A Guide to Construction Overhead
by Kevin Schwartz, CPA
While overhead is a commonly known term among business owners and professionals, the term has different meaning for construction companies than for a business operating in any other industry.
Within the construction industry, overhead expenses are a broad category of costs that are needed to support projects but aren’t specific or directly assignable to any particular project. Typical overhead costs not able to directly assign to a job include:
- Management and administrative expenses
- Non-direct labor payroll taxes and benefits
- Employee benefits
- Office and shop expenses
- Marketing and advertising
- Professional services
- Business insurance (not job specific)
- Information technology
- Small tools and supplies
How are Overhead Costs Allocated to Jobs?
Overhead is typically allocated using a ratio and cost driver. A cost driver is based off a measurable output that can be tracked with each job. This driver is a predetermined rate using the ratio of estimated overhead/estimated activity. These estimates should be reviewed and adjusted on a period basis based of historical results. Typical cost drivers include:
- Labor hours
- Equipment costs or hours
- Direct Materials
Mistakes to Avoid in Construction Overhead
Allocating overhead incorrectly: Overhead should be consistently applied. A common issue is not being able to determine overhead costs from general and administrative (G&A) expenses. In general, G&A expenses are those that benefit the organization as a whole and support the overall operation of the business (labor expenses not supporting jobs, business development, facility repairs and maintenance, telephone, utilities, etc.). If so, it needs to be removed from your indirect overhead to avoid doubling your allocation.
Inconsistent tracking and treatment of Overhead: Once you’ve developed a proper overhead formula, your application must be consistent. This should be reviewed on a periodic basis to confirm the overhead is being treated properly.
Overhead is not revisited and reviewed consistently: Overhead allocation is an ongoing and fluid process that is important for proper job estimates and bidding. When overhead is not reviewed for significant changes, it will lead to misleading results either from overbidding on new work or under bidding and reducing the net margin on contracts. During the periodic review, the following should be addressed:
- Determine where overhead costs can be trimmed.
- Evaluate estimated profit margin vs actual to date.
- Adjust your bidding based off changes in overhead.
When it comes to the construction industry, overhead becomes critically important. Whether it’s a lost job due to over-allocation or under-bidding on a job by under-allocating overhead – overhead costs can hinder the value to your bottom line. For questions on calculating and reviewing overhead for your company, contact a member of our construction team today.
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Kevin Schwartz, CPA
Kevin Schwartz joined Larson Gross in 2016 and specializes in serving general contractors, subcontractors and custom manufacturers with their tax planning and financial statement needs.