How to Calculate Overhead for Construction Companies
If you’ve been involved in the everyday operations of a business, it’s highly likely that you understand the importance of managing your expenses.
Costs associated with production, staffing, supplies, and other essential elements can impact your bottom line. This is especially true when you start your own construction business and have a long list of overhead costs to manage each month.
Do you worry about having visibility into where your business is spending its money, or about whether you’re set up to handle basic business requirements? If so, learning how to calculate overhead could be one of the best decisions you make as a proprietor.
The good news is that you don’t need to feel intimidated when it comes to calculating overhead costs and making adjustments as needed.
Whether or not you consider yourself an accounting expert, there are many ways to reclaim or establish control of your business finances. In this guide, we’ll explain everything you need to know about calculating overhead in your construction business.
Here’s What We’ll Cover:
Introduction to Overhead for Construction Businesses
Construction business owners might find themselves in a tough spot when it comes to calculating overhead. In a field like construction, it’s all too easy to lose track of the exact amounts a business spends on specific job costs, equipment repairs, budgets, bids, indirect costs, and other miscellaneous needs.
Project and site managers might not even have access to specific numbers until after a contract or project has closed.
Unfortunately, the hard truth is that if you continually guess at your job costs, business expenses and overhead, you’ll always be left with less revenue at the end of the day.
Although some numbers can shift and change based on a project’s results or duration, a commitment to good accounting principles at the core of your business should remain stable.
In terms of overhead in your construction business, this means that you should strive to:
- Learn the skills and tools needed to calculate totals correctly
- Accurately track business expenses for better long-term financial results
- Make changes and adapt when and if you discover problems with overspending
- Utilize outside or professional help when your business expenses are in limbo
Types of Construction Costs and Expenses
Within construction companies, there are many expenses that don’t fall into an official overhead category. This is because the term overhead traditionally refers to indirect costs that go towards keeping the business in operation, without directly contributing to specific jobs or projects.
While these costs might take some time to identify, overhead is an especially important principle for industries like construction that have greater needs for raw materials and hired labor.
To help make this easier to understand, here are a few key categories you should consider when learning how to calculate overhead in your construction business:
- Overhead expenses: This category includes costs that impact the entire construction company from an administrative and legal standpoint. You should include things like rental space, employee benefits, insurance costs, marketing, legal fees, and recurring tax or property payments.
- Direct and indirect costs: In construction, the cost of materials per project varies greatly. It also includes an indirect costs category for things that are extremely difficult to track per job site, like nails, wood scraps, and small building materials. These supplies aren’t the same as general overhead costs associated with running the business.
- Labor costs: Labor and employee costs will vary based on the type of workers you hire. Some employees are year-round, while others may be contracted for specific jobs. Remember to make these distinctions as you factor up overhead for each job.
1. Create a Comprehensive List of Overhead Costs
When you first start calculating your overhead costs, the best way to do so is to develop an organization system that flows into your general accounting procedures or software. This way, it’s harder to miss payments and receipts that could make a huge difference in factoring your costs.
Overhead costs in construction can include:
- Rent for office space and other facilities
- Benefits and salaries of full-time employees
- Insurance coverage for both people and equipment
- General liability coverage
- Transportation costs
- Labor hours
- Utilities like electricity, gas, and water
- Government fees and licenses
- Taxes on property, land, or other assets
- Depreciation costs
- Other job costs
Depending on the specific type of construction your company handles, you may also have a separate category of manufacturing overhead costs. If you don’t produce any goods directly, this category may not apply.
2. Add up Total Expenses
The next step is relatively simple. Once you have a complete and categorical list, it’s time to add everything up. The best way to do this is to choose a set period of time (for instance, one month’s worth of overhead) and get your grand total.
The reason for choosing one standard period of time is consistency. You will not have a good idea of your true overhead rate if you don’t estimate when things are due and how often you pay them in order to keep the business running smoothly.
3. Calculate Your Overhead Rate
The next step in the process is determining your overhead percentage rate. The math here is also relatively straightforward since you’ll be dividing the total you found in the second step by your monthly sales total.
The equation looks like this:
Total overhead costs / Total monthly sales = Rate for construction business
To get a percentage instead of a decimal after you first divide, multiply the result by 100. This will give you a percentage number that you can easily work with for a greater understanding of your business operations.
For example, if you have a 25% overhead rate, this means that your company invests 25 cents in overhead for every dollar that you make.
The appropriate overhead rate is industry-specific, so you should take some time to research what the standard is for businesses in your region. A good rule of thumb is 10% overhead with 10% profit.
4. Choose the Right Method for Allocating Overhead
If you want to get even more granular with calculating overhead in your business, you can begin to allocate certain categories of your overhead expenses.
In accounting, overhead allocation simply refers to the practice of distributing indirect costs to the services you offer that generate revenue to ensure that you budget job costs accurately.
This practice generally provides more visibility than simply lumping all types of overhead together.
Overhead allocation depends on whether your construction company is focused on manufacturing, general contracting, land development, or other specialties. Typically, the more that your business grows and spends, the greater your need will be for overhead allocation.
Depending on how you manage your accounting, you may receive different suggestions for allocation. Below are two of the most common ways to allocate overhead costs in this industry.
Rate of Direct Costs
This approach is appreciated for its simplicity because you will look at the costs of one job as a whole. Then, you’ll use a fairly standard percentage for determining how much overhead is needed to cover the job costs. This is a direct relationship that relies on historical data and experience to guide future overhead decisions.
Proportion of Direct Job Costs
On the other hand, when you allocate overhead using a proportion of direct costs, you’re looking for accurate and exact numbers. If you have several jobs or contracts going on at one time, this method divides the overhead amount evenly based on percentage.
Using the proportional approach is often preferred by accounting professionals, as it allows for more accurate tracking of every dollar spent on overhead.
5. Double-check All Expenses and Costs
When you’re managing overhead, it’s important to keep a pulse on how much money is flowing in and out. Failing to carefully monitor these costs can place unnecessary strain on your business resources. Additionally, since overhead costs don’t usually generate income directly, they can hinder your growth and ability to invest in new projects.
Another important question to answer is: Who holds power when it comes to overhead cost decisions? Do multiple people within your organization have the ability to pay recurring bills or decide which fees are important? While it can be helpful to have administrative support, giving access to too many staff members can encourage your overhead to spiral out of control.
As a manager or owner, it’s your responsibility to double-check the numbers carefully. This helps you reduce excess spending and avoid critical mistakes.
6. Make Adjustments to Your Yearly Budget
Have you done all of the math and realized that your overhead costs are just too high? Remember, it’s never too late to make changes.
You can improve your financial situation by:
- Trimming excess overhead costs
- Taking a closer look at your profit margins
- Raising prices on goods and services as needed
- Developing more in-depth accounting procedures
You may need to combine multiple solutions to adjust your yearly budget in a way that’s not only practical, but that also encourages a positive financial trend.
Options for Managing Construction Overhead
Now that you have a better understanding of how to calculate the overhead percentages of your business, it may be time to consider a different approach.
To get a better handle on overhead management, you can choose to take one of several approaches, or a combination of the following.
- The DIY approach: If bookkeeping and tracking is your strong suit, consider a do-it-yourself method for tracking overhead. This provides the greatest transparency, as you’ll need to be extremely hands-on in monitoring recurring overhead. Unfortunately, it might also be the most taxing on your own personal time commitments.
- The tech-based solution: When you choose a cloud-based accounting software like FreshBooks, you can eliminate much of the stress involved with manual tracking. Platforms like FreshBooks are uniquely designed for industries like construction, which require much of your management time to be spent elsewhere.
- An external finance professional: If you have the means to hire an outside consultant, accountant, or tax professional, it can make a huge difference in your business structure. Although this option comes with a bigger price tag, you may reap dividends by saving valuable time, money, and effort.
Mistakes to Avoid in Construction Overhead
Despite your best efforts, there are times when you’ll run the risk of making a mistake with your overhead. During these moments, keep an open mind, and be willing to seek financial help.
To help you avoid some of the common pitfalls that construction business owners encounter in this area, we’ve provided a list of common mistakes in construction accounting:
- You allocate overhead incorrectly: As mentioned previously, there are a few different categories to consider for construction overhead. Sometimes, construction businesses try to allocate overhead costs like rent, utilities, and insurance to a specific job only. This misrepresents how overhead percentages can affect the entire company, and in turn, it will result in erroneous reporting.
- You go through lulls in tracking: Once you’ve developed an expense tracking system, stick with it. No matter how busy your construction business gets, or how many new jobs you take on, you can’t afford to lose sight of vital financial data. If you find it hard to track overhead during certain times of the year, consider outsourcing this aspect of your bookkeeping for a set amount of time.
- You don’t get back on track financially: If your overhead calculations don’t reveal what you’d like them to about the longevity of your business, remember that that future is in your hands. Make adjustments and tweak your business model, but don’t give up. Succumbing to poor overhead management will have detrimental consequences on your company’s financial future.
The Bottom Line for Construction Businesses
When you want to see your business become successful, you must be willing to dive deep into the practices and habits that encourage business growth.
By learning the ins and outs of your own business overhead, you’ll not only be able to answer for every dollar that your business spends, but you’ll be better equipped to make long-term decisions that affect both you and your employees.
Always remember to come back to the basics. Start with listing your exact job costs, complete a few simple math steps to determine totals and percentages, double-check everything, and make adjustments as needed. The entire process can be as simple or as complex as you need it to be for your unique organization.
The ability to establish a thriving business is always available to you, no matter how long you’ve been in business. When you invest time in the right strategies and tools, you can chart a new path forward in your entrepreneurial journey.