What is Overhead and Profit in Construction?

In the construction industry, understanding overhead and profit is crucial for both contractors and clients. They are fundamental to accurately pricing construction projects and ensuring the financial health of a construction business. 

At E2L Consulting, we specialize in providing top-tier fractional CFO services to construction businesses. In this article, our goal is to explain overhead and profit and demonstrate why they are important to your construction business. 

What is Overhead?

Overhead is the indirect costs associated with running a construction business. Unlike direct costs, which can be attributed to specific projects (such as labor and materials), overhead costs aren’t directly linked to a single project. 

Instead, they are necessary expenses for operating the business. Overhead can be categorized into several areas, including:

• Administrative costs
• Operational costs
• Marketing and sales costs
• Regulatory costs

If you want to remain a profitable business, you have to accurately calculate overhead costs. 

In most cases, they are spread across all projects to reflect each project's share of the total overhead burden.

What is Profit?

Profit your business’s financial gain after all expenses have been deducted from revenue - your reward for taking on the risk and effort of running the business. 

Profit serves several important functions:

• Business growth
• Financial stability
• Owner compensation

It is usually expressed as a percentage of the total project cost and is factored into the pricing of bids and proposals. This percentage can vary depending on the size, complexity, and risk associated with the project.

Importance of Overhead and Profit in Construction

Properly accounting for overhead and profit is vital for several reasons:

1. Accurate Pricing

Including overhead and profit in project bids is the best way to ensure the business covers all costs and achieves a sustainable margin. Underestimating these components can lead to financial shortfalls and jeopardize the business.

2. Competitiveness

While it's important to include overhead and profit, you also have to stay competitive. 

Be transparent and justify the costs. This can build trust with clients and set your business apart from less thorough competitors.

3. Financial Health

Consistently accounting for overhead and profit helps keep the business financially healthy. It ensures you can continue to operate and grow, even during lean periods.

4. Project Management

When you understand and track profit and overhead, you can spot potential issues early on and make the needed adjustments. This results in better project management and financial forecasting.

How to Calculate Overhead and Profit in Construction

Calculating overhead and profit involves the following steps:

1. Determine Total Overhead Costs: Add up all indirect costs over a specific period (e.g., monthly or annually). This gives you the total overhead.
2. Allocate Overhead to Projects: Spread the total overhead across all projects based on a fair allocation method, such as project size or duration.
3. Set Profit Margin: Decide on a reasonable profit margin percentage based on industry standards, project risk, and business goals.
4. Include in Bids: Incorporate the allocated overhead and desired profit margin into project bids and proposals for comprehensive and competitive pricing.

Don’t Overlook Overhead and Profit in Construction? 

Understanding and managing overhead and profit in construction businesses is critical. 

With these elements, you can accurately price bids and projects and sustain your business. As an experienced outsourced CFO specializing in construction companies, one of my goals is to help clients understand and manage overhead and profit. 

If this is an area you are struggling with, book a Right Fit Call today to walk me through your needs so we can figure out the way forward.