Contractors often ask what percentage of revenue their overhead should be.
There isn’t one percentage that works for every construction company.
A custom home builder, commercial general contractor, remodeler, roofer, and electrician can have completely different cost structures. Company size, location, staffing, equipment, and the amount of work performed in-house also affect the number.
Instead of borrowing another contractor’s percentage, start by calculating what it costs to keep your own company operating for one year.
Overhead includes expenses that support the company as a whole and can’t be traced to one specific project.
Common examples include:
Direct job costs are expenses you can assign to a specific project, including labor, materials, subcontractors, permits, and equipment rented for that job.
Some costs require more thought.
A truck used across the entire company may belong in overhead, while a vehicle dedicated to one project could be assigned to that job. General accounting software is normally overhead, but software purchased for one project may be a direct cost.
Estimators and project coordinators can also fall into different categories depending on how their time is used.
The goal is to create a reasonable policy and apply it consistently.
Use this formula:
Annual overhead ÷ annual revenue = overhead percentage
If your construction company has $300,000 in annual overhead and produces $2 million in revenue, overhead equals 15% of revenue.
That doesn’t automatically make 15% good or bad.
A contractor with high material and subcontractor costs may have a lower overhead percentage because those costs increase total revenue. A labor-heavy service contractor may have a higher percentage.
Review both your trailing 12 months and your forecast for the next year. Future overhead may include another employee, higher insurance premiums, new vehicles, or additional software.
Low overhead can indicate an efficient company, but it can also mean the owner is performing several unpaid jobs.
If you’re acting as the estimator, project manager, salesperson, and collections department, the work still has a cost. It simply isn’t showing up clearly on the profit and loss statement.
Consider what it would cost to replace the work you currently perform. You may not need to hire those people immediately, but ignoring that value can make the company appear more profitable than it really is.
Your jobs must produce enough gross profit to cover overhead and leave the company with a profit.
Suppose a contractor produces $2 million in annual revenue and has $1.5 million in direct job costs.
That leaves $500,000 in gross profit, or a 25% gross margin.
If annual overhead is $300,000, the company is left with $200,000 in operating profit, or 10% of revenue.
Now imagine the contractor prices work at a 20% gross margin instead. The same $2 million in revenue would produce only $400,000 in gross profit.
After paying $300,000 in overhead, just $100,000 remains.
The company completed the same amount of work but lost half of its potential operating profit because its pricing didn’t produce enough gross profit.
Start by reviewing your last 12 months of expenses and separating direct job costs from operating overhead.
Next, forecast your upcoming overhead and choose a realistic profit target. Add those two numbers together to determine how much gross profit your jobs need to generate.
That gives you a pricing target based on your company instead of a generic industry percentage.
If you’re unsure whether your overhead is too high, your pricing is too low, or expenses are being categorized incorrectly, Beyond Books Solutions can help you make sense of the numbers.
