Jack Ganley, CPA, shareholder and director of construction services of Kirkland, Albrecht & Fredrickson, LLC. For more information on KAF Financial Group's team of accounting, tax and business advisors, visit www.kafgroup.com or call 781.356.2000.
Fewer industries have been as hard hit by the recent economic landscape as the construction field, and while the climate has started to shift in a more positive direction, the need to maximize profitability is more important than ever.
Tight competition and subsequent tighter profit margins equals no allowance for costly mistakes; as such billing rates must be "right on the money."
In order for a construction company to properly determine its billing rate for each class of employees, it must first establish its labor burden rate, followed by the fully-burdened cost per hour worked by employees and the overall average for each class of employees. But in the absence of a thorough understanding as to all the elements that comprise labor burden rate, this vital component to profitability cannot be properly calculated.
Labor burden rate is defined as the total indirect contract costs, calculated as a percentage of the construction company's direct labor. In other words, for every dollar of direct labor allocated to a contract, labor burden is applied as a percentage of the direct labor. But before a contactor can accurately calculate labor burden rate, all contract costs assumed by the company must be fully accounted for and factored into the final labor burden rate equation.
Contract costs are broken into two classifications-direct and indirect. Direct, or prime contract costs, are all known expenditures directly associated with the project. Examples of prime costs include subcontractors, direct labor, materials and supplies, equipment rentals, bonds and permits. These costs are obvious inclusions for estimators preparing bids for a potential contract. What may not be as obvious are the indirect contract costs.
Indirect contract costs that should be part of the final labor burden rate calculation include:
- Workers' compensation
- General liability and automobile insurances
- Motor vehicle and equipment repairs and maintenance
- Field communications expenses
- Employee benefits such as health, life, disability, profit sharing, bonuses and 401(k) match
- Payroll taxes
In fact, all costs associated with paying employees, including FICA, unemployment and Social Security should be calculated as part of labor.
The lengthy and varied list of indirect contract costs continues with vacation time, holidays, sick days, drivers, warehouse personnel, training, safety and clothing.
Other expenses that are regularly ignored when calculating labor costs include small tools that are often lost, stolen or abandoned during or after a job. Variable overhead should also be factored into the overall mix. This category includes all costs directly related to employees that cannot be divided accurately between jobs, such as fuel and cell phones.
All too often, these overhead expenses are overlooked by contractors and therefore not included when calculating a project's labor burden rate-a true disservice to the bottom line since, depending on the benefit package involved, employee related costs will typically account for 24 to 33 percent for a non-union contractor. For a union contractor, the labor burden rate for employee related costs will range from 60 to 70 percent. It should also be noted that the rule of thumb is to use a 1.0 workmen's compensation modification rate if the contractor's rate is more than 1.0.
Burden rates for open-shop contractors will vary, based on employee benefit packages, state unemployment insurance (SUI) rate, workmen's compensation modification rate, depreciation on new equipment and automobile insurance.
Companies that are equipment intensive-such as small paving contractors-should include all equipment and related operational costs as part of its labor burden rate since the same equipment is used consistently by the paving crew. Larger paving contractors that primarily fulfill public contracts typically use the services of a separate equipment company. The labor burden rate for these companies should be based on a calculation of the estimated average cost per hour for each pool of equipment based on the estimated and known costs divided by the estimated annual hours the equipment will be used.
It's wise to review labor burden calculations roughly every six months-regular assessments will open eyes to costs that might otherwise be forgotten; as an example labor burden calculations should always be adjusted when a company's insurance rates change. And don't forget to add in anticipated employee raises for the upcoming year in advance of bidding on projects that will be completed over the next twelve months when that raise is in effect.
In order to maintain a proper accounting of all labor burden rate components, construction companies should meet the imperative of maintaining separate accounts for all direct and indirect contract costs. A company's software package can calculate and affix indirect contract costs to the total job cost as each labor dollar is applied. Seeing the burden delineated on job management reports can help to accurately bill a job, gauge future estimates and keep management informed of a job's true costs. Only then can a genuine measurement of the operation's burden rate be taken, leaving no aspect underestimated or much worse, overlooked.
Construction Business Owner, June 2010