In part 1 of this 2-part series, I wrote about the importance of understanding your numbers and becoming more bottom line focused and less revenue focused in order to have a sustainable highly profitable business. I reminded you that when it comes to construction, profit margins should be thought of first.
I also covered the most important financial numbers that can make or break your business.
You can read part 1 here where we went over the difference between gross profit and net profit and why these numbers can make or break your business
In part two we are going to talk about another very important number that you need to identify, measure and track in order to maintain the highest level of profitability, and that is your Overhead.
Did you know that almost 30% of construction business owners have no idea what it costs them each month to keep their business open!
More often than not, when I ask my new or potential clients what their overhead costs run per month, either by actual dollar amount or even by percentage they are usually embarrassed to admit to me that they have no idea.
Overhead costs are often one of the main culprits for low profit margins. Understanding this number is the key to increasing profit, making better business decisions, and improving your bottom-line.
What Is Overhead?
Overhead is the cost of running a business. It includes all of your ongoing business expenses that you have to pay in order to keep your doors open— and are not directly attributed to a specific project you are working on.
Examples of overhead expenses are rent, insurance, utilities, supplies, marketing services, and your salary.
Overhead is different from direct costs because direct costs (or cost of goods sold) are any costs directly related to the performance and completion of a project. It includes costs like labor, equipment, and materials.
Knowing your overhead costs are a critical piece to developing and winning profitable bids. Understanding how overhead expenses can affect the profits your company retains can help you determine effective pricing strategies.
Over the years I have seen so many construction business owners leave out adding an individual markup for overhead in their bids and as a result they have an extremely low profit margin or even a loss on an individual project when all is said and done. This can also lead to running in the red consistently and having to close your business.
Determining Your Overhead Cost
“Whether you have 1 job, ten jobs or zero jobs – you have to continue to pay overhead in order to keep your doors open…”
Overhead = Fixed/Variable Monthly Expenses + Indirect Costs
Indirect costs are costs that are not specific to a particular project but are required as a part of the construction. They usually benefit multiple projects at the same time and can vary depending on the volume of the work.
These can include warehouse space for storing materials for various jobs, the vehicle you provide to your project manager, safety and PPE and project related software to name a few.
Although indirect costs don’t relate to a specific project, they need to be distributed to all projects and should be included in the overhead expenses. This cost affects the profit margin of your projects. Allocating them correctly to your project estimates and bids is important in order got you to maintain profitability.
Fixed/variable expenses. Fixed expenses are things like rent or mortgage payment, insurance, phone and internet service. Variable expenses may recur from month to month, but the costs can fluctuate such as water, electric, gas, and maintenance etc.
These expenses directly affect the overall profitability of a business. You must be aware of this figure in order to determine how much to charge in order to break even and make a profit.
Construction Profit Margins Explained – Overhead Costs and Profit
Once you understand your overhead number you can determine where your business stands financially – is your construction business really providing you a decent living?
Whether you have 1 job, ten jobs or zero jobs – you have to continue to pay overhead in order to keep your doors open, so it is important to know what your numbers are and track them closely.
Profit = Project Cost – Overhead + Direct Costs
To calculate your overhead the easiest thing to do is to add up your annual costs and then divide by 12 to get your monthly expenses.
That number tells you how much gross profit ( Gary can you link to part 1 here?) you must have each month to keep your business alive.
Once you’ve calculated your monthly overhead, you can determine your markup. This is the percentage to add onto a project estimate to cover your overhead and keep your projects profitable.
In construction, profit margins being low means it’s time for some changes in the way you run your construction business and estimate your jobs.
Focusing on increasing the bottom line or net profit before you worry about increasing sales will make for a stronger more sustainable business and a business that actually works FOR you.
If you would like to discuss your specific business situation and how you can improve it, I am here to help. I understand the challenges faced by construction businesses as a former construction business owner myself and I am here to help you overcome them! Sign up for a free consultation call.
