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Contractor overhead and profit is a term used in daily terms in the construction business. The success of the business lies in how well a contractor manages overhead costs, indirect costs, and monthly fixed costs.
In this blog, we will discuss topics like overhead and profit calculations, what is general contractor profit and overhead costs, which expenses shall be considered under overhead expenses, how project costs and direct costs are affected due to this, tips to boost contractor profit and reduce overhead costs, etc.
In the construction industry, IBIS World reports that the average net profit margin is between 3% and 7%.
While we learn about overhead and profit calculation, the simple crux of the article is you cannot raise your profit margins without controlling your overhead and operational costs.
What is Overhead and Profit?
Let’s discuss the term contractor overhead and profit and the typical contractor overhead and profit considerations in a construction project.
The term “contractor overhead” is used in the construction industry to refer to both the direct costs, which are expenses that are directly related to individual tasks, and the indirect costs, which are expenses that are necessary to manage a firm. While calculating overhead and profit margin, the overhead is simply the costs that are necessary for the operation of a construction company.
Examples of overhead costs in the indirect costs:
- Employee salary
- Monetary benefits paid to office personnel
- The rent paid for a building
- Office supplies costs
- The costs of marketing and advertising
- Legal fees, and other similar expenses
Be it construction projects or general contractors – the overhead expenses are always separated into two categories.
In simple terms, when you are doing some work and if any expense occurs, then check if you can assign that cost to any of the significant heads like – material, tools, labor costs, etc. If they are, then it is a direct cost.
They are directly related or traced with a specific head of expense category. Now, in Indirect costs.
These are your other non-task-specific general, administrative, and operational expenditures that are essential to the completion of projects. Things like rent or fixed monthly expenses, mortgage payments, utilities, insurance, taxes, and legal fees all add up.
Contractor Profit Margin
Now, talking about profit – it is the amount that remains in the hands of a contractor after deducting the cost of overhead, labor, and supplies from the contract price.
If a job is worth $50,000, and it costs $20,000 in labor and supplies plus $ 5,000 in overhead, then the profit is $25,000.
Knowing both your expenses and your desired profit margin can help you determine your bid’s suggested contract price.
~~~~~~~~~~IMPORTANT THING TO NOTE~~~~~~~~~~
Don’t get confused between the Markup and profit margin. Let us have an example: you are a construction contractor and interested in taking up a project which is about $10,000. The cost includes direct and indirect costs. Now, if you want to have a profit of 12%, then you need to add another $1200 to your bid offer so that you can have a net profit of 12% (Profit percentage)after covering all the costs.
Don’t get confused between Markup and profit margin. They are not the same at all.
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How To Calculate Overhead And Profit?
Now that you have understood about general contractor overhead and profit, contractor overhead costs. Now, it’s time to see how to perform overhead and profit calculations. You can call it as oh&p calculations.
Accurately determining your construction overhead is crucial for project budgeting and pricing to ensure profitability.
Here is the six-step guide on how to determine your general contractor overhead and profit:
- Identify Overhead Costs
- Track Overhead Expenses
- Calculate Overhead Rate
- Overhead Rate = Total Overhead Costs / Total Direct Labor Hours
- Allocate Overhead to Projects
- Overhead Cost for a Project = Estimated Direct Labor Hours for the Project x Overhead Rate
- Review and Adjust
- Monitor Profitability
Well, while working out job costs, every organization has its technique. You can also use any free overhead and profit calculator online. Just search Oh&p on Google, and you will see the results.
Setting Profit Targets and Calculating Profit Margins
When establishing profit goals for business growth, Construction companies target a minimum net profit of approximately 8%. The industry average typically hovers around 10%, while an ideal profit margin can reach up to 15%.
Here’s a straightforward formula to help you understand the breakdown:
Total Revenue – Overhead = Job Costs and Profit
5 Tips to Boost Contractor Profit & Reduce Overhead
Now that we have seen overhead and profit calculation, – what efforts could you put into increasing profits in future projects?
Here are five key tips to Boost Contractor Profit and reduce Overhead. Don’t miss out on any of these.
1. Make Sure You Are Not Missing Any Important Costs
While calculating overhead percentage – make sure that you have covered all the major construction costs such as estimating costs, advertising costs, premium of business insurance, and other relevant office expenses.
Also, make sure you are thinking ahead of the future, and you have some extra contingencies cost for the same.
2. Make Use of Software for Contractors
It’s 2023, and if you are not taking advantage of technology and doing labor-burden work, then you are well behind your competitors. Make use of software for contractors like construction management tools, tools for professional invoicing, time tracking software, etc.
Well, focusing on your invoicing can help, too – Making accurate invoices using a Contractor invoice template can get you high profitability.
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3. Closely Pay Attention to Accounts Payable
If you are not paying your bills on time, then it will directly affect your profit margin – as your vendor or service provider will charge you a penalty amount. (For example, interest on late mobile bills and insurance policies)
So, always have an eye on your Accounts Payable. Here, again you can use an invoicing cum accounting tool that can remind you of upcoming bills or expenses.
4. Try To Increase Your Profit Margin
While you still use software for contractors and contractor invoice templates – another way is to increase your profit margin. Yes, we have discussed a lot of things in contractor profit and overhead – and this is one of them.
Increasing profit margin doesn’t really mean that you always quote high and double to your clients. Still, as a shroud businessman, you must evaluate your margin regularly and provide the revised rates with a letter or message.
5. Don’t Fall for High-Interest Credit
Being in a business, we are all aware of the credit systems with a supplier or a vendor, but that credit comes with a rate of interest. So be watchful when entering into a credit agreement, even for a credit card in the name of business.
So, that is it; we have covered all the necessary sections that are included in typical contractor overhead and profit blogs.
One key part is the general contractor overhead, and profit largely depends on how you conduct business and how well you use the technology. For example, creating professional-looking invoices is a huge boost to profit margins.
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A Typical contractor’s overhead and profit include the costs that are indirectly incurred to finish the job, such as office equipment, salaries, etc. In contrast, profit is the net amount that remains with the contractor after all the deductions.
For calculating the contractor overhead and profit, you must divide your overall project estimate by the total project estimate minus the overhead costs such as material and labor costs. The answer is the profit percentage.
As per the industry norms, a contractor shall make a profit in the range of 8-15%.
An overhead cost in construction is a cost that cannot be associated with direct costs like material costs, labor costs, etc., but still is necessary to do it for the completion of the task.
While working on a project, by the time 50% of the project is completed, nearly 80% of the contractor’s overhead and profit shall be paid.