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Construction costs can include both those that are directly attributable (such as labor) and indirect costs (such as labor burden or insurance). Companies must be particularly careful with their indirectly attributable overhead costs.
Overhead costs can include items such as office rent, insurance, advertising, accounting, and legal fees. While these costs may not be directly associated with a project, they’re still important—if you aren’t tracking your overhead, you’re not making the profit you think you are.
Below, we’ll take a deeper look into how to calculate overhead costs in construction projects.
As a construction project manager, you need to have a clear understanding of all the costs associated with a project to stay on budget. Overhead costs are often overlooked or underestimated, which can lead to cost overruns and schedule delays.
It’s possible you’re even losing money on a project—you just don’t know because you haven’t calculated your overhead. If you’re operating on particularly lean margins, this is more likely.
Overhead costs refer to any indirect costs of doing labor. Common overhead costs include:
The costs that are not included in overhead are directly attributable costs: direct labor, direct material, and direct expenses.
To calculate your overhead costs, you’ll need to first identify all the indirect costs associated with each project. Just as there are work codes, there are specific accounting codes that help you allocate overhead expenses.
Your accounting software should do the bulk of the heavy lifting—but you still need to consider these overhead costs when estimating your project profits.
There are a number of ways to calculate overhead costs in construction projects. The most common method is to use a percentage of the direct costs incurred. This can be done by estimating the total project cost and then applying a certain percentage to that amount. If the estimated cost of the project is $100,000, an overhead rate of 10% would result in an overhead cost of $10,000.
Large enterprises will calculate overhead costs on a more granular level. They will estimate exactly how much administrative overhead, advertising overhead, and labor burden they have on a per-project basis. They may use expensive simulation, forecasting, and modeling utilities to accurately estimate what each project will cost. But this is overkill for a small business.
An accurate method of calculating your overhead is to marry your indirect costs with your direct costs. An example of this would be labor burden. Labor burden is the amount of overhead that your labor incurs; for every hour of labor, you have direct labor costs and labor burden. Use a burden rate calculator to make sure you calculate it accurately. Likewise, your equipment may have a direct cost (the equipment itself) and maintenance costs.
However, there will also always be additional overhead—such as rent, leases, and insurance—that will need to be calculated based on a general overhead rate.
Let’s take a look at an example for calculating overhead costs for a small business. Assume that your business generates $350,000 in revenue every year on top of $200,000 in expenses.
Usually, overhead isn’t included directly in billing; it’s used internally to make sure that your projects have the right profit margins.
For that $10,000 project, you can’t charge less than $12,500 because you’d be losing money otherwise. Furthermore, if you charge $20,000 on that project, your profit isn’t $10,000—it’s $7,500.
Overhead is difficult to estimate. It wouldn’t be wrong to say that many smaller contractors don’t even bother. That’s a mistake. It’s better to have a loose estimate of your overhead costs than to not estimate them at all.
If you follow the above strategy, you should get close—your overhead estimates should even out on a project-by-project basis. But if you find that each of your projects has a vastly different overhead amount, you need to increase the accuracy of your calculations.
Here are some tips for better forecasting your project overhead.
This includes anything that’s not a direct cost of the project, such as salaries, benefits, insurance, office space rent, and so on. Take a look at indirect costs that only apply to some projects, not others—such as bonding costs that may only be involved in more complex projects.
Consider estimating your indirect costs on a category basis, such as labor costs, administrative costs, and bonding costs. From there, you can apply overhead to each project based on what you think might be involved in each project.
A fence company might discover that installing vinyl fencing has an overhead rate of 12% whereas installing brick-and-mortar fencing has an overhead rate of 18%. By splitting up overhead estimates by project type, you can increase the accuracy of your estimates.
There are many complex software solutions that can do this kind of thing for you through project and budget forecasting. But you don’t need expensive tools, you just need the right numbers.
In our example above, the overhead rate is 25%. This is very high and is cutting into the company’s profit margins. A better rate would be 10 to 11%.
One important reason to track your overhead costs is to reduce them. Once you know how much your overhead is, you can start the work of paring it down.
Consider using automation where possible and look for ways to reduce the amount of time that your employees spend on administrative tasks. Automate your payroll processes, optimize your scheduling, and improve your labor management.
Office leases tend to be the largest expense for a business after labor costs and materials. Consider renegotiating leases, looking for new offices, or even using online infrastructure to limit the number of physical offices you need.
Recurring expenses, like insurance, can sneak up on you if they go unchecked. Insurance policies should be re-quoted rather than just being renewed every year. The same goes for any other recurring costs, such as utilities. Recurring expenses generally go up over time if not renegotiated.
Carrying too much inventory can be costly. Make sure that you only have enough on hand to meet customer demand. This is known as just-in-time supply chain management, and it reduces the chances you could get stuck with materials that aren’t needed for a job.
These materials cost you not only directly but also indirectly in terms of storage and loss.
Track reimbursable costs such as mileage using apps. By improving client reimbursements, you can avoid leaving money on the table after a project is complete.
In construction, you should be able to get your overhead into a 10 to 11% range. If you can’t, there may be some “leaks” in your expenses.
Are you accounting for all your overhead costs? Most companies aren’t. In reality, your overhead consists of everything that you don’t directly bill out. Every paperclip your administrative office uses is technically overhead—and if you aren’t accounting for everything, you could be losing money.
Of course, some mistakes are more costly than others. A paperclip isn’t going to shut down your office but forgetting your insurance costs might. Here are some of the most common mistakes when calculating overhead in construction:
As long as you’re on top of your indirect costs and are allocating them appropriately, you should have a firm handle on what each project is costing you.
Workyard helps you estimate, track, and reduce your overhead costs. A GPS-powered time clock app and labor management system, Workyard will:
Still wondering how to calculate overhead costs in construction projects? Workyard helps you control your project expenses by giving you the information you need to calculate and reduce your overhead. Are you ready to see what Workyard can do for you? Sign up for a free trial today.
The average overhead percentage for construction is between 10 to 11%. However, this number can vary greatly depending on the size and scope of the project. A small residential project may have an overhead percentage of 10%, while a large commercial project could have an overhead percentage of 15% or more.
The typical overhead costs in construction projects include administrative expenses, bonding premiums, insurance premiums, equipment expenses, vehicle expenses, and labor burden. Every company is different, which necessitates overhead calculations on a company-by-company basis.
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