- OVERHEAD IS A COST.
- We add an Overhead charge to an estimate to cover the costs of running the business that is going to construct the project.
- The art of assigning Overhead to a project estimate can be viewed as either:
- linear (a certain percentage of every dollar); or
- non-linear (adjusted for various factors).
- This app provides a guide for quantifying the intuitive feeling that there must be a better way to estimate a project.
- Whichever alternative is selected, the best way to make sure company overhead costs are covered is to make sure that each project is assigned the correct overhead amount.
Consider using BBOS Estimator as your estimating platform. Non-linear Overhead calculation is a built-in feature.
The premise behind the linear Overhead Charge is:
- The company requires an additional XX% of every dollar of any project direct cost to be applied to the cost of running the business.
This is the model used by most construction businesses to price projects.
PRO:
- Easy to implement
- “Set It and Forget It”
- Works well if all projects are the same size and require the same amount of managerial resources.
CON:
- Assumes that same percentage of overhead resources will be used by each project, regardless of size.
- Hopes that the pool of Overhead Charges to all projects is large enough to cover Overhead Costs.
- Tends to skew pricing toward small projects, which will be subsidized by large projects.
The premise behind the non-linear Overhead Charge based on Production Capacity is:
- Based on the existing company structure, the company is capable of producing $REV revenue each month.
- The company’s average monthly Overhead expense is $OH.
- This project will require X% of the Company’s monthly Production Capacity.
- The project Overhead Charge will be the same X% of the Company’s monthly Overhead expenses.
PRO:
- Recognizes that each project must contribute to Overhead expenses in the same proportion that it uses Overhead resources.
- Attempts to make certain that all Overhead Costs are adequately covered by Overhead Charges.
CON:
- Each project will require a separate calculation.
- This calculation will impact ratio analysis where the analyst is expecting a specific Overhead margin, as the emphasis is on covering Overhead costs, not on realizing a standard Overhead margin.
The premise behind calculating the Overhead Charge based on Management Resource Use is:
- All non-direct business operation expenses, including management and clerical payroll, rent, utilities, technology, etc. make up the company’s management resources.
- There is a finite limit to these resources.
- No matter the amount of Revenue this project will produce, it is going to take X% of management resources to complete the project.
- The Company needs to match the percentage of Management Resources required by this project with the same percentage of Overhead Expenses.
The implication is that, if appropriate, the overhead charge can be reduced on large-dollar projects (which will make the company’s price more competitive) as long as the small-dollar projects are priced to pay their fair share of the overhead to cover the relative management resources they actually require.
- This will skew our entire production portfolio to the larger projects, where we will be more competitive.
- Don’t think of the project adding XX% to the overhead pool, think of the project contributing to the coverage of the total costs of running the business pro-rata with the Management Resources it will require.
PRO:
- Matches Revenue production with the Management Resources required to produce that Revenue.
- Small projects with high Management Resources requirement will incur an Overhead Charge commensurate with that requirement.
- The production portfolio will skew to larger projects on which the company’s pricing will be more competitive.
CON:
- Requires expertise in anticipating the percentage of Management Resources which will be required by the project.
- Salesperson will require skill in explaining why the small project Overhead Charge is disproportionate to the large project Overhead Charge.
Company Information
- Company Production Capacity (mo) = the maximum monthly sales from all projects the Company is capable of producing given the existing overhead structure.
- Do not enter an heroic amount. Enter a number that can be accomplished comfortably.
- Average Overhead costs per month = Average of last 12 months total administrative (G&A) expenses (found on the Income Statement).
Project Information
- Soft Direct and Hard Direct Costs = all net direct costs for the project.
- Managerial Resource Use = the amount of managerial time and company asset utilization (managerial resources) which this project will require during the construction period, expressed as a percentage.
- Consider all the factors involved in the project. Meetings with clients, telephone calls and emails, Change Orders, chasing down specialty products, supervisor time on the site, meetings with subs to answer questions, Scope of Work development, inspections, handling difficult clients, etc.
- Anticipated Project Duration = construction period from contract to completion.
- Both the Overhead Charge based on Production Capacity and the Overhead Charge based on Management Resource Use consider the Average Overhead costs per month.
- The Overhead Charge based on Standard OH Margin does not adjust for Average Overhead costs per month.
- Consider using the recommended Overhead Charges to make sure you are covering the Average Overhead costs per month in your estimates.
- To build a template for this app, complete the Company Information and then “Save” as “Project Overhead Calc” in the Templates folder.
- To re-use the template, access the app on the website, “Load” the template with the button at the lower left, and you are ready to go.
- See the File Management tab for best practices for using the JSON files.
- Both the Overhead Charge based on Production Capacity and the Overhead Charge based on Management Resource Use consider the Average Overhead costs per month.
- The Overhead Charge based on Standard OH Margin does not adjust for Average Overhead costs per month.
- Consider using the recommended Overhead Charges to make sure you are covering the Average Overhead costs per month in your estimates.
- By using the Recommended Overhead Amount, you may be able to decrease your total amount of the estimate (making your price more competitive), while still covering your Average Overhead costs per month.
- To build a template for this app, complete the Company Information and then “Save” as “Project Overhead Calc” in the Templates folder.
- To re-use the template, access the app on the website, “Load” the template with the button at the lower left, and you are ready to go.
- See the File Management tab for best practices for using the JSON files.
I bring on additional help as my business grows?
- Increase Average Overhead cost per month by $6,000.
- Increase Company Production Capacity per Month by $50,000.
- See the new result.
I improve the efficiency of my company by implementing a Subcontractor Management System?
- Increase Company Production Capacity by $50,000.
- See the new result.
- Confirm all inputs to verify that they are realistic.
- If the estimating platform you are using allows, enter the dollar amount of overhead selected. Always round up.
- If the estimating platform requires a percentage, enter the percent amount corresponding to your selection. Always round up.
- Whatever profit percentage you are targeting should be added to this overhead number. If your estimating platform does not add profit to the overhead calculation, add it manually.
- Consider the “Percent of Production Capacity” number in the context of other projects you are currently producing or are currently estimating.
- Exceeding the production capacity of the company can be very uncomfortable.