Top 5 Mistakes Contractors Make with Overhead Costs

In the world of construction, managing finances effectively can be the difference between a successful project and one that wastes your time and money. One of the most common areas where contractors struggle is with overhead costs. To keep your healthy profit margins, you need to understand and control these costs. In this article, we'll dive into the top 5 mistakes contractors make with overhead costs and give you tips on how to avoid them in this piece.

1. Underestimating Overhead Costs

A common mistake that companies make is not figuring out how much their overhead costs really are. Many contractors focus heavily on direct costs like materials and labor, while overhead expenses - such as office rent, utilities, and administrative salaries - are often overlooked or poorly estimated. This oversight can lead to significant construction cost overruns, cutting into your profit margins.

Underestimating overhead costs can lead to underbidding on projects, which might win you the contract but result in losing money in the long run. Small costs can add up and have a big effect on your building business's finances if you don't keep track of them.

How to avoid it:

• Making a Detailed Budget: Make a full budget that covers all possible overhead costs. Use information from the past to make accurate estimates of costs.

• Regular Review: Continuously monitor your overhead expenses and make changes to your budget as needed.

• Use Software: Leverage construction management and bookkeeping services to keep track of and handle your overhead costs well.

The best method depends on your specific business model. For labor-intensive projects, allocating based on labor hours might make sense. For material-heavy jobs, allocating based on direct costs could be more accurate. Consider consulting with a construction accounting professional to figure out the best way to run your business.

Read more: Construction Overhead Costs: Key Difference Between Direct & Indirect

2. Failing to Allocate Overhead Costs Properly

Another mistake that many people make is not properly dividing up extra costs among various projects. Contractors sometimes spread overhead evenly across all jobs, no matter how big or complicated they are. This way of doing things can throw off your financial analysis and cause you to make bad decisions.

Improper allocation can make some projects appear more profitable than they actually are, while others seem like a loss. This distortion in financial reporting can affect future bidding strategies and overall business planning.

How to avoid it:

• Job Costing: Set up a job costing method that divides up overhead costs based on the needs of each project. This ensures a more accurate reflection of each project's profitability.

• Project Analysis: Check the financial performance of each project on a regular basis to make sure that overhead costs are allocated correctly.

Read more: How to Allocate Overhead Costs in Construction: A Beginner's Guide

3. Ignoring the Relationship Between Overhead & Volume

Many contractors fail to understand how changes in business volume affect their overhead costs, leading to poor financial planning.

As your business grows or contracts, your overhead costs don't always change proportionally. This can lead to unexpected financial strain during slow periods or missed profit opportunities during busy times.

How to avoid it:

Understand the difference between fixed costs (which remain constant regardless of volume) and variable costs (which change with volume). Then:

• Calculate your break-even point at different volume levels

• Develop contingency plans for managing overhead during slow periods

• Plan for how to scale efficiently during growth periods

Implement a flexible budgeting system that adjusts for different volume scenarios.

4. Overlooking the Importance of Financial Reviews

Many contractors make the mistake of not conducting regular financial reviews. Without consistent oversight, it's easy for overhead costs to spiral out of control. Contractors might not realize their financial health is declining until it's too late.

 Without regular reviews, contractors can't identify areas where overhead costs can be reduced or reallocated. This lack of insight can lead to poor financial decisions and ultimately hurt your business.

How to avoid it:

• Monthly Reviews: Implement a system for monthly financial reviews, focusing on overhead costs and overall budget performance.

• Use Reporting Tools: Sign up some financial reporting tools that provide real-time insights into your overhead cost management.

• Seek Professional Help: If managing these reviews becomes overwhelming, consider hiring a professional accountant or using bookkeeping services to assist you.

5. Not Adjusting Overhead Costs as the Business Grows

As your construction business grows, so too will your overhead costs. However, many contractors fail to adjust their budgets and financial strategies to account for this growth. What worked when you were a smaller operation may no longer be sufficient as you take on larger projects and more clients.

 Failing to adjust your overhead costs as your business grows can lead to budget shortfalls, misallocation of resources, and ultimately, a decline in profitability.

How to avoid it:

• Scalable Budgeting: Develop a scalable budget that grows with your business. This should include adjustments for increased overhead costs as you take on more projects.

• Focus on  Planning: Regularly revisit your financial plans and adjust them to reflect your business's current size and future growth projections.

How Can You Manage Overhead Costs Better

Managing overhead costs is crucial for maintaining profitability in the construction industry. Start by creating a comprehensive budget that categorizes all overhead expenses, including office rent, utilities, insurance, and administrative salaries. This budget should be reviewed regularly to ensure that you're staying on track and identifying areas where costs can be reduced.

One effective strategy is to negotiate better rates with suppliers and service providers. For example, you might renegotiate your lease or switch to more cost-effective utility providers. Additionally, optimizing resource usage, such as reducing energy consumption or downsizing unused office space, can lead to significant savings.

Another key approach is to outsource non-core functions like bookkeeping and administrative tasks. Outsourcing these services to specialized firms can help you reduce overhead by eliminating the need for in-house staff and related expenses. This allows you to focus on your core business activities, like project management and client acquisition, while ensuring that your overhead costs are kept under control.

By staying proactive and continuously seeking cost-saving opportunities, you can better manage your overhead and improve your  financial health.

Read more: Top 4 Effective Strategies To Reduce Construction Overhead Costs

Conclusion

Avoiding these common mistakes can make a significant difference in your construction business's profitability. By accurately estimating and allocating overhead costs, regularly reviewing your finances, and adjusting your budget as your business grows, you can ensure long-term success. And if you need help, remember that Construction Cost Accounting is here to assist with all your bookkeeping services needs.