How to stop losing money you already earned
By Derrick Rebello, CPA & Brad Carlson
Gray, Gray & Gray, LLP
If you’ve worked in construction for a while, you remember when material prices were just a simple number. You’d call a supplier, get a quote, add it to your estimate, and move on. Those days are gone. Although the wild swings from 2020 to 2022 have calmed a bit, “stabilized” doesn’t mean “predictable.” Lumber prices still jump with housing starts and mill capacity. Steel costs change as soon as tariffs are announced. Diesel, which affects nearly everything, shifts with unpredictable global events.
Contractors who protect their margins now aren’t just lucky with timing. They’ve set up the right systems, contract terms, and internal discipline to handle price swings without taking the hit. Here’s how you can do the same.
Escalation Clauses: Stop Absorbing Risk That Isn’t Yours
Most contractors know about escalation clauses, but fewer use them regularly, and even fewer use them effectively. The usual worry is competition: “If I include an escalation clause, the owner might pick someone who doesn’t.” That’s a real concern on some projects, but it’s also why many contractors have lost six-figure sums on jobs they actually won.
An escalation clause transfers some of the material price risk back to the owner if prices exceed an agreed limit during the contract. A good clause clearly lists the materials covered (like steel, lumber, copper, fuel, concrete, or a set group), the index used to track price changes (such as the ENR Construction Cost Index, PPI for certain commodities, or the U.S. Energy Information Administration’s diesel prices), the price increase that triggers the clause (usually 5 to 10 percent over the bid), and how costs are shared once that limit is reached.
Most contractors sell themselves short when it comes to the sharing formula. Asking the owner to cover 100 percent of costs above the limit is tough to get approved. But splitting costs 50/50 above a 10 percent increase is fair and more likely to be accepted. You’re not asking the owner to take all the risk, just to share it in a situation neither of you can control.
On public projects, owners and general contractors have grown much more open to escalation clauses after seeing cost spikes since 2020. Many public agencies now include standard escalation terms. If you’re a subcontractor on these projects, make sure your contract includes the same protections. A common margin leak happens when a GC has escalation protection from the owner but doesn’t pass it down to subs. Don’t be the subcontractor left holding the risk that’s already been covered higher up.
Change Order Management: The Money You Leave on the Table Every Single Project
Change orders are where contractors either recover profit or lose it, and most contractors aren’t as good at managing them as they believe. A survey by the Construction Financial Management Association shows that unresolved or underbilled change orders are one of the top reasons profits shrink on projects. The numbers are clear: a project with a 7 percent margin can lose it all from just 1 to 2 percent in change order losses.
These problems usually come from culture more than process. Project managers want to keep things smooth. Superintendents don’t want to pause work to document changes. Owners resist, and PMs, pressed by schedules, take on the extra work hoping to handle it later. But later often never comes or arrives too late.
Price Before You Proceed
The most effective way to handle change orders is also the simplest: price the change before starting the work, or at least get written approval before you proceed. A verbal “just go ahead, we’ll figure it out later” from an owner’s rep won’t help when you submit a $40,000 change order weeks later and they don’t recall the conversation.
Create a change order log for each project that tracks every possible change from the moment you spot it, not just when you submit the form. Record the date, the directive (verbal or written), the work done, labor and material costs, and the status of your submission. This gives you a clear paper trail for negotiations and solid evidence if you need to file a lien or claim.
The Markup Problem
Here’s a question to consider: Do you keep a consistent overhead and profit markup on all change orders, or does it shrink under pressure? For original bids, most contractors have a target margin. But with change orders, many discount because the work feels “extra” and they want to get it done fast. Yet change orders are often tougher, need faster work and buying, and carry the same overhead. Your markup should reflect that, not get smaller.
Real-Time Job Costing: If You Find Out in Month Three, You’ve Already Lost
Job costing isn’t new; every contractor does it in some form. The issue is that most job costing happens late, often 30 to 60 days after the work. That means when you review costs in month three, you’re seeing what happened in month one. By the time you spot a problem, you’ve already spent two more months making it worse.
Real-time job costing means linking fieldwork and financial reports as closely to daily as possible. You don’t need fancy software for this. It takes discipline: field teams must enter labor hours by cost code daily, purchasing must code material receipts by job, and accounting must process data quickly without long delays.
Labor Is the Variable That Kills You Slowly
Material cost overruns are easy to spot: you ordered steel at $X, but the invoice is $Y. Labor overruns are trickier. A crew running 15 percent over budget won’t announce it; the hours just add up, the job goes on, and you only notice when the final report arrives. The solution is tracking labor by phase against estimated rates. For example, if drywall was estimated at 0.05 labor hours per square foot but the actuals are 0.065 per week, you need to address that gap now, not at project end.
Most modern construction ERP systems, like Sage, can provide this data. The real bottleneck isn’t software; it’s making sure field teams consistently enter time by cost code and that project managers review the numbers and take action.
Committed Costs Matter as Much as Actual Costs
A real-time job cost report showing only actual costs tells only half the story. If you’ve issued a purchase order for $85,000 of HVAC equipment that hasn’t arrived, your report should count that as a committed cost. A contractor who looks only at actuals and sees green on a job with $200,000 in committed purchases still to come isn’t seeing a healthy job; they’re seeing a false positive.
Make sure your job cost reports separate actual costs (invoices paid), committed costs (purchase orders and subcontracts issued), and projected final costs (your forecast for total job cost). The projected final cost is the key number that guides your decisions.
Margin Leakage Diagnostics: Finding the Holes Before They Drain You
Margin leakage is the gap between the margin you estimated and the margin you collect. On a well-run project, some leakage is inevitable. On a poorly managed one, it compounds from multiple directions simultaneously, and the job that looked like a 9 percent margin ends up at 2 percent or negative by closeout.
A margin leakage diagnostic is a regular, structured check that compares your estimates to actual results throughout the project, not just at the end. Think of it like a check engine light for your project’s finances.
The Six Most Common Sources of Margin Leakage in Construction
Material variance is the obvious cause: you paid more than you estimated. But this can be managed with escalation clauses and smarter purchasing.
Labor productivity variance is less obvious but often bigger. You estimated crew productivity, but conditions such as weather, site access, or design changes added extra hours. The estimate was good, but the conditions changed. This calls for an honest discussion of whether the estimate was realistic and whether the extra work should be compensated.
Subcontractor scope gaps cause leakage when subs do work outside their contract, and you cover the cost instead of billing it upstream. This is a scope-and-change order management issue, not a subcontractor problem.
Billing timing mismatches cause leakage when you incur costs this month but can’t bill for them until later. On big projects, this affects cash flow; on smaller ones, it can mean lost revenue if final billing isn’t carefully handled.
Warranty and punchlist costs are often underestimated. Most contractors include a small allowance, but the real cost to finish a project, especially complex ones, is usually higher. Track these costs over time and use real data to set your reserves.
Finally, overhead absorption fails when a project takes longer than planned and your overhead allocations don’t cover the extra costs. If a six-month job stretches to ten months, you need to renegotiate general conditions or at least document it as a compensable delay.
Run the Diagnostic Now
Choose your three biggest active projects. Gather the original estimate, the current job cost report, including committed costs, and your billing-to-date. Calculate the projected margin at completion. If it’s more than two points below your original estimate on any job, you have active leakage. The sooner you find the cause, the more you can recover.
How you recover depends on where the leakage is. Material overruns might justify a change order or escalation clause claim. Labor overruns could be due to compensable owner delays or design changes. Scope additions can be billed if documented properly. Not all leakage can be recovered, but some can, and contractors who look for it find money others miss.
Welcome to the New Bottom Line
Volatile material markets aren’t a short-term problem. They’re the new normal. Contractors who succeed will be those who treat contract language, change management, job costing, and financial checks as essential skills, not just paperwork.
You don’t need new software or extra staff. What you need is consistent discipline in practices you probably already know you should follow. The difference between knowing and doing in these areas is where your margin lives.
If you’d like to run a margin leakage diagnostic on your current project portfolio, or help in drafting escalation clause language appropriate to your contract types, we’re here to work through it with you.
For questions about your specific contracts, job costing systems, or financial reporting, contact Derrick Rebello or Brad Carlson, Partners in the Construction Practice Group at Gray, Gray & Gray, LLP, a business consulting and accounting firm that serves the AED and construction industries. Derrick and Brad can be reached at (781) 407-0300 or powerofmore@gggllp.com.
Frequently Asked Questions (FAQ)
Competitive pressure is a legitimate concern, but it is also the reason many contractors absorb six-figure losses on jobs they “won” without one. The key is structuring the clause reasonably: a 50/50 cost-sharing arrangement above a 10 percent threshold is far more palatable to owners than asking them to absorb 100 percent of overages. On public projects, escalation provisions have become increasingly standard since 2020, and many owners now expect them. Framing the clause as shared risk management rather than a contractor demand tends to improve negotiation outcomes.
They generally do not hold up, which is why written authorization before proceeding is so important. If work is verbally directed and you must begin immediately, follow up the conversation with a written notice to the owner’s rep the same day, documenting the directive, the scope of work, and your intent to submit a change order. Maintain a change order log that records the date, the directive, the work performed, the costs incurred, and the submission status from the moment a potential change is identified. This paper trail protects you in negotiations and is essential if a dispute escalates to a lien or claim.
The most common reason is lag. Most systems process data 30 to 60 days behind actual field activity, so the report you review today reflects conditions from last month. The fix is not new software but tighter discipline: field teams entering labor hours against specific cost codes daily, purchasing coding material receipts promptly, and accounting processing data without multi-week delays. Also, check whether your reports include committed costs alongside actuals. A report showing only paid invoices can appear healthy on a job that has hundreds of thousands of dollars in issued purchase orders still arriving.
It depends on the source of leakage, which is why diagnosis comes first. Material variance above a contract threshold may support a change-order or an escalation-clause claim. Labor overruns tied to owner-caused delays or design changes are often compensable. Scope additions that were performed but not billed are recoverable if they were documented at the time. Not all leakage is recoverable, but some of it almost always is. Contractors who actively look for it consistently find money that contractors who do not look never see. The earlier in the project leakage is identified, the more options for recovery exist.
Run the diagnostic on your three largest active projects right now. Pull the original estimate, the current job cost report with committed costs included, and billing-to-date. Calculate the projected margin at completion for each. If any job is more than two percentage points below the original estimate, you have active leakage, and the clock is running. From there, the source determines the action: escalation clause support, an underbilled change order, a scope conversation with a sub, or a general conditions renegotiation. The discipline of regularly reviewing these numbers, not just at closeout, is where margin protection begins.