January 27, 2020
Direct and indirect costs are associated with every job. Direct costs are those associated with building the structure. These include material, labor, equipment, and subcontractor costs. Indirect costs (overhead) are not associated with a specific job or task. Indirect costs are divided into two categories: job (project) overhead and general (main office) overhead.
Job overhead costs are typically calculated as a percentage of direct costs associated with the actual job. Job overhead costs can either be fixed or variable. Fixed costs are consistent and do not change. Variable costs change in proportion to the job. Examples include safety facilities, training, temporary offices, parking facilities and other costs to support work crews. Site overhead costs can account for 5% to 15% of total job costs.
General overhead costs are calculated as a percentage of the total project costs and are added at the end of the estimate. General overhead costs cannot be charged directly to a specific project. These costs support the activities of the company. Examples include main office expenses, director and manager compensation packages, accounting, marketing, and sales. Fees for professional service providers can be considered job overhead costs or general overhead costs depending on what is done and why. General overhead expenses can account for 2% to 5% of contract direct costs. A percentage of general overhead costs should be allocated to each job.
Estimating Job Costs
Estimating job costs can be difficult. There are so many variables and different items that must be included in a job estimate. The scope of work (SOW) document prepared by a contractor or estimator defines every aspect of the job to determine the estimated cost to build the structure.
Once the SOW is completed, the contractor or estimator can prepare a quantity takeoff to determine how much of each item will be required to build the structure. A good rule of thumb is to mentally construct the building starting with the footing and ending with the roof. A spreadsheet or job estimating software can be used to list every item in columns by category, quantity needed, and estimated cost.
The categories used should be related to a certain part of the project. For example, the cost items associated with footings include structural excavation, concrete, formwork, backfill, and disposal, as well as machinery and labor.
Consider everything that is needed to produce each item and how much material is needed. Going back to the earlier example on footings, the amount of concrete required to lay the basement floor and potential waste needs to be taken into account.
All costs (fixed and variable) related to the job are then calculated to determine the total job cost. Ensure that planning costs, land acquisition fees, feasibility studies, operating costs, risk analyses, permits, costs associated with complying with environmental and regulatory requirements, property taxes, and other costs related to the project, but beyond the scope of building the structure, are included.
Estimators can find cost information from various resources such as past projects, quotes from subcontractors and suppliers, and published cost data.
Contractors need to keep a watchful eye on specific job and general overhead costs. Costs can be controlled by establishing, monitoring, and managing a job budget throughout the project. Contractors can use current and historical data to help keep within budget.
Budgeting is important to managing a contractor’s bottom line. Consistently reviewing and analyzing a budget can make a difference in the job being profitable or not. If a contractor is aware of cost overruns in one area, the budget may be able to be adjusted in another area to make up the difference.
Contractors should add a reasonable amount to each job estimate to cover unexpected increases in fixed and variable costs such as snow removal, labor, and material costs. This is especially important in today’s environment of fluctuations in the weather, labor shortages, tariffs, trade wars, and increased government oversight.
Martin C. McCarthy, CPA, CCIFP
McCarthy & Company, PC
Disclaimer: This alert is for informational purposes only and does not constitute professional advice. Information contained in this communication is not intended or written to be used as tax advice, and cannot be used by the recipient to avoid penalties that may be imposed under the Internal Revenue Code. We strongly advise you to seek professional assistance with respect to your specific issue(s).