Overhead Cost Calculation in Construction: Step-by-Step Guide

Understanding overhead cost calculation is essential for contractors aiming to manage costs and maximize profits. Direct costs, like materials and labor, are easy to keep track of. But overhead costs, which are important to the success of the project but not directly related to labor, are often forgotten. This guide breaks the process down into steps that you can follow to get accurate cost management.

What Are Overhead Costs?

Construction overhead costs in construction include all indirect expenses incurred during a project. These are essential for running your business but don’t directly contribute to building a structure. Examples include:

• Office rent and utilities

• Insurance premiums

• Equipment depreciation

• Salaries of administrative staff

Properly calculating these costs ensures accurate project pricing and maintains healthy construction profit margins.

Read more: Direct Vs. Indirect Costs In Construction Industry

Why Is Overhead Cost Calculation Important?

Accurate overhead cost calculation has several benefits:

• Competitive Bidding: Helps you avoid underpricing while staying competitive.

• Profit Maximization: Ensures projects are priced to cover all overhead expenses and achieve profits.

• Improved Budgeting: Prevents cash flow shortages by allocating overhead correctly.

Read more: How to Allocate Overhead Costs in Construction: A Beginner's Guide

Step-by-Step Guide to Calculating Overhead Costs

Accurate overhead cost calculation requires careful identification, allocation, and application of indirect expenses to ensure profitability in construction projects.  Let's look into each step in more detail.

Step 1: Identify All Overhead Costs

Begin by listing every indirect expense that your business incurs. These costs are not tied directly to a specific project but are essential for running your operations. To streamline this process, group your expenses into the following categories:

• Administrative Costs: Include salaries of office staff, payroll taxes, office supplies, and software subscriptions.

• Facility Costs: Cover rent, utilities (electricity, water, and internet), and property taxes.

• Equipment Costs: Account for depreciation, maintenance, and insurance for tools and machinery.

• Other Overhead Costs: Include marketing expenses, legal fees, and licensing.

Example Overhead Costs Table

Category	Expense	Monthly Cost
Administrative	Office staff salaries	$5,000
Facility	Office rent	$2,500
Equipment	Depreciation	$1,200
Other	Marketing expenses	$800

Once listed, calculate the total overhead cost for a given time frame (e.g., monthly or annually).

Step 2: Choose Overhead Allocation Methods

To allocate overhead costs to projects, select a method that best reflects your business operations. The two most common methods to calculate overhead percentage are:

1. Percentage of Direct Costs

Divide the total overhead by the direct costs (e.g., labor and materials) and multiply by 100 to find the percentage. Suitable when most projects share similar resource requirements.

Formula:

Example:If your monthly overhead is $10,000 and your total direct costs for a project are $50,000:

2. Labor Hour Allocation

Allocate overhead based on the total hours worked on a project. This method is effective when projects vary significantly in size or complexity.

Formula:

Example: If your total overhead is $10,000 and 500 labor hours were worked, your cost estimation overhead rate is:

You can then allocate this rate to each project based on the labor hours worked.

Step 3: Incorporate Overhead Costs into Bids

After determining your overhead allocation, integrate it into project bids. This makes sure that your prices cover all of your extra costs and that you can make a profit. 

Steps to Include Overhead in Bids:

1. Add the calculated overhead cost to the total direct costs for each project.

2. Adjust for desired profit margins.

Example:

• Direct Costs: $50,000

• Overhead Costs (20%): $10,000

• Desired Profit (10%): $6,000

• Final Bid: $50,000 + $10,000 + $6,000 = $66,000

Step 4: Regularly Review and Adjust Overhead Calculations

Overhead costs are not static. Regularly review your construction cost accounting records to ensure your calculations remain accurate. If you make changes to your business, like hiring new people or buying upgraded equipment , these costs may change.

Tips for Effective Reviews:

• Quarterly Assessments: Check for fluctuations in costs every three months.

• Monitor Trends: Identify seasonal changes or industry-wide cost shifts.

• Update Allocation Rates: Adjust your overhead percentage or hourly rate to reflect current expenses.

Practical Tips for Managing Overhead Costs

• Automate Expense Tracking: Use accounting software to monitor overhead in real time.

• Separate Fixed and Variable Overhead Costs: Understanding this distinction helps manage cash flow better.

• Invest in Professional Bookkeeping Services: A dedicated service ensures your records are accurate and up-to-date.

Final Thoughts

For contractors, knowing how to handle and understand overhead costs changes everything. You can stay competitive, make more money, and build a more stable business if you follow this plan and use professional construction bookkeeping services.

At Construction Cost Accounting (CCA), we understand the unique challenges construction businesses face in managing overhead costs and maintaining financial clarity. Our customized bookkeeping services are made to meet the needs of contractors, making sure they can accurately control costs, compliance, and profitability.

Partnering with CCA not only helps you manage your overhead costs but also provides the tools and insights you need to grow your business. With our team by your side, you can confidently bid on projects, improve profit margins, and plan for the future. To set up a free consultation, contact CCA today. Please let us help you with your accounts so that you can focus on your clients.