No matter how well you plan something, always having a backup plan would be best. It’s difficult to foresee all the possible issues you may encounter in a project, and that’s normal.
In the construction industry, the backup plan usually involves setting aside money. This money may be accessed if unforeseen issues arise that must be corrected.
The money that’s been set aside is considered your construction contingency.
You don’t want to tap into those funds if you don’t have to, but it can act as a safety net after the project award.
In this article, we will cover the following topics:
By the end, you should better understand contingency and how it can be applied.
The Definition of Construction Contingency
Construction contingency is money set aside for unforeseen events during a project. The contingency money can be accessed for quick resolution and to prevent project delays if issues arise. The amount is typically a percentage of the contract value which can be determined based on the following:
- Project Size
- Risk With the Project
Importance of Construction Contingency
As mentioned earlier in the article, a construction contingency reserve is a backup when unexpected issues arise.
With so many potential issues, it’s challenging to pinpoint everything. A construction company may add some contingency money in its estimate if uncertain of the project outcome.
When I started estimating with a general contractor, they added a large amount of money as a contingency to my first estimate. Since I was inexperienced, they figured adding 15% to the project would cover anything I missed.
The standard contingency percentage is between 5-10%.
Our bid got selected and we were awarded the project. Ultimately, we didn’t have to tap into the contingency money, which went to our profit margin.
Contingency can be added for many different reasons. This is just one example.
Here’s a list of reasons you would want a contingency reserve.
- Weather delays
- Fluctuations in material and labor costs
- Cost overruns
- Overtime shifts
- Scope of work gaps
- Repairs to damaged work
An owner’s contingency reserve may be available for items such as:
- Owner-requested design changes
- Design upgrades/modifications
- Errors or incomplete designs
Understanding the Project Contingency Clauses
Contingency is only sometimes applied in the example that I provided earlier.
Depending on the project, the contractor may not be required to account for additional costs. Instead, the owner may be the one carrying the contingency cost.
Review the contingency clause for the project to determine how this will be managed.
Types of Contingencies in Construction
There are two types of projects that we need to look at when it comes to the contingency clause.
Cost Plus Contracts: Projects completed based on time and material costs. There will be an owner contingency fund for this type of work. They’re basically reimbursing the contractor for time and material expenses accrued for the job, including profit.
Guaranteed Maximum Price (GMP) Contracts: GMP projects involve a fixed price to complete the work provided in the contract construction documents. As a result, any work that the contractor missed in their construction cost estimate needs to be paid out of pocket. Contingency will be included in the contractor’s price to cover unexpected costs.
Most projects will be the GMP type. I’ve only done cost-plus jobs when the project’s scope is small.
Note: Cost plus is also called time & material (T&M) in the construction industry.
How Contingency is Used in a Construction Project Between Parties
As mentioned above, the contractor’s contingency will not always be included in their price. It could be the project owner or design engineer.
Let’s look at how construction contingencies are used between the parties involved in a project.
Project Owner: Money is set aside if any unknown conditions come up that are not covered by the contractor. Depending on how much of the contingency is spent, they can use it for purchasing higher-quality materials.
Construction Contractor: In a GMP project, you factor in your contractor contingency to cover any work missed during the bidding phase. You will tap into the contingency fund when unforeseen work occurs that was included in the contract plans & specs. This money is also available for any cost overruns, construction repairs, rework, and overtime unaccounted for.
Design Engineer: The engineer will include design contingency money for issues arising during the construction phase. If the contractor finds a problem with the design or incomplete plans, they will submit an RFI to correct it. The redesign will result in extra work requiring a change order.
How to Calculate Construction Contingency
The methods of calculating construction contingency can come in multiple forms. Typically, it is a fixed percentage of the total contract price.
Since the contingency is part of your price it will be worked into the project SOV. Any unused contingency funds will go towards your profits.
We will look at two methods of calculating the contingency. You can then determine how you want to factor this into your next project.
A good construction contingency percentage is 5-10% of the contract value. You would then calculate the amount using the deterministic method.
The percentage is selected based on project size, complexity, and level of risk.
Your upper management will usually be the one to determine the percentage. If you’re a seasoned estimator, you may be able to figure out the contingency percentage yourself.
Let’s look at an example of how you might calculate the contingency for a project. This assumes a contingency between 5-10%.
If the total project costs are $1,000,000, the contingency cost could be calculated as $50,000 to $100,000.
Contingency is determined using a statistical approach with this method. There are a couple methods that we will look at here.
- Expected Value
- Range Estimating
Check out Project Control Academy for the best explanation of these methods. There you will better understand how these methods work to determine your contingency cost.
The expected value method combines “probability of the risk occurring” and “impact if the issue occurs.”
Next, you need to identify all potential risks with the project. Determine the likelihood of the issue occurring and the amount of the unanticipated costs.
Take the sum of all the potential risks, and calculate your contingency amount.
The equation you would use is as follows:
Expected Value = Probability of Risk Occurring x Impact if Issue Occurs.
Using this equation, let’s look at a specific example.
You have three potential risks in the project you’re bidding on.
- 1st risk probability is at 10%. The cost to correct the issue is $10,000.
- 2nd risk has a probability of 30%. The cost to correct the issue is $5,000.
- 3rd risk has a probability of 5%. The cost to correct the issue is $50,000.
Your Expected Value for each risk is $1,000, $1,500, and $2,500, respectively. These values equal $5,000, which is your contingency amount.
This is a detailed analysis approach to determining your contingency amount.
It involves developing a statistical model based on a given project’s minimum and maximum contingency. I haven’t seen this method used for a construction project to date.
If you want a better understanding of the Range Estimating method, use the Project Control Academy link.
Of the methods laid out here, you’ll most likely use the deterministic approach.
Calculating the exact contingency amount for more minor projects may not make sense. When you’re short on time to produce an estimate, you can’t afford to calculate the precise contingency amount.
Sure, determining the exact amount might give you a more competitive bid. But the difference you could expect would be marginal for the smaller jobs.
How to Manage Construction Contingency
Now that you know how to calculate the contingency amount, let’s talk about managing issues as they occur.
The importance of Effective Contingency Management
You develop the contingency to mitigate project risks and ensure projects are completed on time and within the total budget. Having contingency available will allow you to move forward if issues arise on the construction site.
The last thing you want is to pay for work out of pocket. Your contingency is there to act as a buffer when unexpected problems occur.
As a project manager or engineer, you should actively monitor the project to avoid dipping into the contingency fund. We will cover some strategies to manage this.
Remember, the less contingency money you use, the more profit your company makes.
Strategies for Managing Contingency
While working actively on a project, consider some of the following strategies.
- Regularly monitor and review the project budget and schedule. You want to identify potential delays or cost overruns.
- Develop a risk management plan that identifies potential risks and ways to minimize the impact.
- Communicate with stakeholders, owners, and other contractors involved with the project. Keep them informed of potential issues that could result in a change order.
When it comes to construction, there are many aspects that you don’t have complete control over. Having some contingency available protects your construction business should issues arise.
If you have the opportunity, see if you can sit in some bid meetings in your company. This is when the project is discussed with the upper management.
In the bid meeting, they can collectively decide on the contingency percentage. As a reminder, it’s typically between 5-10%, but this isn’t fixed.
With more experience, your understanding of the potential risks in a project will improve. One day you’ll be calling the shots on the contingency percentage!
Before you go, consider reading my article on example construction schedules. There you will learn how to create and update a schedule. Once you have this knowledge, you can begin to identify potential delays in the project.
Avoid using your construction contingency if it’s unnecessary!
Thank you for reading.
BillieMead. (2023, February 28). Contract prep: Owner vs. contractor contingency. ProcureAbility. Retrieved March 4, 2023, from https://procureability.com/contract-prep-owner-vs-contractor-contingency/
Construction contingency: Definition, types and faqs – indeed. Construction Contingency: Definition, Types and FAQs. (2021, June 22). Retrieved March 5, 2023, from https://www.indeed.com/career-advice/career-development/construction-contingency
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