Revenue leakage in construction

Revenue leakage in construction is money you have earned but never invoice or never receive: variations carried out without a written instruction, provisional sums that are not settled, price increases the contract allows you to pass on but nobody recharges, and stage payments that lag behind actual progress. It rarely leaks in one large item. It leaks per project, in dozens of small differences between what happens on site and what ends up on the invoice.

This article covers where exactly that happens, how to find it and what it costs. For the broader picture of how to monitor it structurally, see Revenue Intelligence for construction companies.

Why is construction more exposed than other sectors?

In most B2B companies there is one hand-over between sale and invoice: from the CRM to invoicing. In construction there are five or six. Estimating prepares the budget, the project manager buys in and directs, the site manager decides on site, pre-construction tracks changes, project administration prepares the valuation and finance sends the invoice. Every hand-over is a place where information can get stuck.

Add three characteristics of construction projects that make it worse:

• The scope changes during delivery. A specification is a starting point. Unforeseen ground conditions, changes from the architect, additional client requests: almost every project has additions and omissions.
• Projects run for a long time. Between the estimate and the final account there are often months, sometimes years. Whoever made the agreement is not always still involved at the final account.
• Decisions are made verbally. Something is agreed on site with the clerk of works or the architect. The site manager knows it is a variation. They also know it has to be put on paper, but the work comes first.

Where does revenue leak in construction companies? Seven places

When people talk about revenue leakage in construction companies, they almost always mean one of these seven patterns.

1. Variations without a written instruction

The classic leak. Extra work is carried out at the request of the client or their representative, but the instruction is recorded nowhere. At the final account a dispute arises, and without evidence you concede or settle for part of it. The work has been done, the materials paid for, the hours worked. Only the revenue is missing.

2. Variations that were recorded but never invoiced

Less visible and often larger. The variation instruction was signed and sits in the project file, but never made it into the valuation or onto an invoice. This happens mainly with small items the project manager meant to bundle, and on projects where the project manager changes.

3. Provisional sums that are not settled

A provisional sum is an amount in the contract sum for work not yet fixed at tender. At the final account, the difference between the provisional sum and actual cost has to be settled, including the agreed mark-up. If the provisional sum is exceeded and not adjusted, you pay the difference yourself. If you forget that the mark-up on the excess may also be charged, you leak the margin.

4. Price increases the contract allows you to pass on

Many construction contracts include a mechanism for cost increases, for example linked to a published price index. That mechanism does not work by itself. Someone has to calculate at the right moment what may be charged, support it and submit it. If that does not happen, you carry the rise in material and labour costs yourself. More on this in revenue leakage from missed price indexation.

5. Stage payments that lag behind progress

The payment schedule ties invoices to milestones or a percentage of completion. If the valuation is not updated, you invoice later than the contract allows. That is not a loss of revenue, but it is a loss of money: you pre-finance the project. And the longer a stage stays open, the greater the chance that it gets absorbed into the final account and partly lost there.

6. Daywork with incomplete hours and materials

For work on a daywork basis you invoice actual hours and materials. The job sheets are the source. Missing sheets, materials taken from stock without being recorded, hired plant that stays on site longer than booked: every missing piece is revenue that never arrives.

7. Snagging items and retentions that stay open

Part of the contract sum is often only paid after completion or after snagging items have been resolved. If a small snagging item stays open, so does the last payment. After a year nobody asks about it any more, and after two years it is a bad debt.

Why you do not see it in the figures

The awkward thing about leakage in construction is that the project simply appears to have ended badly. The post-completion cost review shows a lower margin than budgeted, and the explanation seems obvious: setbacks, price increases, a difficult client. That part of it is work you were entitled to invoice, you only see by putting the cost review line by line next to the variations administration and the contract.

That rarely happens, for two reasons. The cost review only comes once the project is finished and the team is working on the next one. And the data sits in different systems: the estimate in an estimating package, the hours in time recording, purchasing in the accounts, whether that is Xero, Sage, Exact, AFAS or a sector package, and the variation instructions in email and the project file.

Worked example

Worked example: suppose a commercial building contractor turns over EUR 15 million across roughly thirty projects a year. On each project the following happens:

That is 1.9 percent of revenue. No single project feels like a disaster, and yet together it is more than many contractors keep as net profit in a year. The interest cost of late stage invoices and the unrecovered price increases are not even included here.

The figures are an example, not an average. There is no reliable sector average for leakage in construction. What it is for you depends on how many variations your projects have, how you record changes and how quickly you settle after completion. The commonly cited estimate of 1 to 5 percent of revenue for B2B companies in general is a reasonable starting point to set your own figure against.

How do you find it?

You do not have to wait for a system to do it for you. Three checks almost always turn something up.

For each completed project, put the variations list next to the invoices. Take the last ten completed projects. For each project, list all variation instructions, signed or confirmed by email. For each instruction, find the invoice line or valuation in which it was included. What you cannot find is a candidate for leakage. How to approach this systematically is covered in invoice checks for construction companies.

Put the cost review next to the provisional sums. For each provisional sum: what was budgeted, what was actually spent, what was settled? An overrun without adjustment is a direct finding.

Read the contracts for price mechanisms. Which live contracts have an indexation or risk mechanism? When may it be applied, and has that happened? This is the territory of contract checks for construction companies.

How do you prevent it?

Checking afterwards finds the leaks. Preventing them happens at the front end, with arrangements small enough to keep up on a busy site.

1. One variation form, always. Digital or paper, but one format. Description, reason, who gave the instruction, estimated value, signature or confirmation by email. No form, no work, except for urgent safety matters.
2. A weekly variations register per project. One list with a status: requested, approved, carried out, invoiced. The project manager goes through it every week. Anything marked carried out for three weeks without an invoice goes to the office.
3. Valuation on a fixed day. Progress is assessed on a fixed day each month and invoiced straight away, even if the amount is small.
4. Contract features in the project file. At the start of each project, the price mechanism, provisional sums, payment schedule and payment terms go on one sheet. The office then knows when there is something to charge.
5. Settle within a fixed period after completion. Agree internally that the final account goes out within, for example, six weeks of completion. The longer you wait, the weaker your position.

What it returns

Recovering leakage in construction has a property cost-cutting does not have: it is almost entirely margin. A variation of EUR 2,500 that you still invoice has already incurred all its costs. The full EUR 2,500 goes to your result. In a sector where a net margin of a few percent is normal, 1 percent of revenue recovered is often half your profit or more.

If you want to know where it sits in your company without connecting systems first, you can have it investigated once. The Revenue Audit goes through eight areas with you, in conversation, and puts an amount in euros on every finding.

Frequently asked questions

Is a variation without a written instruction always lost?

No. Whether you can still invoice it depends on your contract, the rules in your jurisdiction and what you can demonstrate: emails, site minutes, photos, statements. But your position is weaker than with a signed instruction, and in practice it often ends in a settlement. Prevention is cheaper than proving it afterwards.

How often should I check the variations administration?

Weekly per project by the project manager, and a quarterly sample by someone outside the project. The weekly check catches what gets stuck. The sample catches what goes wrong structurally.

What is the difference between a loss and leakage on a project?

A loss arises when you carry out work at a higher cost than budgeted. Leakage arises when you carry out work you were entitled to invoice and do not. In the cost review they look the same. That is why, for every disappointing margin, you have to ask which part was loss and which part leakage.

Are small contractors as exposed as large ones?

Often more so. A smaller contractor has less pre-construction and project administration, so more depends on what the site manager remembers. Large construction companies have more control, but also more hand-overs and more projects running at once.

Which systems do you need to check it?

For a first check, what you have is enough: the project file, the variation instructions, the invoices and the cost review. A spreadsheet is enough to put them side by side. Automation only becomes worthwhile when you want to do it every month across all projects.