What Is a Construction Contingency, and Why Do You Need One?
You’ve looked at every detail of your construction project and made estimations based on your careful planning and knowledge.
But you’re worried about what you don’t know.
How can you adequately or precisely prepare your budget when there are a variety of unforeseen events that can happen anywhere along the way?
You can’t remove all risk from your project, but you can minimize risk by considering a construction contingency.
If you’re not sure you need a contingency for construction, continue reading to learn:
- A construction contingency definition
- Why having a contingency plan is important
- How to create a contingency construction budget; and
- The types of construction contingencies utilized
Table of Contents
- Flexbase: Streamlining Analytics Is One Part of Our Construction Contingency Budget Solution
- What Are Project Contingencies?
- Why Is Construction Contingency Important?
- How Much Should a Construction Contingency Be?
- How to Create a Construction Contingency Budget
- Is a Construction Contingency The Same as a Retainage?
- Manage Your Contingency With Flexbase’s Built-In Analytical Tools
Flexbase: Streamlining Analytics Is One Part of Our Construction Contingency Budget Solution
Every construction project involves estimating the costs of every part of the job — and that’s a lot of details. Incorrect or incomplete estimations can ruin your budget, let alone extra costs that come when unforeseen issues arise.
Wouldn’t it be amazing if there was a way to plan for unexpected issues and costs?
That’s what construction contingencies are for, and Flexbase can help you know when to use those funds that you’ve set aside for surprises.
We can track cost analytics, so contractors know exactly when they need to use their contingency funds.
In addition to streamlining cost analytics, Flexbase makes construction administration easier by:
- Managing your cash flow
- Sending invoices
- Generating compliance documents
- Accessing working capital
- Sending payment reminders and legal notices
- Tracking expenses with Flexbase Cards
- And more
Flexbase has everything you need to successfully run your construction business — and it’s all in one place and is easy to use.
What Are Project Contingencies?
A project contingency for construction is a specific amount of money, usually a percentage of the total cost, that is set aside in case any unforeseen or extra costs arise during the construction process.
When you’re hit with surprises, construction contingencies act as a sort of insurance policy that will help you stay on budget and finish the work according to agreed-upon time commitments.
Contingencies are not allowances or extra cash on hand that must be spent.
If your contingency isn’t used, that’s a plus, meaning you planned, estimated, and used funds well.
Contingencies should be considered part of your budget from the beginning rather than an add-on expense later on.
What Is an Example of a Contingency?
Construction-related contingencies happen for a variety of reasons such as:
- Issues with supplies (price increases or shortages, etc.)
- Weather delays
- Personnel costs
- Subcontractor changes
- Design changes or incomplete designs
- Incorrect scope estimations
- Inaccuracy in price estimates
- Funds not reimbursed by a change order
In 2020, during the Covid-19 pandemic, many construction contingency funds may have been used when the price of lumber skyrocketed, causing an overage in the price of supplies needed.
The National Association of Home Builders estimates that “lumber prices have skyrocketed more than 300% since April 2020,” surely causing some contractors to dip into their contingency funds.
When it comes to construction contingencies, knowing when to use them is critical.
Flexbase accurately manages your cost analysis and can help you know when it’s time to dip into the contingency.
Types of Construction Contingencies
There are three types of construction contingencies:
- Owner; and
No matter which type you may end up using, everyone agrees that construction contingencies are necessary for every project.
Everyone understands that:
- Prices increase
- Unexpected problems occur; and
- Mistakes happen
A contractor contingency takes these things into account and allows the contractor to manage funds when problems occur out of the blue.
A contractor contingency is an amount included in the contractor’s estimated price for the project.
This amount goes beyond what is included in the schedule of values and is set aside for unanticipated costs or other problems that fall to the contractor.
Changes in the project are not always because of contractor oversights or errors.
Sometimes the owner may want to make modifications to the …
- Design; or
… that were not included in the initial bid.
In this case, the owner contingency is an amount set aside to cover any changes that the owner requests along the way.
Owner contingencies are often used with guaranteed maximum price (GMP) contracts.
What if the owner contingency isn’t used?
Most owners will request for remaining owner contingency funds to be used for project improvements like:
- Adding items back in that were removed because of budget constraints
- Adding wish-list items that were initially “on hold”
- Other betterments to materials or supplies
Designers do their best to create thorough designs before a project is underway.
Oftentimes, though, design elements may change throughout the project because of:
- Unavailable materials
- Scope creep
- Required upgrades
When these issues come up after construction has begun, the designer may decide to use the design contingency to cover the costs of these issues that are outside the “as-bid” plan.
Why Is Construction Contingency Important?
Even though everyone involved on the planning end of a project makes a thorough analysis of what it will take to complete the job, many things contribute to the need for contingencies, like:
- Budget issues
- Design plans
- Timelines; and
- Resource schedules
The construction contingency acts as a sort of insurance policy in the case of unforeseen changes or additions — like weather delays or materials shortages.
Having a construction contingency lets you plan for the unexpected, allowing you to stay on budget and on time with your project.
3 Benefits of Construction Contingency
Though construction contingencies shouldn’t be considered as “extra cash,” a contingency benefits everyone involved when things out of your control happen — things like:
- Supply issues
- Materials shortages or cost increases
- Weather delays
- Personnel cost increases
- And more
Construction contingencies help you:
- Deal with surprises
- Stay on budget; and
- Manage your risk
Benefit #1: Handling Surprises
Surprises often throw us for a loop, but the cost of those surprises can derail your project — unless you have a construction contingency.
A construction contingency allows you to manage the unexpected and can even help keep you on budget.
Since the contingency is an amount built into the cost estimate, unforeseen costs can be handled without putting a major dent in the budget.
Benefit #2: Staying on Budget
All kinds of things can threaten your budget:
- Inaccurate estimations
- Cost increases
- Need for more personnel
- Material shortages
- And much more
But with a construction contingency budget inclusion, your budget remains safe even when unexpected changes and costs occur.
And the construction contingency is part of the budget, not an add-on, so your budget isn’t inflated, assuring you that you’ll be able to handle the surprises when they come.
Benefit #3: Managing Risk
Risk is high in the construction industry, there’s no doubt about it.
Adding construction contingencies to the pricing estimate is just one of the ways to minimize risk and deal with unexpected issues and costs.
How Much Should a Construction Contingency Be?
In general, most construction projects use a rate of 5-10% of the total budget to set the construction contingency amount.
Setting the amount of the construction contingency can be tricky.
You want to make sure you have enough set aside to handle the unanticipated issues, but you also need to make sure you keep enough cash on hand to keep the project moving along.
Managing cash flow is challenging in the construction industry because of the rate of cash flowing in and cash pouring out.
Flexbase not only has the tools to help you know how much cash you actually have on hand, but when you need working capital, we can help you access it in just one click.
How to Create a Construction Contingency Budget
Including a contingency clause in a contract is essential, and setting the proper amount is crucial.
Construction contingencies should outline:
- The contractor’s contingency
- The owner’s contingency; and
- The designer’s contingency
Each contingency should outline the set aside amounts decided upon and what types of costs the contingency should be used for.
In addition, the contingency clause should spell out how the contingency funds are to be accessed and what the approval and paperwork process may include. The clause should also contain wording that explains how unspent contingency funds will be handled.
Identify Potential Risks
When creating the construction contingency budget, plan for the worst and hope for the best.
Factoring in risks ahead of time like …
- Weather delays
- Cost increases
- Substitute subcontractors
- Partial design plans
- Other project delays
- Added personnel costs
… can help you know where you may need to allocate contingency funds and what the amount of those set-aside funds should be.
Identifying potential risks is necessary, but minimizing risk is a way to be proactive.
Communicating well with your team and performing careful and detailed planning will go far in minimizing risk.
When attempting to minimize risk, it’s important to:
Have a clear idea of the scope of the work
Do a complete walk-through with:
- Engineers; and
Enter the bidding process with a complete set of drawings
All of these will foster good communication with the whole team, so everyone knows their roles and duties.
Is a Construction Contingency the Same as a Retainage?
Though a construction contingency and a retainage are similar concepts, they are not the same thing.
How are they similar?
- They both act as a sort of “emergency fund,” meaning that when things don’t go as planned and there are extra costs, those costs may be paid from a contingency fund or a retainage that is withheld from the one who is responsible for the issue — either a contractor or subcontractor.
- Both a retainage and a contingency are made up of about 5 to 10% of the total cost of the construction project.
That’s where the similarities end and the differences begin.
- A retainage is an amount that is being withheld even though it has been earned.
- A contingency is an amount added to the estimate of the price of the project to cover unexpected costs.
The biggest difference between the two is that a retainage consists of monies that are earned and are owed to someone, and a contingency is not owed to anyone.
A contingency can end up being a positive thing if the funds aren’t used for unanticipated issues.
Manage Your Contingency With Flexbase’s Built-In Analytical Tools
Having a contingency is great, but knowing how much money you have on hand and when it’s time to dip into the contingency is the challenge.
Flexbase has what you need not only to keep you cashflow positive, but also to give you the knowledge you need to know how and when to use those funds.
Flexbase has built-in analytical tools that help you track:
- How much money you have
- How much money you owe; and
- How much money you should be expecting to come in
You’ll know exactly when you need to use your contingency with easy-to-interpret analytical reports.
The Flexbase app is easy to use, and you don’t pay anything until you are paid. You only pay 0.5% when you receive money.
There are no licenses or subscriptions, and the full Flexbase platform is available for you to use immediately.
Schedule your free demo today.