A construction contingency is money saved to pay for unexpected things that may occur during a construction project. Risk management is very important in construction, and having that extra money in your budget will help protect you from unexpected problems. Read on to learn everything you need to know about construction contingency budgets.
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What is construction contingency?
In construction, a contingency is like a safety net for money. It’s a part of the project’s budget set aside to pay for any unexpected costs that might pop up. Think of it as emergency money that’s there if needed but not assigned to buy anything specific right from the start.
Deciding how much money to keep in this safety net is tricky. You want enough to cover surprises, but you must also keep enough cash available for the ongoing construction work. Usually, construction projects set aside about 5% to 10% of their total budget as a contingency. This amount is generally sufficient to handle any unforeseen expenses during the project.
This emergency fund helps keep things running smoothly if prices increase or something unexpected happens. It’s not extra money to spend on anything; it’s just there to help avoid problems. If you end up not using this emergency fund, you did well planning and managing your money.
Types of Construction Contingencies
There are three primary types of construction contingencies, each serving a distinct purpose and catering to different stakeholders within a construction project: contractor contingency, owner contingency, and design contingency.
Contractor Contingency
This type of contingency is integrated into the contractor’s project estimate, covering unforeseen costs directly related to construction activities. These funds are set aside to manage risks such as price increases, unexpected site conditions, or errors in execution. Including a contractor contingency acknowledges the inherent unpredictability of construction projects. It is considered by contractors as an essential part of their bid, earmarked for unexpected expenses that may arise during the construction phase.
Owner Contingency
Owner contingency is reserved for changes initiated by the project owner, often relating to modifications or enhancements in the project scope. This contingency is particularly relevant in projects with a Guaranteed Maximum Price (GMP) contract, where any scope changes not included in the original bid necessitate additional funding. The owner contingency ensures that the project can adapt to the evolving requirements or desires of the owner without financial strain, covering costs for changes like schedule adjustments, design alterations, or the inclusion of additional resources or materials.
Design Contingency
Design contingencies cater to costs emerging from changes during the design phase, often initiated by the client or resulting from unforeseen necessities like unavailable materials, scope creep, or essential upgrades. This contingency allows for the flexibility to address design-related issues that arise after the initial planning stages, ensuring that the project’s aesthetic and functional goals can be achieved even when unexpected design challenges occur.
Each of these contingencies plays a vital role in the financial planning and execution of construction projects, providing a structured approach to managing risks and unexpected costs. By allocating funds for contractor, owner, and design contingencies, project stakeholders can mitigate the impact of surprises on the overall budget and schedule, ensuring a smoother path toward project completion. Whether it’s accommodating unforeseen problems, adapting to changes in scope, or refining design details, construction contingencies are indispensable tools for navigating the complexities of building projects.
Examples of construction contingencies
Here are some common examples of scenarios where construction contingencies might be used:
- Design Changes: After construction begins, the project owner or architect might alter the design, requiring additional work not included in the original plan.
- Material Price Fluctuations: The cost of materials can vary due to market conditions. If prices rise after the budget is set, contingencies can cover the increased costs.
- Unforeseen Site Conditions: Discovering rock during excavation, contaminated soil, or archaeological finds can lead to additional work and expenses.
- Weather Delays: Severe weather conditions like heavy rain, hurricanes, or snow can delay construction, increasing labor and rental costs.
- Subcontractor Issues: If a subcontractor fails to deliver on time or goes out of business, contingencies can cover the cost of hiring a replacement.
Why Is Construction Contingency Important?
Construction contingencies are decisive in construction projects’ financial condition and success. They protect against the unpredictable nature of construction, where market fluctuations, unforeseen details, or unexpected problems can often change initial cost estimates based on subcontractor bids and vendor quotes. These preliminary budgets, drawn up months before actual work begins, are vulnerable to changes in costs and prices, threatening the builder’s profit margins if prices are not fixed early with subcontractors and vendors.
Moreover, construction projects are complex endeavors that involve juggling many details, and it is not uncommon for hidden costs to emerge as work progresses. With a contingency plan, these unforeseen costs can protect the project’s financial stability, eroding margins and causing losses.
This proactive financial planning tool ensures that projects can remain profitable despite the challenges of:
- budget overruns
- design changes
- deadline pressures
- scheduling conflicts
By anticipating the unexpected and planning for it financially, construction contingencies help projects stay on budget and schedule, effectively acting as an insurance policy against the many risks of building and construction.
The top five benefits of using construction contingencies
The importance of contingency plans in the construction industry cannot be overstated. These funds are not just a financial cushion but a comprehensive strategy that benefits builders in multiple ways by improving project execution, financial stability, and overall risk management. Here are five key benefits of integrating construction contingencies into project planning:
1. Protects the project budget
Contingencies are allocated specifically for contingencies, which ensures that the project budget remains untouched by unexpected costs. This means builders can avoid diverting funds from other projects or taking out loans to cover unexpected expenses. For example, suppose an unforeseen foundation problem arises that requires additional labor and materials. In that case, the contingency budget is there to cover those costs without affecting the overall financial plan of the project.
2. Reduces financial risk
As a financial safety net, unforeseen costs reduce the risk of budget overruns, which can threaten the project’s financial health. Unexpected problems, such as discovering water damage during renovations, can significantly inflate costs. Contingencies will cover these additional costs, keeping the project on track and within the original budget framework.
3. Provides peace of mind
Knowing that money has been set aside to solve unexpected problems gives builders and project managers the confidence to focus on the quality and efficiency of their work. This is especially valuable in areas prone to natural disasters, where external factors can otherwise cause significant delays and cost overruns. A contingency plan for such events ensures that projects can proceed with minimal financial disruption.
4. Improves project planning
Including contingencies in the project budget encourages thorough planning and foresight, allowing teams to anticipate potential challenges and develop effective strategies in advance. This level of preparedness is critical to navigating complex processes such as obtaining government permits, where delays are common but can be mitigated with proper contingency planning.
5. Encourages proactive problem-solving
Effective project planning, supported by contingencies, allows builders to resolve issues as they arise quickly. This proactive approach helps minimize delays and avoid cost overruns by ensuring that challenges such as mold growth or other unanticipated repairs are swiftly resolved without disrupting the project schedule.
In addition, construction contingencies offer broader benefits beyond these top five, including the ability to handle supply issues, material shortages or cost overruns, weather-related delays, and unexpected personnel costs. By enabling project teams to deal with the unexpected, stay on budget, and manage risk more effectively, construction contingencies are a critical component of successful project management, ensuring that projects can adapt to the unpredictability of construction work while maintaining financial and operational integrity.
How to use a construction contingency budget
When managing a construction project, understanding how to use the contingency budget effectively is crucial in managing contingencies and ensuring project success. A contingency budget, including owner and contractor contingencies, covers unexpected costs, such as incomplete projects, project delays, the need for replacement subcontractors, price increases, and more. Here’s a guide to using these contingency funds effectively.
Preparation of contingency budgets
- Detailed expenses: Your contract should clearly describe what contingencies are intended to cover. This can range from specific challenges, such as design changes, to more general issues, such as unforeseen price increases.
- Access procedures: Establish a straightforward process for accessing these funds, including necessary notifications, paperwork, and approval processes. This ensures that when unexpected expenses arise, there is an easy way to deal with them.
- Manage unused funds: Plan how the remaining contingency funds will be handled. Are they distributed as incentives to contractors or subcontractors, or do they return to the funder? Clearing this up beforehand can avoid arguments later.
Implementation of contingencies
- Manual methods: For those who prefer traditional approaches, setting aside 5-10% of the project budget for contingencies is standard. Manual tracking involves calculating this percentage of all costs before considering the profit margin, using paper-based methods or simple calculations. Although this approach is familiar, it requires close monitoring to reduce the risk of errors.
- Software methods: Technology provides a more sophisticated means of managing contingencies. Spreadsheet programs such as Google Sheets and Microsoft Excel allow you to use formulas to manage contingencies, although they require detailed attention to avoid errors. For a more integrated solution, construction management software such as Bauwise offers tools to automatically create, track, and adjust contingency budgets across different budget units, simplifying financial management throughout the project lifecycle.
A contingency budget is an important component of construction project planning, providing financial protection against unpredictability. Whether managed manually or with specialized software, a clear and structured approach to using these tools protects the project budget and provides peace of mind for all involved. By preparing for unexpected costs and delineating the procedures for using and managing contingency funds, builders can navigate the complexities of construction projects more smoothly and efficiently.
Is a Construction Contingency the Same as a Retainage?
In the construction industry, contingency funds and retainage are financial safeguards, yet they operate on different principles and serve distinct purposes.
Understanding the Difference
- Contingency Funds: These are allocated as part of the project’s budget to cover unforeseen expenses that arise during the construction process. This is extra money planned into the project’s cost from the start or set aside by the project owner to deal with unexpected issues. If not used, the contingency can benefit project stakeholders, potentially distributed among participants, thus serving as a proactive measure for managing the unknowns in a project.
- Retainage: On the other hand, retainage refers to a portion of the contractor’s or subcontractor’s payment (typically 5-10% of the contract value) that is withheld until the completion of the project. This practice aims to ensure contractors fulfill their obligations and address any issues that may arise, acting as a financial incentive for quality and completion. Retainage is money earned by the contractor but held back by the project owner as a form of security.
Key Differences
- Purpose and Timing: While both are used as financial safeguards, retainage is a deferred payment for work already performed to ensure completion and compliance with project standards. Contingency funds, however, are set aside in anticipation of potential unforeseen costs.
- Ownership and Owing: Retainage represents funds owed to contractors for work completed but withheld to guarantee project completion to standards. Contingency funds, by contrast, are not owed to any party and are designated for unexpected expenses. If unused, they may be reallocated or returned according to the project agreement.
- Utilization: Contingency funds are accessed to address unexpected costs not accounted for in the initial project budget. Retainage is released upon satisfactory completion of work and is often used as leverage to ensure project standards and timelines are met.
Conclusion
While retainage and contingency funds are crucial for the financial management of construction projects, they serve different roles. Retainage acts as a financial holdback to ensure project completion and adherence to quality, whereas contingency funds are proactive financial planning tools for unforeseen expenses. Understanding the distinction between these concepts is vital for effective project management and financial planning in the construction industry.
Construction contingency FAQs
How much should I allocate for construction contingencies?
Construction projects generally allocate a contingency amount that ranges between 5% and 10% of the total project budget. This percentage is sufficient to handle any unforeseen expenses that might occur during the project.
How do you calculate the construction contingency percentage?
To figure out the percentage of your construction contingency, divide the total contingency fee by the total estimated project cost. Alternatively, you can multiply the contingency percentage by your project’s total estimated cost to calculate the contingency fee.
The calculation formula is:
Percentage (%) × Estimated Base Cost of the Project = Contingency Amount
If the risk is assessed at 10% for a project with a base cost of $50,000, the contingency budget would be $5,000.
When should I use a contingency budget?
A construction contingency is intended for use in situations where unanticipated expenses or delays arise within a construction project. It accommodates these additional costs or makes necessary modifications to the project timeline.
What types of costs can be covered by a contingency?
A contingency fund addresses various unexpected expenses in a construction project. These include unforeseen site conditions, project scope modifications, emergency repairs, timeline setbacks, and regulation updates like building codes or zoning laws.
What happens if I don’t have a contingency?
Lacking a contingency can result in considerable financial strain and disruptions to the schedule when unforeseen delays or modifications occur in a project. Despite meticulous planning, numerous unexpected events can arise. Having a contingency is a prudent approach to mitigating such risks.
What happens to unused construction contingency funds
Unused contingency funds can be allocated in several ways. For example, they can be returned to the project owner, shared between the owner and the contractor, or given entirely to the contractor as a performance incentive. The contract should clearly state the agreement on distributing the remaining contingency funds and providing incentives.
Written by:
Taavi Kaiv
Taavi Kaiv is a construction specialist with over ten years of experience in the construction industry. Taavi is an accomplished construction project manager with many successful projects that have been completed under his guidance. Taavi holds a master’s degree in construction management from the Tallinn University of Technology. View profile
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