Overhead is the sum total of the expenses required to operate a business other than job costs.
Identifying Overhead
Overhead is the sum total of the on-going costs associated with being in business, these are items which typically are not directly related to any particular job. In the remodeling industry, contractors are aware that they must accurately define their Overhead Costs. This is as important for the fledgling company as it is for the well-established. In the newly established or smaller company, it is not unusual for the owner/contractor to wear many hats. This may be a temporary condition which the owner hopes to out-grow at some point in time. In order for the owner to accurately gauge profitability and know the financial impact of additional employees who may ultimately perform his job, the owner must compensate himself for every job he performs. For example, if the owner is playing the part of the production manager, salesman, and part-time carpenter, he or she must be compensated at what could be described as “replacement cost” for each of those activities. When the time comes to hire a salesperson, for example, if the owner had been performing those functions, he or she could see the feasibility of paying a new person at the same rate of compensation. The result is that there is no increase in job cost or overhead, the associated costs of adding a new person are simply shifted from the owner to the new hire, leaving the owner free to devote his energy to the remaining activities. If the owner were compensating himself at less than his replacement cost, the expense of a new employee could immediately increase Overhead by an amount which would be hard to ascertain.
Established contractors identify and categorize Overhead by simply studying the history of their company, as written in the check book. Every check that is written in the business is typically charged to either Job Cost or Overhead. The established contractor reviews his check book for the previous period, monthly, quarterly, semi-annually, or annually and assigns each check which is not a Job Cost item to one of the several Overhead categories, such as rent or lease, advertising, communication, transportation, etc. Surplus funds which can not be allocated to any of these categories might belong to that elusive category known as profit. The new contractor who is just starting out projects a realistic number for the appropriate categories.
In either application, the Overhead Projection is a living document which is updated and reviewed periodically to determine if the performance of the business is with-in the projected ranges established. The need for periodic review is based on the fact that as volume increases or decreases the overhead numbers will change although not necessarily in direct proportion to the increase or decrease of volume. Overhead may vary up or down in reaction to the efficiency of management, the number of employees, the volume of work produced, the efficiency with which money is collected and numerous other factors.
Overhead might be described as the sum total of the expenses required to operate a business. It can be expressed as a percentage of total or gross sales. By identifying overhead as a percentage of gross sales, contractors identify the percentage that must be added to the Total Job Cost in order to arrive at a sales price which will cover all of the Job Costs, as well as the Overhead. In the remodeling industry overhead figures for contractors producing $500,000 in gross sales might be in the range of 25% to 40% or higher. As the volume increases, the overhead figure typically increases also, as the business usually becomes less efficient until a volume well over $1,000,000 is attained.
The equation we work from to determine the proper price which we will present to our prospect:
Total Job Cost+Overhead+Profit=Price