A construction contingency is a predetermined sum of money allocated to account for unforeseen expenses that may arise during a construction project. Managing risks is crucial in the construction industry, and including a construction contingency in the budget is an essential step to safeguard against unexpected circumstances.
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What is construction contingency?
A construction contingency is a predetermined sum of money allocated to account for unforeseen expenses that may arise during a construction project. Managing risks is crucial in the construction industry, and including a construction contingency in the budget is an essential step to safeguard against unexpected circumstances. Here are some key points about construction contingencies and a brief guide on their utilization.
1. Purpose of a Construction Contingency:
A construction contingency serves as a financial cushion, providing a buffer to cover additional costs resulting from unforeseen events, changes in scope, design modifications, or other unexpected circumstances. It helps protect the project’s overall budget and timeline by allowing for flexibility in dealing with uncertainties.
2. Types of Contingencies:
– Design Contingency: This type of contingency accounts for potential design changes or adjustments that may arise during the project. It allows for modifications to the original plans without impacting the budget significantly.
– Scope Contingency: Scope contingencies are set aside to accommodate changes in project scope, such as additional work requested by the client or unforeseen site conditions that require adjustments.
– Schedule Contingency: Schedule contingencies account for possible delays or disruptions that may occur during construction, enabling the project team to address issues promptly and mitigate their impact on the timeline.
– Cost Contingency: Cost contingencies provide a financial safety net for unanticipated expenses, such as price fluctuations in materials, labor cost increases, or unexpected site conditions.
3. Determining the Contingency Amount:
The contingency amount is typically calculated as a percentage of the overall project budget. The specific percentage may vary based on factors such as project size, complexity, and level of uncertainty. Common industry practices often allocate contingencies ranging from 5% to 15% of the project budget.
4. Proper Utilization of the Contingency:
– Identification: Regularly assess the project to identify potential risks and uncertainties that may require the use of the contingency.
– Evaluation: Evaluate the impact and cost implications of the identified risks. Prioritize and allocate funds from the contingency accordingly.
– Documentation: Maintain thorough documentation of contingency usage, including the reasons for its utilization and any associated changes to the project.
– Monitoring: Continuously monitor the project’s progress, risks, and expenditures to ensure the proper management and allocation of the contingency funds.
By incorporating a construction contingency into the budget, project stakeholders can enhance their ability to handle unexpected events effectively, minimize disruptions, and protect the project’s financial health.
How is Construction Contingency Calculated?
Construction contingencies are typically calculated at 5-10% of the construction budget. This percentage varies depending on the project. There are more precise methods for calculating this, such as the deterministic and probabilistic methods.
Under this method, you use 5-10% as a predetermined percentage. The formula would be:
% x Project Base Cost Estimate = Contingency
For example, if the risk probability is predetermined to be 5%, then a project with a base cost of $40,000 would yield a contingency budget of $2,000.
How would you know which percentage to use? You would need expert judgment and predetermined guidelines from individuals with sufficient experience and competency to specify a percentage of contingency. However, the Association of Advancement for Cost Engineering (AACE) explains that predetermined guidelines can be in the form of a table of contingency values.
There are several probabilistic risk assessment methods, but one of the most common is the expected monetary value. The expected monetary value of potential risks is used to quantify the impact of those risks on a project.
First, the team identifies the risks that could cause them to dip into a contingency fund. Once the risks are listed, each risk’s probability and cost impact are estimated. The expected value is then calculated by multiplying the probability of each risk occurring by the resulting cost if it happens, and then adding the results.
It can be expressed as:
Expected monetary value of risk = Probability of Risk Occurring x Impact if it occurs
The Construction Institute provides more color on how to implement this method. That said, the probabilistic method is complex and its use isn’t merited on every project. It is recommended for projects in excess of $15M, or when entering a new market, using unfamiliar tools or technology, or when new project delivery methods are being utilized.
Types of Construction Contingencies
There are two primary types of construction contingency funds: contractor contingency and owner contingency.
A contractor’s contingency is an allocated amount included in the contractor’s projected price for the project to accommodate unforeseen risks that cannot be accounted for in the schedule of values. This reserve is specifically set aside to cover any mistakes made by the contractor.
Contractors view these funds as already spent, as they acknowledge that unexpected costs are inherent in the construction process and include this additional funding in their estimates.
An owner’s project reserve is a dedicated amount set aside for any additional work or modifications to the project scope. Such contingencies are typically used in contracts with guaranteed maximum prices (GMP).
Any changes not originally included in the bid will have to be covered by the owner-funded contingency. Incomplete plans or changes directed by the owner are the primary reasons for tapping into the owner’s contingency fund.
How to use the contingency budget
Utilizing the Contingency Budget
When encountering a construction contingency clause in a contract, it is crucial to consider several factors. The contract should outline both the owner’s and contractor’s contingencies, specifying the predetermined costs that the contingency funds can be used for.
The contingency budget should include a comprehensive process for accessing the funds, including notice requirements, necessary paperwork, and approval procedures.
Additionally, the contingency budget should address the handling of any unspent portions. Will the remaining funds be shared as incentives with the contractor or subcontractors? Or will the funds revert back to the party funding the contingency? Clearly defining the management of unspent contingencies from the outset can help avoid complications later on.
Is Contingency the Same as Retainage?
A construction contingency fund is not the same as retainage, although the concepts are similar. Both retainage and contingency provide emergency funds for unexpected costs. However, there are fundamental differences between the two.
Retainage represents a portion of the contract price that is earned but withheld as payment. It serves as security, ensuring that payment is withheld until the completion of the project. In contrast, construction contingency is an actual inflation of the contract price to account for unforeseen circumstances. It is either funding set aside by the owner or an increased contract price to accommodate unexpected issues.
While it may seem like a matter of wording, there exists a significant and fundamental distinction between the two.
Retainage signifies earned but unpaid funds, and this amount can make all the difference between a construction contingency business making a substantial profit or suffering losses on a project. On the other hand, contingency is not owed to anyone and can even turn into a positive outcome if the contingency fund remains unused and is distributed among project participants.