August 28, 2014 – In today’s competitive construction environment, it is imperative that construction contractors are able to accurately estimate costs associated with a contract. Without an understanding of what their overhead burden is, contractors are merely hoping they make money.
So what is overhead burden? The burden is made up of those costs associated with the performance of a construction contract which are not directly or easily traceable to a specific contract. These costs commonly include indirect payroll costs such as union dues, fringe benefits, payroll taxes, workers compensation insurance, indirect labor, project supervision, tools & equipment, supplies, general liability insurance , repairs & maintenance, depreciation & amortization and equipment operating costs. These costs must be allocated to specific contracts using a consistent methodology.
Burden allocation should be driven by some factor which occurs consistently within the contracts. Typically this will be tied to the direct attributes of contract performance such as direct materials, direct labor costs, direct labor hours, direct machine hours or total direct costs. Three common allocation methods are 1) cost to cost, 2) hours to cost and 3) a hybrid method.
The cost to cost method allocates burden based on direct job costs incurred. The hours to cost method allocates burden based on either direct labor or direct machine hours incurred. The hybrid method allocates burden based on a combination of the cost to cost method and the hours to cost method.
Whatever allocation method is used, the contractor must insure all burden costs are allocated across both open and closed contracts for the year. When a contractor has an effective grasp of burden allocation, they must also incorporate enough gross margin on the contract to cover general and administrative costs and desired profits.
Understanding the impact of overhead on contracts reduces the guess work on contract profitability.