What Should Your Overhead Mark-Up Include?
To make more money, should your job costs be as high as possible and your overhead be as low as possible?
Many contractors don’t know their exact job costs, equipment costs, overhead budget and how much profit they should make. Without an understanding of your numbers, working hard in a financial vacuum keeps you busy and broke instead of productive and profitable.
In order to bid projects successfully, you first need to know what it takes to cover your annual overhead. When I ask contractors what their yearly overhead is, they often answer 10% or 15%. Overhead is not a percentage of costs or sales. You don’t pay your staff as a percentage of the jobs you bring in, do you? Therefore, your overhead is a fixed amount of money covering every expense it takes for your company to stay open and do business during the year without any jobs under construction.
Job charge or overhead expense?
A common problem occurs when companies don’t properly job charge field costs to their respective jobs. When you don’t setup separate job accounts for every job, you can’t go back to see if you are bidding the right unit prices for your work or know if you made money on each job. Also when all your equipment is paid for out of your overhead budget, you don’t know if owning equipment makes you any money either. And even worse, when field employees are not charged to individual jobs, you never know what it really takes to build a project or if you’re making a profit.
When you bid work, your field labor rates include employee burden costs, taxes and insurance. For example, a worker who earns $20 per hour with a 50% burden expense is bid out at $30 per hour. When all burden costs are paid as part of your overhead costs, your job cost accounting doesn’t give you a clear picture of how well your job did upon completion. The same is true with your field equipment. Even though you may bid out equipment at fair market rates, company owners often don’t know what their equipment really costs to own. And to make matters worse, some contractors don’t charge jobs for the use of their equipment which makes it impossible to know if you are really making or losing money on projects.
Track your job costs!
To make more money, you must track and keep updated accurate job costs. At the completion of each project, you must be able to review results to see if your bid was accurate and made any money. Therefore, job costs must include every expense it takes to build projects including project management, supervision, labor burden, equipment, and insurance. Without jobs under construction, you won’t spend money on these items and therefore these must be a part of your job costs. When you job charge every field expense to jobs and remove them from your overhead costs, your overhead will be accurate and as low as possible. This will also make your job costs, field labor rates, and equipment rates higher and more accurate. This strategy will pay off when performing extra work at higher rates and sign contracts that limit mark-up allowed for additional items, change orders, and cost-plus work. Also as a general contractor, contract awards are often made based on fee and general conditions costs. A lower mark-up is easier to sell than lower field rates.
Overhead must include your annual costs for management and administrative expenses; salaries and burden/fringes for the president (not profit distribution), management team, office staff, sales, estimating, and accounting; office and shop expenses, office supplies, computers, internet, and office phones; vehicles for officers and management personnel; marketing, sales and advertising; personal development, associations, and training; interest and banking; professional services, legal, CPA, and business coaching; service, closed job and warranty work; contributions, miscellaneous, taxes and depreciation.
Overhead also must include business insurance to keep your company operating (but not liability insurance to build or run jobs); administrative employee labor burden and taxes, worker compensation insurance, health insurance, and fringes for management and office staff only who do not work on jobs under construction; field employee labor and their burden costs who are not working on the jobs under construction during slow times or downtime; and field vehicles and field equipment expenses, gas, and maintenance when they are not working on the jobs during downtime or slow times.
Overhead must NOT include items that are used to build projects in the field and should be included in your bid estimate and charged to job costs including: project manager, superintendent, foremen, field crews and all of the field labor burden expenses and insurance costs; all field vehicles, field equipment expenses and small tools used in the construction of projects; and liability insurance premiums based on job expenses and costs. To keep your overhead mark-up low, do not include any of these costs in your overhead costs or budget.
General conditions costs include field expenses required to manage, supervise, coordinate and run your projects. These costs should not be included in your overhead or mark-up rate. When you bid on projects, setup a standard template for general conditions (or mobilization). As outlined above, include field costs in your general conditions project budget for every administrative cost including: project management, supervision, vehicles for project manager and superintendent, onsite temporary facilities and utilities, temporary protection, clean-up, mobilization, testing, permits, meters, engineering, liability insurance, and performance bond.
Setup your finances the same way as you bid, estimate, and build projects and your accounting will start to make sense to you. When you co-mingle your costs, it’s impossible to know when or if you’re making money. Keep it simple. Your job costs and annual overhead budget must match how you do business in order for you to understand your costs. To receive a sample construction company annual overhead budget/income statement and general conditions template, email [email protected].