item or in a single category of project contingency. Project amounts are normally about 5-10% of total budget but those percentages can change based on estimate uncertainty, risk exposure, environmental issues, entitlement approvals, historical experience, and the expected difficulty of a construction project.
So how do you know if your project has the right amount of project contingency built in the budget? We put together this quick guide to help you determine if your project is at financial risk.
Analyze Estimate Uncertainty
To determine estimate uncertainty, find out how the construction cost estimate was derived. For example, the initial estimate may have been based on another completed project with similar parameters. Since this estimate is based on old project information, it’s possible the market or materials cost more than originally estimated. This estimate uncertainty should be accounted for in construction contingency. Alternatively, there are established construction cost indexes that identify construction inflation based on project start and market location. The market may also drive the design of the project above that of the completed project.
Figure Out Risk Exposure
Formulate risk exposure by performing a structured project risk review. Do this by gathering a detailed description of project scope, requirements, schedule, major stakeholders, resources, lessons learned from past projects, and a detailed list of major assumptions and constraints. Also, identify risks such as potential weather that could affect schedule. Understanding the risk exposure of your project will help you determine an accurate percent of construction contingency needed.
Establish Contingency Amount
Before you establish the contingency amount look for ways to help minimize project risk. Preconstruction services and planning are a great place to start. Also, clearly define scope so contractors and vendors know exactly what needs to be done. Once you’ve completed this, you should feel confident in determining how much contingency you will need. Remember, too much contingency can lead to poor allocation of funds and too little contingency may lead to large cost overruns, interruption to schedule, and delay getting the additional funds needed to complete the project.
Examine Contingency Amounts Throughout the Project
Don’t just set it and forget it. Throughout the life of the project compare contingency reserves to the remaining estimate uncertainty and risk exposure of the project. This process is used to check the adequacy of contingency as the project progresses so you can determine if there is potential to release contingency or a need to increase it.
Other Contingencies to Consider
Typically, there are three project contingencies to manage.
- Design – Design contingency is used to resolve unforeseen issues during the design period. The design contingency is used when the original budget didn’t address project requirements, potential changes in market prices, and inaccurate project information available when the budget was developed. Design contingency also includes upgrades in materials or general quality of the project made by the owner-designer team in traveling from concept design to construction documents. These upgrades are often market driven.
- Owner – Owners may request changes to the project after the project is released into construction. Ownership may want to make improvements to design or materials. Force majeure events such a severe weather or unforeseen underground or environmental conditions may materialize. There may be delays caused by permit approvals and utility companies. These are risks that General Contractors are usually unwilling to accept. Good preconstruction planning can mitigate most of these risks but the Owner should plan on some risk exposure.
- Construction – In a typical GMP construction contract, the general contractor will require a contingency to cover un-estimated scope issues and coordination issues that are with-in his control. The challenge is in negotiating the “fair” amount with the general contractor. We have the experience to manage this.
Construction projects are never perfect. There is always some unforeseen issue or overlooked item in the planning stages. Project contingency is a risk management tool used to financially prepare for the unexpected. With proper planning, establishing the right amount of contingency, and diligent oversight and management the project will be delivered on-time and on-budget.
If you need additional guidance on project contingency, contact Verity Commercial’s project management team for help.