Getting the Best Numbers on Your Estimate

Eugene Peterson | Advise & Consult, Inc. | August 18, 2016

Numbers in our business are pretty important.  With few exceptions our disputes center on actions which include remedies that are translated into numbers.

Is there anything more terrifying than having to go to court with numbers you are uncertain of or question?

It seems logical and sensible to believe that the best numbers come from the actual costs that have been expended.  But if that is true, why then are there so much conflict and so many actions/disputes filed when the established agreement is based upon the use of actual costs?  Could it be that one party perceives that they are being taken advantage of by the other party?  Maybe there is a perception that the other party is making winter work out of a summer job?  Could it be that trust is lost due to lack of progress, or that the other party is not acting in their best interests, or promised commitments just don’t get fulfilled.  And we all know that a failure in communications can be the kiss of death.

Right or wrong and no matter which side of the fence you are sitting on, lots of conflicts occur where there eventually is a knock down drag out fight over a perceived injustice or a bad agreement.

When the boxing gloves are put on and the parties come out fighting, having the best number in your corner of the ring becomes a paramount concern in resolving the conflict. And having the right numbers from the get go might have prevented the conflict when numbers were presented and expectations were set.

I want to share an example where an owner lost faith and confidence in the contractor hired to build a $4.5 million home in Park City, UT.  We could be on either side of this conflict, but in this case I am representing the home owner who is going against her builder.

In our example a cost plus contract was agreed upon and used by both parties.  A cost plus contract is one in which the contractor submits all invoices to the owner for payment, plus his costs for profit and overhead.  The schedule presented by the contractor was to complete the project in 18 months.  The cost to build was estimated and budgeted to be $4.5 million.  Four years later and three million dollars over budget, with no end in sight, the owner lost trust in the contractors ability to complete the project.

The problem started with the way the contractor arrived at the initial budget.    His standard way of estimating a job/budget was estimating by using past experience and giving a basic cost to build by the square foot.  He declared that to build a home of this magnitude it would be $250 per square foot. In his mind that seemed to be plenty of dollars. The contractor felt pretty safe, since it was going to be a cost plus contract.

This type of estimate is used more than you might think.  But when this number was turned into a cost plus contract, the number, considering the expectations of the owner, immediately became an unrealistic number.

A building schedule was arrived at in the same manner and became part of the contract.  Now both budget and schedule were unrealistic.  The contractor felt safe, because, in fact, they had executed a time and material contract.

Adding to the problem, this contractor was unexperienced in projects of this size and it was being built on a mountain, where the soil was full of boulders.

The additional add on fee agreed upon turned out to not be adequate to even cover the contractors overhead, which made it impossible to generate a profit.

Finding himself deeper and deeper in the hole, the general contractor started to be creative in generating revenue to cover his costs.

• He hired his son to be the superintendent, paid son $25 p/hour, charged $70
• Created invoices for the subcontractors – supposedly saving them time — but padding the invoice with money that he kept
• Created subcontractor invoices for work and material that was not done or provided
• Got several subcontractors to submit inflated invoices, and then took a portion of the money for him.
• Ordered materials, submitted the invoices for payment and then returned the materials for an account credit.
• Diverted materials and labor paid by this account to other projects, including his personal residence

The contractor was submitting cost plus time and material invoices as draw requests monthly.  The homeowner was simply paying the draw requests, without questioning any of the invoices.  She lived in NYC and occasionally visited the property while under construction.

During analysis of discovery documents it was revealed that the contractor was creating bids and invoices for willing subcontractors, then submitting for payment invoices that were sometimes double the actual costs.  Once we learned of this action we found the other questionable creative financing activities listed above.  Interviewing one of the subcontractors we learned that the contractor had the sub create an identical custom designed fireplace mantel for his own home.

This time and material contract was all of a sudden becoming profitable. The contractor was soon transferring funds to other projects, businesses, activities and then even into his own pocket.  At this point there was no reason or financial incentive to even finish the project.  It reminded me of the goose that laid the golden egg.  What is the hurry to end the project, (kill the goose) while the goose continues to lay the golden egg.

If it was simply the fraud and malfeasance of the contractor it would not have been difficult to come up with numbers to settle this matter.  But there were other factors of incompetence that were involved specifically $1.5 million worth of construction defects.

If you were a party to this action, would you want good numbers?  How would you get them?

One of the solutions and approaches was to hire the services of a good forensic accountant who sifted through the detail of the thousands of documents provided by the contractor in discovery.  Weeding out fraudulent invoices was difficult and expensive.  Subcontractors who participated in the fraudulent activities, as you might guess, were uncooperative.  Other subcontractors were out of business and others had computer meltdowns that made reproducing documents and invoices impossible.

The only way we were able to get good numbers, even after the expense of the forensic accountant was by preparing a very detailed and comprehensive estimate.  And you can bet that we didn’t do it by saying that this type of structure costs $500 dollars per square foot to build.

Obviously good numbers were important to have in determining the damage associated with this action.  In this case we created an estimate that was hundreds of pages long.  The other side produced an expert who scratched his numbers out by hand on a napkin (just kidding, it was actually several pieces of paper).  And although the judge wanted a bottom line, he also took into consideration the detail that went into the estimates that were provided as evidence.  The good news is that we prevailed; the bad news is that the contractor declared bankruptcy.

There are multiple other situations where we used estimates, instead of labor and materials invoices.

• When work is yet to be complete the best numbers come from an estimate.

Most people enter into time and material agreements with the belief that they are getting the best deal, because it is only going to cost them the actual costs, plus a small manageable fee.  But a person is foolish to proceed with any type of an agreement/contract without first having a good numbers.

Getting the right numbers, with appropriate scientific backing and detail, can be a significant factor in helping you to prevail and win your cases too.  And of course we know that without good numbers/estimate, the ship has a more difficult time staying afloat.

Quick show of hands: who thinks they are really good at consistently getting accurate numbers and estimates?

At this juncture it is important for you to know that not all estimates are created equal.

The quality of an estimate primarily stems from how close it represents reality.  There are several challenges to creating accurate estimates.

My experience is that most estimates come from a place of optimism.  Those of us who write estimates often imagine doing the work under the best possible circumstances.  We often ignore the unknowns, and fail to include the extra work that is generated because circumstances were not as expected.  Is this really representative of the world we live in?  Sadly this leads to underestimating.

On the other hand, perhaps we have had a very difficult experience with a similar task.  The memories of a painful experience may cause us to estimate far too high.

Or with little experience, as is the case with complex matters, we simply take a shot in the dark.  Is the estimate too high, too low, or who could possibly know?

Thank goodness there are few things we can do to improve our chances of getting good numbers.

A first step is to understand that all estimates are not created equal.

From R.S. Means, a company who publishes books devoted to helping contractors find prices for labor and material, they categorize estimates into four different groups.  You may recognize the same estimates by different names.

1. 1. Order of Magnitude Estimates
      • With accuracy plus or minus 20%
      • This is an educated guess, in very general terms based upon past experience with similar type of projects.  This type of estimate takes minutes to complete and is often referred to as a napkin estimate because the person creating the estimate grabs the closest piece of paper and writes down a number.  And in truth it sometimes has been a simple napkin. It is the least accurate estimate.
      • You’d be surprised at how many people use this type of estimate to resolve disputes.
   2. Square Foot and Cubic Foot Estimates
   • Accuracy plus or minus 15%
   • Home builders are notorious for using this approach as the basis for their contracts.
   • This is better than the order of magnitude estimate, yet it has its flaws in terms of accuracy.
   • This is the type of estimate the Park City contractor used to create his initial budget.
   3. Assemblies Systems Estimate
   • Accuracy plus or minus 10%
   • This is a very common way of estimating projects.
   • It is based upon a measurable building component.  For example, a linear foot of interior wall, which contains wood studs, drywall, paint and perhaps finished trim materials costs $2.00 per lineal foot.  The estimate simply measures the number of lineal feet, and then multiplies that number by the calculated cost of labor and material for one lineal foot of the wall.
   • This estimate requires a great deal of discipline in compiling.  It is easy to miss this item and/or that item.  The measurements when calculated by hand could be problematic.
   • A historic database is often used well beyond its useful life.
   • The accuracy is much better than the other types of estimates we have reviewed so far.
   4. Unit Price Estimate
   • Accuracy plus or minus 5%
   • Time consuming to prepare as it requires drawings or physical measurements of the property or building.
   • Line items need to be detailed and identified.
   • Estimating software then calculates quantities based on the sketches or physical measurements and the line item entries.
   • The person writing the estimate must be very detailed and precise to include all the components needed for the project.
   • The science behind this estimate is the best of all the estimates we have examined.
   • Xactimate is a type software that can be used to get a unit price estimate and is used by 22 of the major 25 insurance companies in the United States to resolve a majority of their claims and losses.

The person writing the estimate must be very detailed and precise to include all the components needed for the project.

The science behind this estimate is the best of all the estimates we have examined.

The final step in getting the best numbers is finding an experienced person, skilled in the complexity and nature of the project to be estimated.  Using someone who is inexperienced is like water skiing behind a low powered 25 horsepower motor boat.  You eventually may get to your destination, but the pain in being dragged across the lake maybe unbearable.  Whereas a 75 horsepower motor on the boat will not just drag you across the water, it will actually pull you to the surface where you can ski quickly across the lake to your destination.

Getting the right numbers can be a combination of any or all of the estimating systems discussed earlier.  And certainly having legitimate invoices in your hand can provide you with good numbers too.

It is our hope that you will be victorious in winning your cases and will be able to recognize, acquire and use the best numbers.