Over the past 3 decades our firm is repeatedly asked “What differentiates your most profitable contractor clients?”
While there are many reasons contractors are more profitable than others, one significant area of differentiation is how change orders are originated, processed and followed up on within the organization.
My most profitable contractors will not do work without a signed change order.  They follow this guideline religiously and it pays off in the following ways:
  1. The most successful contractors document every change order from the smallest change to the largest change.
  2. If a change is of a certain magnitude or greater, the contractor sets up a special cost code or phase in their job cost accounting module.
  3. Even if dollars are not agreed upon immediately the scope of the change must be agreed upon in writing.  Handshake agreements are not accepted.
  4. Project managers who work on change orders without signed authorization to proceed are let go.
  5. The accounting department sets up a change order number and tracks it from origination to billing to collection.
  6. Often times contractors design incentive compensation plans around two criteria for project managers.  The two criteria are job profitability compared to budgeted profit and bonuses for generating successful change orders.
  7. At a minimum, proper change order accounting allows for the “worst case” situation in terms of providing support for a claim to be filed against the Owner. In our experience, the party with the best evidence “wins” in claims cases and control over change orders and related cost controls help support that ongoing communication was taking place as to changed conditions or additional work required.  By setting up a separate phase or job code for change orders you can then use this report to help support your claim for extended home office overhead and additional costs.

Some contractors bid on a very low margin hoping and counting on change orders to increase the contract in a favorable manner.   Change orders are often negotiated as opposed to being fixed price or lump sum and thus can have higher margins if estimated properly.

Knowing your proper T & M (time and material) hourly rates including burden can allow for increased margins on change order work.

The worst error in this area that we have noted is when contractors wait to bill change orders after the job is complete.  You have lost any lien rights you may have and are not in a strong position to negotiate.  The owner already has a completed job and you have lost your leverage.

 The most profitable contractors focus on change order management.  Obviously a proper bid to begin with is equally important if not more so but what job has no change orders? Nearly all jobs have changes and managing those change orders is paramount to your success.

By Glenn Gelman, CPA