Contractor's Guide: How to Calculate Overhead Cost in Construction Projects

For individuals in the construction industry, deciphering overhead expenses can be a complicated task, and calculating overhead accurately is a crucial part of this process. Excelling in this area requires understanding and estimating these additional costs, thereby preventing any unwanted cost escalations, as overhead is one of the significant costs that can impact profitability if not managed properly. Proper handling of overhead costs is essential in simplifying complex processes and enhancing your company’s profitability.

Table of Content:

• The Mystery of Overhead Costs

• Dissecting the Components of Overhead Costs

• Estimating Overhead Costs in Construction

• Efficient Management of Overhead Costs: Cost Saving in Construction

• Conclusion

The Mystery of Overhead Costs

Construction overhead costs, otherwise known as indirect costs, are often misunderstood by many in the construction field.

These are expenses that, while not connected to a specific project, are critical for the overall functioning of your construction enterprise. They encapsulate a variety of expenses, including office expenditures, insurance, legal fees, and staff wages unrelated to a particular job. Common overhead costs include office supplies, equipment costs, administrative salaries, bonding and insurance expenses, and insurance expenses. Equipment expenses and other labor related costs are also examples of indirect overhead costs that should be considered.

Despite their potential to significantly affect your profits, these costs often go unnoticed when the focus is solely on direct project costs.

Dissecting the Components of Overhead Costs

The initial step towards controlling overhead expenses is to comprehend their components. Generally, indirect costs are classified into two categories:

• Fixed Overhead Costs: These are consistent costs, such as rent, insurance, and salaried employee wages, which do not change with the number of projects. Understanding the difference between construction accounting and regular accounting can help further clarify these expenses.

• Variable Overhead Costs: These are costs that change according to the number of projects, such as utilities, materials, and hourly wages. Knowledge of construction cost categories can assist in better understanding variable costs.

By categorizing your expenses, you can identify where your finances are being allocated and potential areas of savings.

Read more: Top 5 Mistakes Contractors Make with Overhead Costs

Estimating Overhead Costs in Construction

Projects Knowing overhead costs is different from calculating them. Here is a simplified guide to estimate your overhead costs:

• Identify your overhead costs: Determine the expenses required to operate your business, which are not directly related to a project. Be sure to account for all the costs, including indirect overhead costs, equipment expenses, and other labor related costs.

• Total your overhead costs: Accumulate these costs over a specific period, say, a month or a year.

• Allocate costs accurately: Make sure to allocate costs for both direct costs incurred and direct expenses, as well as labor cost, labor expenses, and labor costs, to ensure precise project costing.

• Calculate your overhead rate: Divide your total overhead costs by the total revenue, total direct costs, or total labor hours to ascertain your overhead rate. Use overhead costs incurred and overhead rates in your calculation for accuracy.

The overhead rate depicts the proportion of overhead expenses to your revenue or labor input, providing insight into your company's performance. To delve deeper into these numbers, you might find mastering work-in-progress reporting useful.

Example of how to calculate overhead in a construction project:

Let's assume we have a construction company working on a project. To have overhead cost formula, we consider both fixed and variable expenses.

Fixed Overhead Costs:

1. Rent: $2,000 per month

2. Insurance: $500 per month

3. Salaries of administrative staff: $3,000 per month

Variable Overhead Costs:

1. Utilities (electricity, water, etc.): $1,500 per month

2. Materials: $2,500 per month

3. Equipment rental: $1,000 per month

To calculate the total overhead costs for the construction project, we add up the fixed and variable overhead costs:

Fixed Overhead Costs: $2,000 + $500 + $3,000 = $5,500 per month

Variable Overhead Costs: $1,500 + $2,500 + $1,000 = $5,000 per month

Total Overhead Costs: $5,500 + $5,000 = $10,500 per month

So, in this example, the total overhead cost for the construction project is $10,500 per month. By understanding and accurately calculating these costs, the company can effectively manage its finances and make informed decisions to control overhead expenses.

Efficient Management of Overhead Costs: Cost Saving in Construction

Once you've calculated your overhead costs, the next step is effective management of these expenses. You can accomplish this using the following strategies:

• Regular Overhead Analysis: Regular examination of overhead costs can help identify potential areas for cost reduction.

• Effective Budgeting: Employing sound budgeting strategies for your construction projects and your business can lead to significant savings. Best practices for construction accounting can provide insights into effective budgeting.

• Resource Optimization: Strive for the maximum utilization of resources to minimize waste and optimize costs.

Conclusion

Engaging an expert can be beneficial to ensure these steps are properly executed. This is where our service, CCA, comes into play. With CCA's bookkeeping services for construction companies, you can efficiently track your overhead costs. Our team of experts can provide in-depth financial insights, aiding you in navigating and managing overhead expenses, ultimately steering your business toward financial success.

Demystifying overhead costs in construction projects need not feel like navigating a maze. Armed with the right knowledge and tools, you can confidently manage your company’s finances and drive your construction business toward steady growth. Be sure to regularly understand your cash flow statement and understand how construction accounting is different to stay ahead of any potential finance-related issues. Regularly calculating overhead costs is essential to ensure ongoing financial stability.