I just spoke at a national convention of specialty contractors. I was shocked to see how many business owners or estimators didn’t know how to charge for their services. I estimate that more than 75% of installation contractors don’t know what markup to use to generate the desired net profit while also covering all of their annual overhead costs.
Business owners who know how to run and manage their companies like professionals suffer from contractors who undercharge for the work they perform. Every year, these contractors who use estimates undercharge and lose a lot of money. When contractors bid jobs to get them at a low price in order to get work and keep their crews busy, I call that stupid low bidding. They don’t regularly estimate or know what their true labor costs are. To determine their bids, they employ a standard industry square foot, lineal foot, or other ballpark pricing technique.
The majority of contractors also do not understand the distinction between markup and margin. For example, how much more should they bid in order to break even or turn a profit at the end of the year. If you follow these guidelines when pricing your next jobs, you will understand the distinction between mark-up and margin, which will enable you to earn more money than you do now.
Overhead is the annual fixed indirect cost of operating your business. Every expense required to keep your doors open throughout the entire year, whether or not there is construction going on, is included in overhead. It covers the costs of your office or warehouse, phones, utilities, postage, office supplies, computers, office equipment, and staff. It also covers administrative costs such as bookkeeping, sales, marketing, and advertising, as well as legal, banking, company insurance, and costs associated with completed jobs. Don’t forget to factor in the owner’s or president’s vehicle expenses in addition to their regular salary when calculating overhead.
Please take note of the following items that are NOT covered by your annual overhead expense: field labor, field labor workers compensation insurance, field labor benefits, field trucks, field equipment, gas and maintenance for field vehicles, job insurance, job supervision, and project management. Since they are not necessary unless you have jobs to build, these field costs should be included in your overall job costs.
The non-job billable portions of your project management, field supervision, field labor, and field vehicles that you pay for while they are not on a job need to be included in your overhead. You must include that portion of a superintendent’s salary in your overhead expenses, for instance, if you must continue paying him during the winter. Additionally, you must factor in the downtime days in your overhead costs if you can’t bill out for your vehicles every day.
Establish Your Break-Even When all of your construction jobs for the year generate enough revenue to cover all of your direct job costs as well as your annual overhead costs, you break even, even if no profit is made. You must include your overhead costs and a profit margin in your bids in order to break even. Your overhead margin is easy to calculate. It is calculated by dividing your annual overhead costs by the projected sales for the year.
You must estimate the annual sales you can expect to generate for the entire year in order to determine the break-even overhead margin to use on your bids to break-even. You’ve estimated three levels of annual sales in Example #3 below: $1,000,000, $2,000,000, and $3,000,000. You will need a different Overhead Margin to add to your bids in order to break even for each sales level you estimate.
Get Your Business to Work! and The Business Success Blueprint For Contractors, written by successful entrepreneur George Hedley, are available at his online bookstore. He supports entrepreneurs in creating successful businesses as a well-known speaker and business coach. E-mail: gh@hardhatpresentations. or subscribe to his free monthly e-newsletter at to request your free copy of “Profit 101 For Contractors!” Call 800-851-8553 or go to www.if you want to hire George to speak, join his BIZCOACH program, or enroll in a “Profit-Builder Circle” boot camp. HardhatPresentations. com. Related.
Level 1 General Construction | Overhead and Profit Explained
What is profit in construction?
After deducting overhead and direct costs, a company’s total earnings are considered its profit in the construction industry. When businesses can calculate total profits from a project’s final cost and after construction projects are complete, they typically calculate profits. Profits are what a company keeps after deducting overhead and other costs, as opposed to overhead, which accounts for the cash flow that leaves a business. However, depending on the business’s operations, profit calculations may take into account additional deductions related to particular projects. Apply the equation profit = (project cost) – (overhead + direct costs) to determine total profits.
What is overhead in construction?
In the construction industry, overhead includes all expenses required for your company to remain operational. For instance, rent or mortgage payments, utility bills, insurance premiums, and credit obligations for office and warehouse space used for business operations and material storage may be considered monthly fixed costs.
Another element of overhead in construction is indirect cost. Indirect costs of a business are frequently comprised of both fixed and variable costs required to maintain operations. Office supplies and business vehicle expenses are a couple of instances of the variable costs a construction company must pay. Salaries for administrative staff, tax obligations, and employee benefits are examples of fixed indirect costs. Utilizing the equation overhead = fixed monthly expenses + indirect costs, you can determine your construction overhead.
How to calculate overhead and profit in construction
The steps below will help you determine overhead and profit in the construction industry using the formulas overhead = (fixed monthly expenses) + (indirect costs) and profit = (project cost) – (overhead + direct costs):
1. Total all monthly fixed expenses
Add up all of the monthly fixed expenses your business incurs to get an idea of your overhead. Assume, for instance, that a construction company pays $2,500 in loan obligations each month, $12,000 in property expenses each month, $650 in company vehicle insurance each month, and $6,000 in tax obligations each month. The business determines a monthly accounting cycle cost of $21,150 by adding these fixed monthly costs.
2. Add up indirect costs
If your company has either variable costs or fixed costs, you must account for both in order to calculate overhead accurately. Assuming the construction company determines its fixed indirect costs using the prior example If the business pays administrative salaries of $24,000 per month, employee benefit coverage of $4,000, and vendor contracts of $5,000, its total fixed indirect costs come to $33,000.
The business then adds these amounts to its fixed indirect costs by combining all variable indirect costs, such as any maintenance on equipment or additional office supplies. Let’s say the example company increases its fixed indirect costs by $300 in additional office supplies and $800 in vehicle maintenance. According to this calculation, the company’s total indirect expenses are $34,100.
3. Combine monthly fixed expenses and indirect costs
You can combine these figures after figuring out all of your company’s monthly fixed and indirect costs. The outcome gives you the total overhead and can give you important information about your company’s spending habits. Assume that the same business wants to calculate its total monthly overhead for the previous accounting cycle using the examples from above. The business adds its fixed expenses of $21,150 and its indirect costs of $34,100 using the formula overhead = (fixed monthly expenses + indirect costs):
Overhead is equal to fixed monthly costs plus indirect costs, or $21,150 plus $34,100.
Overhead = $55,250
4. Determine total direct costs
You must determine the direct costs your organization contributes to a project in order to determine the total profits from that project. Direct costs in construction can include both variable and fixed costs, similar to overhead and indirect costs. For instance, a construction company may establish its material and supply costs as fixed amounts when completing similar projects, giving the business information on how much funding it needs to allocate to projects with comparable specifications.
Moreover, variable costs include costs that may be particular to each project your business completes, giving you a fluctuating amount from month to month. Assume the hypothetical business from the previous steps determines its fixed direct costs to be $10,000 per month for stocking basic construction materials and its variable costs to be $4,500 to complete a special project. In this instance, the businesses’ total direct expenses come to $14,500.
5. Subtract overhead and direct costs from project cost
You can calculate the potential profit your company can make per project once you know your overhead and total direct costs. Subtract your overhead and direct costs from the price your company bills for each project it completes using the formula profit = (project cost) – (overhead + direct costs). Use the numbers from the previous example business, assuming its overhead is $55,250, its monthly direct costs are $14,500, and its project cost is $150,000, to apply the formula:
Profit is calculated as follows: ($150,000) – ($55,000 + $14,500) = ($150,000) – ($69,500) = (project cost) – ($overhead + direct costs).
Profit = $80,500
Example
For more information on how to determine overhead and profit in the construction industry, consider the example below:
Let’s say True Green Eco Builds bills $250 000 for each project it completes in the commercial sector. Senior executives are looking for the best cost-cutting and profit-boosting tactics. Accounting departments can estimate expected profits per project construction teams complete by calculating overhead. Accountants use the following values to determine overhead:
The company’s accountants predict that after classifying and combining these values, overhead will total $89,000 for the month. The accountants at True Green Ecos use this value to calculate the total direct costs that the company will pay for each project. The accountants use $18,000 in direct costs for each project and the following profit calculation:
Profit equals the project cost less the overhead and direct costs, or $250,000 minus $89,000 plus $18,000, or $250,000 minus $107,000.
Profit = $143,000
Now that the business is aware of how much profit it can anticipate making once a project is finished, accountants and financial advisors can work together to develop cost-reduction plans and put into practice strategies to boost revenue.
FAQ
What is the formula to calculate overhead?
According to the data, the typical profit and overhead for construction projects in 2019 were 9% and 11%, respectively. These percentages are extremely close to the “10 and 10” rule, which the majority of construction companies set as their goal.
How do you calculate profit percentage in construction?
The amount your company spends on producing a product or offering services to customers is known as the overhead rate or the overhead percentage. Divide the indirect costs by the direct costs, then multiply the result by 100 to determine the overhead rate.
Is profit calculated after overhead?
Add up your monthly revenue and expenses for a typical month. then multiply the result of your overhead divided by your profit by 100. Let’s say, for illustration, that your profit was $40,000 and your overhead was $15,000. That means that you spend 37. You spend 5% of your revenue on overhead and operating costs.
How do you calculate project overhead cost?
How to calculate your construction profit Your profit is the money that remains after all project costs and overhead have been met.
How much is profit and overhead?
You might want to examine overhead as a proportion of project sales for a more useful analysis of your project’s overhead costs. Divide your project’s monthly sales or revenue by the total monthly overhead costs of your company to determine the overhead rate. Multiply this number by 100 to get your overhead rate.
