In This Article
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.
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.
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.
What Is Included in Overhead Costs in Construction?
Overhead costs 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.
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.
How To Calculate Overhead Costs in Construction Projects
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.
Directly Associating Indirect Costs with Direct Costs
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. 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.
Step-by-Step Guide to Calculating Overhead Costs With 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.
First, Identify All the Indirect Costs Associated With Your BusinessThis includes administrative expenses, bonding and insurance expenses, equipment expenses, vehicle expenses, and labor burden—all costs that weren’t associated with a project.
Example: Your business has $40,000 in administrative expenses every year.
Next, Calculate Your Total Project Costs by Adding Up All the Direct Costs IncurredYour 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 really 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.
Determine What Your Overhead Rate Is for Your Business by Dividing Your Overhead Costs by Your Direct ExpensesWe 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%.
Use Your Overhead Rate To Calculate Overhead in Upcoming ProjectsOnce you’ve calculated your general overhead rate, you’ll be able to determine how much a project will cost you with greater levels of 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.
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.
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.
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.
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.
Construction Overhead FAQs
What Is the Average Overhead for Construction?
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.
What Are the Typical Overhead Costs in Construction Projects?
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.