How to Properly Calculate a Change Order
Change orders are tough. It’s hard to get everyone on board, and challenging to get paid the amount you really need to for the business. It would be nice if there weren’t any, but the nature of remodeling means they’re a necessity on most projects. But you could be losing money in a way you’re not aware of.
Probably everyone knows the basics — anything that’s not covered in the contract scope or plans should get written up. Figure out your costs and mark them up. Be sure the mark up is the same as the contract. Add days for the work to be done. Add up the original contract cost and the change orders for a new contract price.Get a signature before starting the work. Don’t lower the price when the client ask why it’s so high, and always collect the money before the work is done.
You’re Missing the Disruption Days
What’s often missing in the calculation is the cost of what I call “Disruption Days.” These are the days not associated with any labor costs, but which will hit the job because of the disruption the change order causes. This is especially critical now — everyone is busy and we can’t just reschedule trades or material deliveries for the lost time of the labor. The job could slow down by week for one day of changes.
Try thinking in terms of overhead per day, per job. If overhead in a company is $500,000 in real dollars for the year with four jobs going at a time, then overhead per day per job is $500.
So, for every day of a job you’re spending $500 of overhead. When you calculate a change order price, the days included in the labor numbers get an overhead amount attached to them automatically, but the Disruption Days do not.
Stop Losing Money
If that overhead money is not recouped another way, your company loses. To add insult to injury, by extending the job extra days not associated with labor costs and revenue, we end up pushing the start of other projects out and losing the “opportunity profit” of another job. So some consideration must be given to adding this extra overhead into the sale price of a change order.
For example, let’s use that same company. They project $2 million in revenue for the year, making the overhead 25% of revenue. Assume there are 250 working days in the year, which means they need to produce $8,000 per day to hit the revenue target. If a few jobs extend past the completion dates, and the extension is not compensated by labor being marked up, the company won’t be able to produce the desired $2 million.
Depending on a number of factors, it’s $8,000 per day. Assume this happens to the tune of 30 days — or $240,000 worth of work — that can’t be produced. That leaves them at $1,760,000 for the year. The 28.4% overhead is robbing net profit of roughly 3.4%
Some of you are thinking “I just can’t add $500 per day extra to every change order!” You’re probably right. But the costs are real. So calculate your overhead per day per job. Write down on each change order the number of Disruption Days. See if you can add that money back in. If not, add something for those lost days. If nothing else, you’ll be aware of what each change really costs you.