In Summary
A change order is a written contract modification adjusting a project’s scope, budget, or schedule. They are a common, predictable part of construction that often account for roughly 10% of total contract value, with late-stage design modifications causing the most significant cost overruns and delays.
Implementing a standardized change order management process prevents contractors from absorbing extra costs, protects tight profit margins, ensures full payment for extra labor or materials, and reduces client disputes.
An effective ongoing process relies on strong initial contract terms, prompt flagging and documentation of variations, detailed tracking of all associated costs, dual approval procedures, and leveraging project management technology for cross-department visibility.
Change orders are a normal part of construction. Owners have new ideas, and designers issue revisions. Site conditions turn out to be different than expected. Each of those situations can affect the scope of work, the schedule, and the contract price, and each one requires a change order. Change orders are one of the more important aspects of construction project management. They protect contractor revenue and keep all parties on the same page. Left to an informal process, they become a source of disputes, unbilled work, and margin erosion. To help clients, prospects, and others, Hanson & Co has summarized the key details below.
Understanding Charge Order Management
A change order is a written modification to the original contract between the contractor and owner. The modification might adjust the scope of work, the contract price, the project schedule, or some combination of the three.
Change order management covers everything that happens between recognizing that a change has occurred and getting it approved and billed. That includes identifying the change, documenting it, estimating its cost and schedule impact, submitting it for approval, and tracking it through to final resolution.
Why Contractors Need a Change Order Management Process
Change orders are common. The volume of change orders on a typical construction project is higher than many people expect. Industry research found that the average number of change orders ranges from approximately 1.7 on smaller projects to more than 11 on larger projects. Change orders are not an anomaly. They are a predictable feature of construction work, and project teams need a process built around that reality.
Most change orders occur when projects are already under pressure to finish. Research has also found that change orders become more common later in the project lifecycle, particularly on larger jobs. By that point, project teams are focused on completion, but a change order means that rework may need to be done. For that reason, changes introduced late in a project often have a greater impact on costs and schedule than changes made early in the process.
- Some changes have a much larger impact than others. Research on large construction projects found that design changes contributed to more than half of project cost overruns and roughly 40% of delays. Not every change becomes an issue, but some changes have a track record of affecting both cost and schedule performance. Project teams benefit from knowing the difference.
- Change orders can represent a meaningful portion of contract value. Some industry studies put change orders at roughly 10% of total contract value on average. On a $10 million project, that is $1 million or more in additional work. Contractors need a process that helps ensure those costs are identified, documented, and billed appropriately.
- A missed change order can mean missed revenue. The full scope of the project must be captured for revenue to align with the contractor’s investment. If there’s not a standardized process to document changes, then it’s very likely that the contractor will not be paid for the full scope of work. One missed change order may not make a material difference. A pattern can put tight margins at risk.
Building an Effective Change Order Management Process
To better manage the profitability of each project, contractors need a process for evaluating, documenting, approving, and tracking all change orders. That starts with the contract. The terms may vary by project, but written documentation on how changes will be handled reduces disputes and puts the contractor in a stronger position throughout the job.
Once a change is brought to the attention of the project team, it should be flagged and documented. For example, an owner might make a request that seems simple, but it means revised drawings and additional labor hours. Without standardized documentation, those costs may be absorbed into the base contract price.
A change order should be completed and issued with a detailed description of the work and an updated schedule. From there, the total cost of the change needs to be recorded, including labor, equipment, materials, and any other costs tied to the change. If the change order reduces the total cost, that needs to be recorded as well.
It’s important that the change order goes through an approval process on both the customer side and the contractor side. Contractors can set a standard procedure for submitting the change order, usually through project management software if available. Technology often gives project leaders and the accounting team visibility to change order and payment status before the project officially closes.
Change order management is an ongoing process. Taking the time to review and standardize the process can make a difference to overall business performance. It also gives leadership an opportunity to identify recurring issues, such as incomplete documentation or work performed before approval. Then, targeted solutions can be developed and implemented rather than overhauling an entire system at once.
Contact Us
Change orders management affects every project. Having a consistent process that’s used across departments can help improve profitability, strengthen cash flow, and reduce change order disputes. If you have questions about change order management or need assistance with another tax or accounting issue, Hanson & Co can help. For additional information call 303-388-1010 or click here to contact us. We look forward to speaking with you soon.