The Imperative: Adjusting for Profit, Overhead & Taxes
Now, for those who are not familiar with the term “overhead,” it’s used to pay for indirect expenses or overhead costs that a business owner incurs while running a contracting business. This can come in the form of office rent, estimating, computers, cell phones, insurance policy, taking general contractors to lunch, misc. expenses that are required to run a construction business and cover the overhead expenses—all while staying profitable.
For example, let’s say you bill out $2,000,000 a year in revenue and have $1,500,000 in direct costs – labor, material, equipment rentals, and tools that are the cost of goods required to produce a finished product and $300,000 indirect expenses required to run your business for the year, so for example, office rent, estimating, sales and marketing for a total $1,800,000. To get your overhead percentage, you would divide $300,000 by $1,800,000 and multiply that number by 100 to come up with your indirect expense percentage. Which in this case would be 16.6% and you would apply this percentage to every project that you bid to cover those expenses.
Do not get overhead costs required to run your business and project overhead costs mixed up. These are two different expenses. One is a direct job cost and the other an indirect job cost. For example, on every project you might have to rent a job trailer, dumpsters, trash removal, and attend general contractor meetings. While these are slightly different than standard direct job costs like material and labor costs, they’re considered a part of the Cost of Goods (COGs) required to complete the work and stay in good standing with the contract requirements of the project.
On the other hand, while most contractors understand the term “profit,” they do not understand how much profit margin they can and should charge for their work and the true meaning of the term. In the context of overhead and profit used in estimating, we’re referring to gross profit margin which is different than the term “markup.”
If you do not understand the difference, you’re not alone. Like many others, you’re more than likely leaving money on the table, so let me explain. Markup is a multiplier you use against direct costs. For example, $100 dollars in cost multiplied by 45% would equate to a 45% markup, but only a 31% profit margin. As you can imagine, this means many people are not as profitable as they think and might be charging less profit margin than is industry standard for their service area.
