Construction Budgeting: A Comprehensive Guide

Written by Bridget Cooper

DateDec 21, 2023
Reading time11 min read
construction site

To complete a construction project successfully, you need a clear financial plan and a resilient construction project budget that can withstand any unexpected construction challenges.

And while construction budgeting might not be the most exciting part of the job for most contractors, it is key to identifying potential financial risks, avoiding project pitfalls, and ensuring smooth project timelines. 

So, in this guide, you’ll learn what construction budgeting is and how to handle the entire process like a seasoned pro. 

What Is a Construction Budget?

To put it simply, a construction budget provides an estimate of the exact amount of funds you need to undertake a construction project from start to finish, whether it's a new building, road or even bridge. It captures all costs that you incur over the course of the entire project such as labor costs calculations, building material costs, land acquisition fees, and consulting costs.

The closer your budget aligns with actual costs, the smoother and faster you can expect your construction project to go. You need to remain flexible, though, -- unexpected costs might sneak in, and your budget needs to have some breathing room for such surprises.

Types Of Costs In Construction Budgeting

Breaking down your construction budget into different categories from the outset makes it easier to identify any overlooked costs. And one of the common ways to do this is to divide your expenses between hard and soft costs -- let's look at each one of them below.

Hard Costs

Hard costs, often termed as brick and mortar costs, refer to any expense directly tied to the physical construction of a building or structure. They typically account for approximately 70% of a construction project's budget. They're often more straightforward to estimate and control compared to soft costs because they involve tangible elements with fixed price.

To give you a better idea of how these direct costs work, let's look at an example. Consider the initial landscaping work for a construction project. This could include activities such as installing pathways, laying down grass and fertilizer, or even installing strip lines or sprinklers. These fall under hard costs because they're directly tied to the physical construction.

However, ongoing landscaping maintenance — such as regular checks, repairs, and maintenance of the irrigation system — are not considered hard costs, as they happen post-construction and are more challenging to anticipate.

Soft Costs

Unlike hard costs that you incur during the physical construction of a building or a structure, soft costs are incurred before or after the project. They are typically more challenging to estimate due to the fluctuating nature of their service fees. 

Consultants, accounting companies, and insurance companies often set many of these costs, and they are typically calculated as a percentage of the building cost. Design fees, for instance, normally account for 8-15% of overall construction costs while insurance fees make up 1-2% of the total project cost.

One way you can differentiate soft and hard costs is through third-party reviews. With hard costs, you generally need third-party inspections to verify and approve expenses. For instance, if you request $10,000 for building materials, your lender may perform a third-party, on-site inspection to verify if that is really the quantity needed.

Soft costs, on the other hand, often involve funds made available without external vetting or a third-party review. An invoice for $1,000 in insurance costs typically doesn't need an external review to be approved.

That said, a complete budget involves more than just hard and soft costs, it also considers:

Contingency Funds

Contingency funds are budget categories you set aside for unforeseen expenses that may pop up during a construction project. These unexpected costs can take various forms such as overtime labor expenses, inflation of materials, or sudden increases in construction material prices. 

A construction contingency typically ranges between 5% and 10% of the project's total budget, providing a financial cushion to navigate unexpected construction twists and turns. 

You can categorize contingency funds into any of the following:

  • Changes in project scope: Changes in a construction plan are often inevitable, and so whenever they come up, your contingency fund should absorb these additional costs. 
  • Unforeseen condition: If unexpected issues, like hazardous materials, arise during the construction stage, these funds can help deal with the problem quickly without causing delays.
  • Delays: Bad weather or logistical problems can cause delays in the project. Contingency funds can act like a safety net against these delays, allowing the project to move on without hurting the budget.

Profit and Overhead

Before giving the green light for a construction project, stakeholders and investors typically need complete construction budgets that factors in all construction costs. 

Within this plan, you need to be transparent about profits and overheads to show the project's value and the expected return on investment. This transparency helps prevent misunderstandings and ensures that everyone involved in the project is on the same page regarding financial expectations.

Also whenever indirect costs and unexpected expenses arise, having a clear record of profits and overheads makes it easy to explain the situation (much like the role of contingency funds.) This benefit is twofold: it not only builds trust but also speeds up the resolution of financial matters. 

Why Is Construction Budgeting Important?

Construction budgeting provides numerous benefits to everyone involved in a construction project – from the project owner to project manager to subcontractors. Let's explore how: 

Guides Decision Making

Construction project budgets often act as a central reference point for everyone involved. In successful projects, subcontractors, employees, and the project owner share a common understanding of the project's financial framework and goals.

Every decision made – from selecting appliances to choosing materials and hiring contractors – revolves around the common goal outlined in the budget.

Keeps Costs Under Control 

Creating a construction budget allows you to keep a close eye on every expense, ensuring that each cost is correctly assigned to the right job and invoiced accurately. This way, you can avoid hidden costs, and you don’t have to shoulder unforeseen costs out of your operating budget.

Also, by planning your budget in advance, you get time to compare and analyze options — from suppliers to manufacturers to machinery producers. This means that you can make decisions that not only maximize value but also maintain control over spending.

Provides Clear Documentation

In a construction project where many details are in motion, having a detailed and approved budget helps reduce confusion and establish clarity. When change orders arise, all the parties involved can refer to the budget to understand the reason for the change, assess potential impacts, and collaborate to minimize overages in the future.

Keeps The Project On Track

Proper budgeting doesn't just set spending limits – it also improves project management. It forces you to establish achievable and realistic goals and track your limited funds. This often involves breaking down the project plan into smaller tasks and holding everyone accountable for meeting each milestone. 

How to Create a Construction Budget

Now that you know the importance of a construction budget, let's walk you through the steps to create one:

Define Your Project Scope

Before starting the budgeting process, you need to first establish a solid foundation to support the process. Your project scope provides this foundation. 

This project scope often serves as your guidebook. It defines what the project will achieve, how it will get done, and the resources and limits involved. By having a straightforward and realistic scope you can prevent conflicts, unnecessary waste, and scope creep. 

To define your scope, you need to first outline the desired outcomes or benefits of the project.

The next step is to define project deliverables. This means specifying the tangible products or services the project will produce to meet the defined objectives. You can break down these project deliverables into smaller, more manageable components like phases, tasks, subtasks, and milestones.

At this stage, you can even develop a formal document – such as a project scope statement– that outlines the project scope in detail. In this document, you can include this such as project objectives, deliverables, acceptance criteria, assumptions, exclusions, and constraints. 

Conduct In-Depth Research 

Once the project scope is crystal clear, start researching and analyzing the project goals and requirements. The first step is to engage with stakeholders to discuss crucial details such as the timeline and customization requests that can impact the budget.

Then, assess the zoning and permitting requirements specific to the build's location – this step helps in anticipating potential costs and avoiding delays.

Following this, collect detailed data on costs associated with similar construction projects. Analyze historical cost data and market trends to identify patterns and potential cost drivers and take note of areas where certain costs went over budget in the past. Also, remember to refer to industry benchmarks to ensure that your budget aligns with prevailing standards.

After gathering this information, draft an initial budget for expenses. This preliminary budget allows you to evaluate the project's feasibility and ensure it fits within realistic financial boundaries.

Consider Cost Estimations

Now that you have a strong foundation and data, it's time to break down your project into its components and estimate costs for each. This way, you can pinpoint potential cost-saving opportunities and try to predict expenses that might go beyond initial expectations. 

With this approach, you can ensure that your budget reflects real-world considerations, and this sets the stage for a financially sound project.

Gather Documentation

Before starting construction, complete a thorough pre-construction checklist and collect all necessary documentation such as contracts, permits, approvals, and any other relevant paperwork. This will help ensure that you account for every aspect of the project. 

It also provides a paper trail, which is essential for identifying potential unexpected costs, as we discussed earlier. 

Start Managing The Project

Engage with key stakeholders — from financial experts, architects, contractors to engineers – throughout the budgeting process. This collaboration helps with two things: It ensures everyone is on the same page on budgetary goals and it also helps in highlighting potential issues before the project starts. You can even avoid costly surprises and ensure a smoother construction process. 

Also, remember to continuously monitor and track actual expenses against the budget. You need to regularly assess the progress and make changes as needed to reduce the likelihood of cost overruns. 

Mistakes to to Avoid When Construction Budgeting

One of the biggest mistakes you can make is focusing only on the bottom line. Of course, you want to complete the project at the most affordable price possible (and this often means accepting the lowest bid ) but cost savings shouldn't come at the expense of quality. To avoid hurting your reputation, make sure that before accepting any bids, take the time to analyze previous performance and work history of subcontractors.

Also, you have to regularly communicate with everyone involved -- from all the stakeholders to your staff. Miscommunication is often at the heart of a lot of project delays and unexpected cost overruns

And a key thing you need to have from the outset is a legally binding contract. With only verbal contract, clients can make changes to the project at any time and you might expect to incur additional costs. Ensure that you're on the same page with your client from the start by signing a contract that outlines every detail of the construction project and avoid any surprises in the future.

Supercharge the Estimation Process with Downtobid

There are a lot of moving parts in the budgeting process. Every detail carries weight and any miscalculation can ripple into costly setbacks for the entire project. That's why you need estimators who not only understand the process but have it completely dialed in. 

Unlike other project management software, Downtobid is a purpose-built platform for estimating teams, designed to streamline the pre-construction process as efficiently as possible. It can help you by: 

Budgeting in construction projects is complex, with every detail critically impacting the project's cost-effectiveness. Precision in estimation is key to avoiding expensive setbacks.

Downtobid differentiates itself from standard project management software by focusing on the pre-construction phase, particularly in streamlining the subcontractor invitation process. Its features include:

  • Subcontractor Invitation and Selection: While Downtobid helps in identifying bid packages and inviting suitable subcontractors.
  • Focus on Bidding Process Efficiency: Downtobid is designed to make the subcontractor invitation process more efficient. The platform focuses on creating meaningful interactions between the project users and potential subcontractors.
  • AI-Powered Bid Package Identification: The AI technology in Downtobid aids in detecting bid packages, which could indirectly support estimators in making informed decisions.
  • Streamlining Bid Package Creation: Downtobid automates some aspects of the bidding process, such as generating bid packages from construction plans. This automation can make the process quicker and more precise.

Sign up for early access today to explore these and many more features. 

Written by Bridget CooperUpdated on Feb 23, 2024

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