On to Scenario 3 or the "Really? Are you sure?" scenario. This scenario often results in significant changes to total estimated cost.
In the example above (3) we are 95% complete, with cost to complete of $25,000. No issues there. However, based on our estimated gross profit, we have an underbilling of $160,000, which seems unusual considering how far along we are on the project. Our gross profit percentage (without considering over/underbillings) is 6% ((505,000-475,000)/505,000) but our estimate is telling us that gross profit should be 29%, that's a huge difference. Why would there be such a large difference, assuming our cost and billing activity is accurate through the reporting date? Why have we been recognizing such little profit on the project when we're estimating much more? You should be asking yourself these questions if you're experiencing such circumstances.
In this example, we would be billing the project owner $195,000 ($700,000 - $505,000) for $25,000 worth of work to complete the project, that's a gross profit percentage of 87%! I'm not saying that will never be the case, it just seems unlikely. That's why this is the "Really? Are you sure?" scenario. Are you sure there's only $25,000 in cost to complete? How much cost (labor, material, subcontract, general, etc.) remains to complete this project? Here's where the estimator provides a list of remaining work with dollar amounts. More often than not, the remaining costs are higher than what's shown on the work in progress schedule (WIP).
Updated Estimate (Scenario 3):
After talking to the estimator, we discover that there's plenty more work remaining on the project. According to the new estimate, there's $125,000 in cost to complete the project (see updated estimate above). That's a $100,000 increase to the total estimated cost. With this adjustment, estimated gross profit, underbillings, and percent complete, drop to 14%, $49,167 and 79.2%, respectively. Now we have $195,000 in billings for $125,000 in costs remaining, with a remaining gross profit percentage of 36% instead of 87%. We're still dealing with estimates so it's still a guessing game. However, the updated estimates appear more reasonable, in other words, remaining activity now seems more reasonable. Additional adjustments may be required, but we're in a better spot in terms of accuracy.
This scenario isn't limited to projects with 80% to 95% completion. You should be asking the same questions about projects with substantial costs remaining that have high underbillings:
1) Why is the gross profit percentage from billing and cost activity so much lower than the estimated gross profit percentage? You should be able to pinpoint why if there's a good reason for it. If not, an increase to total estimated cost may be in store.
2) What are the remaining phases on this job and how much are they going to cost? Compare that tally to what the WIP report shows, and make appropriate adjustments, if necessary.
Thanks!
Ara
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