Do You Understand Your Overhead - And How to Recover These Costs?
What's in your "overhead" - and what isn't? This basic question can be answered a number of ways. Here's a look at what belongs in the overhead category and how you might think about it.
Let’s begin by saying that any employee’s costs that can be charged to a specific project should not be included in overhead. This makes the contracting business different from manufacturing (and most other businesses).
Importantly, overhead calculations can be based on one year – or one month. Overhead costs may be broken down for your electrical operation. Alternatively, these costs could also be broken down by divisions (electrical, mechanical, etc.) and sub-divisions within each division (offices, etc.).
If your company is 100 percent electrical, you still might want to break overhead down into smaller pieces. For example, your service operation might have its own overhead costs and calculations that are kept separate from those of your construction team.
As a contractor, be sure to have your accountant separate the worker’s compensation costs for productive workers from non-productive workers. There was (and is) a reason for this action.
Note that your worker’s compensation experience modification ratio (EMR) is based on your safety experience and the type of worker. Your electrician’s ratio will be higher than your office workers.
If your losses are above average for the industry, your EMR will be above 1.00; if they’re below the industry average, your EMR will be below 1.
What does this ratio have to do with anything? Your premium is multiplied by your experience modification to generate a surcharge.
Worker’s compensation is normally purchased as an insurance to limit your liability in case of a claim. Generally, it covers medical expenses associated with an injury, additional money for permanent injuries, and possible loss of time dollars.
Your worker’s compensation premium is based on the hours worked for a class of worker.
KEEPING COSTS SEPARATE
As contractors, we need to separate the worker’s compensation, federal and state unemployment tax, health Insurance, and other costs applied to productive workers from that applied to non-productive workers.
Here’s where overhead kicks in. The costs listed in the paragraph above, when they are generated by workers who are not working in the field (non-productive workers) are a significant part of overhead.
Within the separations shown above, overhead costs may be broken down into office expense, staff salaries, depreciation expense, miscellaneous, interest, etc.
- Office and shop rent or lease expenses
- Office and shop return on investment, if owned
- Office supplies
- Communication and computer equipment (including phones, cell phones, radios, computers, computer networks, etc.)
- Utilities – including electric, phone, cell phone, internet, etc.
- Project managers (if not included in direct project expenses)
- Administrative staff
- Bonuses (when not part of a specific project expense)
- Office furnishings, including carpeting, furniture, any non-expensed equipment, etc.
- Miscellaneous, indirect expenses like snowplowing
- Office maintenance: cleaning, repairs, etc.
- Indirect employee worker’s compensation, federal and state unemployment tax, health insurance, etc.
- Bad debts not collected (include attorney and court expenses)
- Any interest expense not directly chargeable to a job
WHAT DO YOU LABEL AS OVERHEAD?
Most contractors compute overhead based on a percentage of yearly sales.
Should you go to a monthly computation instead? Perhaps. One reason might be changes in your operation (and overhead expense) due to weather; another might be the varying volume of business.
Some contractors treat their overhead similar to burden, dividing the overhead dollars for a period of time (year, month, etc.) by the number of productive employee hours during that period of time. This enables them to use overhead as a productive-labor burden dollar (a per-hour amount).
A CHECKLIST FOR CONTRACTORS
- Any cost that cannot be charged to a specific project is, by definition, part of your overhead.
- Any changes your company can make to lower overhead will result in those not-borne expenses dropping directly to the bottom line (before taxes)...i.e. profit!
- Think of solar or wind power for your company’s physical facilities.
- Are you using the most efficient lighting or HVAC systems?
- As your fleet ages, are you keeping an eye on operating costs to time when it’s time to replace what you have out there?
- Is your estimating department using up-to-date software and computers? Larger and dual monitors are becoming a must for estimating departments.
Do an internal survey of what your company’s overhead costs are. Take the time to think about what can be done to lower some (or all) of these costs. The result of this effort: You’ll become more competitive.
A WORD TO THE WISE
Always remember that overhead is a cost of doing business. Simply stated, enough money must be collected to cover your company’s overhead expenses, or you’ll be doing business at a loss...or not at all.
Dick Manrod works with McCormick Systems, Chandler, Arizona, an IEC National Platinum Industry Partner. He has more than three decades of electrical contracting experience. For more information on McCormickSystems, visit www.mccormicksys.com.