How To Calculate Overhead Costs in Construction Projects: A Complete Guide

Construction costs consist of both direct costs, like labor, and indirect costs, such as labor burden and insurance. Companies must pay close attention to these indirect overhead costs.

Overhead expenses include things like office rent, insurance, advertising, accounting, and legal fees. While they may not be tied to a specific project, they still impact profitability—if you aren’t tracking them, your profits may be lower than expected.

In the following sections, we’ll explore how to calculate overhead costs in construction projects.

What Are Overhead Costs in Construction?

Overhead costs in construction refer to any indirect costs of doing labor. Common overhead costs include:

• Administrative expenses. Office rent, utilities, insurance, salaries, and professional fees.
• Advertising expenses. Billboards, online ads, flyers, mailers, and business cards.
• Bonding and insurance expenses. Bonding premiums, general permits, and insurance premiums.
• Equipment expenses. Leased equipment, owned equipment, and maintenance and repairs.
• Vehicle expenses. Leased vehicles, owned vehicles, fuel, maintenance, and repairs.
• Labor burden. Payroll taxes, workers’ compensation insurance, and other labor-related costs.

Why Do You Need To Calculate Overhead Costs?

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. 

You may be 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.

How To Calculate Overhead Costs in Construction Projects.

Calculating overhead costs in construction projects can be approached in various ways. A common method is to apply a percentage to the direct costs incurred. To do this, estimate the total project cost and apply a set percentage. For example, if a project’s estimated cost is $100,000 and the overhead rate is 10%, the overhead cost would be $10,000.

Larger companies often calculate overhead costs more precisely. They break down administrative, advertising, and labor burden costs on a per-project basis. These companies may use advanced tools like simulation, forecasting, and modeling software to get accurate estimates. However, for a small business, this level of detail may not be necessary.

Directly Associating Indirect Costs with Direct Costs.

A precise way to calculate overhead is by linking indirect costs directly to direct costs. Take labor burden as an example—this includes not only the direct cost of labor but also any associated overhead per hour worked. A labor burden calculator can help determine this accurately. Similarly, equipment has a direct purchase cost and maintenance costs, both of which should be accounted for.

However, additional overhead costs, such as rent, leases, and insurance, will need to be calculated separately, typically using a general overhead rate.

Step-by-Step Guide to Calculating Overhead Costs Using an Overhead Rate.

Let’s go through an example. Suppose your business generates $350,000 in revenue annually with $200,000 in expenses. Here’s how you can calculate your overhead costs effectively.

1. Identify All the Indirect Costs Associated With Your Business.

This includes administrative expenses, bonding and insurance, equipment costs, vehicle expenses, and labor burden—all costs not directly tied to a specific project.

Example: Suppose your business incurs $40,000 in administrative expenses annually.

2. Calculate Your Total Project Costs by Adding All the Direct Costs Incurred.

Your company should have a complete list of the direct costs of a project and billed out per project. It’s important that all materials and work hours are properly allocated to projects in your accounting software, otherwise, you may not know how much a project costs.

Example: Your business has $160,000 in direct project expenses—labor, materials, mileage—every year. This brings your total expenses up to $200,000 a year.

3. Determine Your Overhead Rate by Dividing Your Overhead Costs by Your Direct Expenses.

We will now determine a general overhead rate for the business by dividing overhead costs by expenses. Note that this doesn’t take into account the fact that some projects may incur less overhead than others—it’s a general estimate.

Example: $40,000 / $160,000 = 25%. Your overhead rate is 25%.

4. Use Your Overhead Rate To Calculate Overhead in Upcoming Projects.

Once you’ve calculated your general overhead rate, you’ll be able to determine how much a project will cost you with greater accuracy—not just directly but indirectly.

Example: Your overhead rate is 25%. So, for a project of $10,000, you could safely estimate that you would have another $2,500 in overhead costs.

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.

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How To Make Your Overhead Estimates More Accurate.

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.

1. Make a List of All Possible Indirect Costs.

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.

2. Estimate the Indirect Costs for Each Category Separately.

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.

3. Use a Variable Overhead Rate for Different Categories of Projects.

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.

Many complex software solutions 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.

How To Reduce Your Overhead Costs.

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.

1. Streamline Your Administrative Processes.

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.

2. Look To Optimize Your Most Significant Costs.

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.

3. Review Your Recurring Expenses.

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.

4. Reduce Your Inventory Levels.

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.

5. Track All Reimbursable Expenses.

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.

Maximizing Efficiency in Managing Overhead Costs.

Managing overhead costs effectively is crucial for ensuring profitability in construction projects. One way to streamline your process is by leveraging construction management tools, which can provide better tracking of indirect expenses and enhance your overall project management. Additionally, incorporating job management solutions allows for improved task allocation and cost monitoring across projects.

Another way to reduce overhead is to automate payroll, helping minimize time spent on administrative tasks and ensuring accurate payments. In addition, utilizing time-tracking devices can help monitor labor costs and enhance workforce productivity. To gain further insights into labor expenses, measuring employee productivity through GPS tracking tools can also provide data on how resources are being utilized on-site.

It’s important to track indirect costs like equipment usage and vehicle costs accurately. Using work order tracking software can help manage inventory and schedule repairs effectively, avoiding hidden costs affecting your bottom line. Lastly, ensuring that time and expenses are recorded correctly can help avoid time-tracking errors, which might otherwise lead to inaccurate budgeting and unexpected costs.

Common Mistakes When Calculating Overhead Costs in Construction.

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:

• Failing to account for all indirect costs. Make sure you include all administrative, bonding, insurance, equipment, vehicle, and labor burden expenses.
• Using an inaccurate overhead rate. Overhead rates can vary significantly from one project to the next. For instance, labor burden isn’t split equally throughout all projects—it’s relative to the number of work hours spent on the project.
• Forgetting to charge customers for reimbursable costs. Some direct costs may not be easily tracked, such as travel and mileage. But these must be tracked and reimbursed or they will be lost profit.

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.

Control Your Overhead Costs in Real-Time With Workyard.

Workyard helps you estimate, track, and reduce your overhead costs. A GPS-powered time clock app and labor management system, Workyard will:

• Accurately track project work hours. Once an employee logs into Workyard, Workyard tracks their location using GPS technology tethered to their device. Automatically allocate employee hours to projects with next-generation geofencing technology. 
• Report and record gas mileage and travel time. Between sites, Workyard will track employee mileage and travel time. Use Workyard reports to get reimbursed for gas mileage and travel time—and to analyze the productivity and efficiency of employees.
• Reduce the time and costs associated with managing payroll. Workyard integrates directly into leading payroll solutions such as QuickBooks, reducing the amount of time you need to spend managing your payroll. Eliminate inaccuracies and inefficiencies with automatic payroll integration.
• Report work hours and job costs in real time. Always know how much time has been spent on a project. Real-time work reporting gives you a bird’s eye view of how your project is progressing—and gives you the information you need to adjust your estimates.
• Optimize scheduling and labor deployment. With a complete view of where your team is in real time, you can enhance your labor deployment strategies. Consolidate your scheduling processes and manage your team on the fly.

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.