Overhead Cost Calculation in Construction: Step-by-Step Guide
- Cost Construction Accounting
- Dec 12, 2024
- 4 min read
Updated: Sep 25
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 comprehensive guide will help you calculate overhead costs accurately and allocate them properly to your projects for better financial control.
Table of content:
What Are Overhead Costs?
Overhead costs in construction encompass all the indirect expenses incurred during business operations that are not directly tied to providing services or manufacturing costs. These indirect costs include:
Administrative salaries and office equipment expenses
Utility costs such as electricity, water, and internet
Insurance premiums and legal costs
Equipment depreciation and maintenance
Accurately calculating total overhead costs ensures your bids cover all operating expenses and maintain healthy profit margins.
Why Is Overhead Cost Calculation Important?
Accurate overhead cost calculation has several benefits:
Competitive Bidding: Avoid underpricing by incorporating all indirect costs.
Profit Maximization: Ensure your pricing covers fixed costs and variable costs appropriately.
Improved Budgeting: Allocate resources effectively and prevent cash flow issues.
Step-by-Step Guide to Calculating Overhead Costs
Calculating overhead costs involves identifying, categorizing, and allocating all indirect expenses to projects. Follow these steps to calculate overhead cost accurately:
Step 1: Identify All Overhead Costs
List all overhead expenses your business incurs, which are not directly tied to production or labor. Group these into categories such as:
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
Select an allocation base that best fits your business model to distribute overhead costs to projects. Common methods include:
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.Â
Steps to Include Overhead in Bids:
Add the calculated overhead cost to the total direct costs for each project.
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 construction businesses, understanding how to calculate overhead cost and allocate indirect expenses appropriately is vital for profitability and sustainable growth. By following this guide and leveraging professional accounting tools, contractors can better manage their business finances, price projects accurately, and reduce overhead costs effectively.
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.
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.
