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When I ask contractors what their yearly overhead is, they often answer in the range of ten to fifteen percent. However, overhead is not a percentage of costs or sales, and it should not be viewed as such. You don’t pay your staff as a percentage of the jobs you bring in, do you? Your overhead is a fixed cost covering every expense for your company to stay open and do business during the year regardless of how much work you take on.
Many contractors don’t know their exact job costs, equipment costs and overhead budget, and consequently, many don’t know how much profit they should make on any given job. Without an understanding of your numbers, you will end up busy and broke instead of productive and profitable.
Job Charge or Overhead Expense?
A problem occurs when companies don’t properly job charge field costs to their respective jobs. When you don’t establish separate job accounts for every job, you can’t look back to see if you are bidding the right unit prices for your work. Also, when all your equipment is paid for out of your overhead budget, you don’t know if owning equipment makes you any money. Even worse: when field employees are not charged to individual jobs, you never really know what it takes to build a project or whether you’re making a profit.
When you bid work, your field labor rates include employee burden costs, taxes and insurance. For example, a worker who earns $20 per hour with a 50-percent burden expense is bid out at $30 per hour. When all burden costs are paid as part of your overhead costs, your job cost accounting doesn’t give you a clear picture of how well your job did upon completion because your fixed costs are lumped together with the costs that vary by job. The same is true with field equipment. Even though you may bid out equipment at fair market rates, company owners often don’t know what their equipment costs to own. To make matters worse, some contractors don’t charge jobs for the use of their equipment. This makes it impossible to know whether you are making money on projects.
Track Your Job Costs
To make more money, you must track and keep updated, accurate job cost information. At the completion of each project, you should be able to determine whether your bid was accurate and whether you made a profit. Therefore, job costs must include every expense necessary to complete projects, including project management, supervision, labor burden, equipment and insurance costs. These are the items that you wouldn’t spend money on without jobs under construction. They are the variable job costs that must be analyzed to determine profitability.
When you job charge every field expense to jobs and remove them from your overhead costs, your overhead will be accurate. This will also make your job costs, field labor rates and equipment rates more accurate. This strategy will pay off when performing extra work at higher rates and signing contracts that limit markup allowed for additional items, change orders and cost-plus work. Also, general contractors’ contract award decisions are often made based on fee and general conditions costs. A lower markup is easier to sell than lower field rates.
Define Your Overhead
Overhead must include your annual costs for management and administrative expenses; salaries and burden or fringes for executive and office personnel; office rent, supplies and utilities; vehicles for officers and management personnel; marketing and sales; personal development, association memberships and training; banking fees; legal, accounting and other professional services; closed job and warranty work; and taxes, contributions and depreciation.
Overhead also must include all business insurance needed for the day-to-day operation of the company itself but not liability insurance to build or run jobs. All field employee labor and burden costs of those who are not working on the jobs under construction (such as during slow times or downtime) should be included as well, and field vehicles and field equipment expenses when they are not being used on jobs should be included.
Overhead must not include items used to build projects in the field. Instead, these items should be included in your bid estimate and charged to job costs. Examples of these items include all field personnel and related expenses, all field vehicles and related expenses, tools and liability insurance premiums based on job costs. Finally, general conditions costs also should not be included in your overhead. These include any field expenses required to manage and run projects.
Set up your financial reporting the same way you estimate, bid and build projects, and your accounting will start to make sense to you. To receive a sample construction company annual overhead budget/income statement and general conditions template, email me at email@example.com.