Calculating Office Overhead Is Essential
Your profit should be enough to cover the cost of doing business, as well as provide additional funds for growing your company.
For our purposes, we’ll define the “cost of doing business” as the amount of revenue you need to cover all office and field overhead not accounted for in job costs. This number is relatively straightforward to discern, assuming you keep good records, own a computer, and are willing to put in the effort.
The “additional funds for growing your company” number is a bit more nebulous and often depends on your life and professional goals. It’s also a number that may be best reached with the invaluable assistance of a financial planner and/or your banker. We can, however, delve into the former — calculating your office overhead — right now.
DO THE MATHLet’s break the process down. Figure 1 shows a basic overhead calculations sheet, one you can use as a model to devise your own office overhead document. It’s a simple example, the numbers are fictitious, and you will almost certainly find yourself adjusting and/or expanding the sheet to fit your unique situation. It’s simply meant to provide a jumping-off point for the office overhead calculation process and offer an idea of what information will be needed for data.
Some input for the sheet can be found and/or researched through past company records and entered as (comparatively) “hard” numbers. Other entered costs may be projected or speculative in nature and will require further research, the assistance of professionals, or (for instance) online sources. And that’s OK, assuming the sources are reputable.
The only golden rule when projecting numbers is to do your homework and be realistic with forecasts. This is no time to fool yourself. The results you generate — if accurate and realistic — will aid you in your revenue goals and ultimately assist you in deciding how much profit is “enough.”
You’ll notice on some line items, I’ve entered the term “job cost.” This is simply to remind you to be cognizant of those items that you may be able to account for in actual job costs — whether it is the whole cost or a percentage. Items such as vehicle fuel and maintenance and small tool expense often fall into these categories.
The decision on whether to make an item a job cost or to include it as an office overhead cost is strictly personal and is based somewhat on how much of that cost can be worked into your job cost while still remaining competitive. This decision, of course, isn’t as easy as it sounds — and often only comes after years of operation. Indeed, there are well-established companies who still grapple with this question. (I talk to them all the time!)
Basically it goes like this: If your local market will allow you to recoup the cost of “gray” items (those items that could fall into either job cost or office overhead) within your normal job costing, by all means work those items into job cost and thereby lower your office overhead total.
THE PROFIT PERCENTAGEOnce you’ve calculated your office overhead and reached your years’ totals, take that percentage (as a product of your gross revenue — assuming you’ve made the proper tax adjustments on your sheet) and add it to the percentage you’ve previously calculated for growth.
Let’s say we came up with a growth percentage of 2.8%. For the year 2001, add 2.8% to the 5.79% shown at the bottom of our sheet. This gives you 8.59% or (rounded off) 8.6%. Next, you’ll want to also make what I call a “real life” adjustment to the new percentage. This adjustment is to cover the almost certain volatility of the construction business.
In short, you know not every job is going to go smoothly. We have our ups and our downs and some jobs will be profitable and others won’t. This is no time to view the world with rose-colored glasses. You may indeed choose to add another 1% to 5% for covering the unknown. (It’s completely a personal choice based on your experiences and market).
For our purposes, let’s say we adjusted our number up to 12%. This is the percentage that you should be averaging throughout the year. The key word here is average. Some jobs (smaller jobs, normally) will garner much higher percentages while others (often larger) will subsist on smaller percentages (but heftier revenue).
The point is, that by the end of the business year, 12% would be your minimum average percentage. At least now you have a benchmark on which to base profit percentage decisions. A better visual picture might be this: take the 12% and multiply it by your total gross volume (in our example, $6 million) and you’ll get a result of $720,000. This would be your target dollar value for the year, the amount left after all office overhead and job costs have been accounted. You need to make $720,000 to cover the cost of operations plus setting aside money for growth.
CONCLUSIONI hope this helps. Of course, this is a simple example because there’s only so much we can cover in one article. The intent is to get you steered in the proper direction. For further assistance, you need go no further than your own accountant, banker, and company records. Also, there is a wealth of information available online.
Saucerman is an author, speaker, and consultant for the construction industry.
Publication date: 10/21/2002