Are You Spending Too Much? Understanding Construction Overhead Costs

If you own a construction business, you're probably familiar with the term "overhead cost". But what do general overhead costs mean in construction, and why are they crucial for your company’s profitability? This article will define overhead costs, explain how to calculate them, and emphasize their importance in maintaining the financial health of your construction business.

Table of Content:

What is Overhead Cost Meaning in Construction?

Why Contractors Need to Calculate Overhead Costs

Breaking Down Construction Overhead Costs: Direct vs. Indirect Overhead Expenses

Transitioning to Overhead Cost Calculation and How to Calculate the Overhead Percentage

In Conclusion

What is Overhead Cost Meaning in Construction?

In the construction industry, overhead costs refer to the ongoing business expenses not directly tied to a specific project or job. These indirect expenses support your overall business operations and include items such as office rent, utility bills, insurance costs, administrative fees, and office supplies. Even payroll taxes and salaries for staff not directly involved in projects fall under general overhead costs. Accurately tracking these overhead expenses is vital for maintaining healthy profit margins and ensuring your projects remain profitable.

Why Contractors Need to Calculate Overhead Costs

As a construction project manager, understanding both direct and indirect costs is crucial for effective project management and budgeting. Overhead costs often get overlooked or underestimated, which can lead to higher overhead costs, cost overruns, and schedule delays. Without properly calculating and allocating overhead costs, you risk losing money on projects without realizing it, especially if you operate on lean profit margins.

Calculating overhead costs helps you track business expenses accurately and allocate overhead costs to specific project costs on a project-by-project basis. This clarity allows you to identify which projects are profitable and which may be draining resources. Moreover, it provides insights that support business growth by enabling better financial planning and cost savings.

Construction Cost Accounting (CCA) offers bookkeeping services designed to help construction companies track their general overhead costs efficiently. This support allows you to focus on the construction process and project management while ensuring your business operations remain financially sound.

Read more: Top 5 Mistakes Contractors Make with Overhead Costs

Breaking Down Construction Overhead Costs: Direct vs. Indirect Overhead Expenses

General overhead costs in construction are typically divided into two categories: direct overhead costs (also called job overhead) and indirect overhead costs. Understanding both is essential for managing overhead allocation effectively.

Direct Overhead Costs

Direct overhead costs are specific overhead expenses associated with a particular construction project but are not part of direct costs like labor or material costs. Examples of direct overhead costs include:

• Job site utilities such as water and electricity

• Equipment rental costs specifically for the project

• Salaries for on-site supervisors and project managers

• Temporary office space and structures like site offices or storage units

• Equipment depreciation and maintenance costs related to project equipment usage

Indirect Overhead Costs

Indirect overhead costs are the general overhead costs necessary to run your construction business but are not tied to any one project. These indirect expenses include:

• Administrative costs such as office rent, office supplies, and utilities

• Insurance costs including general liability insurance and bonding

• Professional fees like legal fees and accounting services

• Equipment expenses related to leased or owned equipment maintenance and repairs

• Vehicle expenses including fuel, maintenance, and leases

• Payroll taxes and employee benefits for non-project staff

Labor Overhead and its Significance

Labor overhead is another vital aspect. It covers indirect costs associated with employees. Examples include health insurance, retirement contributions, and taxes. Understanding labor overhead is critical for calculating the construction overhead percentage. This figure shows your business's financial health.

Read more: How Overhead Costs Impact Your Construction Budget

Transitioning to Overhead Cost Calculation and How to Calculate the Overhead Percentage

Transitioning to Overhead Cost Calculation

Keep in mind that not all costs are overhead. Costs that are directly linked to the project's work, such as labor, materials, and direct expenses, do not count as overhead costs.

So, how do you calculate overhead costs? First, identify all the indirect costs related to each project. These costs are your overhead. Just like work has specific codes, there are also particular codes for overhead costs. These codes help you allocate these expenses properly.

While your overhead accounting software can do most of this work, it's crucial that you understand these overhead costs. They play a vital role when you estimate your project's profit.

How to Calculate the Overhead Percentage

The overhead rate, sometimes referred to as the construction overhead percentage, reflects how much your business spends to deliver its services or make its products. Here's how to calculate it:

1. Identify Total Overhead Expenses: Compile all indirect expenses, including administrative overhead, insurance costs, office expenses, equipment costs, and labor overhead, over a set period (usually monthly).

2. Determine Total Direct Costs: Calculate the total direct project expenses such as labor costs, material costs, and direct job costs.

3. Calculate Overhead Rate: Use this formula to find your overhead percentage:

Overhead Percentage = (Total Overhead Costs / Total Sales) * 100

For instance, if your overhead costs are $120,000 and your total sales are $800,000, your overhead percentage would be ($120,000 / $800,000) * 100, which is 15%. This means that for every dollar your contracting business makes, 15 cents are used to cover overhead costs.

You can also compute your overhead percentage in relation to labor costs by replacing total sales with total labor costs in the formula above.

Using project management software can streamline this allocation process, helping construction companies track costs more accurately across multiple projects.

In Conclusion

Understanding and managing general overhead costs in construction is critical for maintaining profitability and supporting business growth. By accurately calculating and allocating overhead expenses, construction companies can price their projects appropriately, control costs, and improve profit margins. Whether you are managing office expenses, equipment depreciation, or administrative fees, keeping a close eye on overhead costs will help your business stay competitive in the construction industry.

Construction Cost Accounting is here to support you with expert bookkeeping services tailored to the unique needs of construction businesses. Contact us today to learn how we can help you manage overhead costs and keep your projects profitable.