In construction, nothing is more important than completing a project on time and within budget. However, one of the biggest obstacles that can hinder this goal is overhead costs. Overhead refers to the indirect expenses incurred during a construction project, such as administrative fees, insurance, equipment rentals, and utilities.

While these costs may seem small in comparison to direct project expenses like labor and materials, they can quickly add up and significantly impact a project’s bottom line. In order to avoid unnecessary overhead expenses and keep your construction projects running smoothly, it’s important to understand what causes overhead and how to minimize its impact.

In this guide, we’ll take a closer look at common sources of overhead in construction and tips for reducing these costs.

Key Takeaways

• Understanding and managing overhead costs in construction is critical for maintaining profitability and having success in your construction business.
• Overhead costs include indirect expenses such as administrative costs, legal fees, office supplies, and equipment expenses.
• Keeping overhead costs low can significantly impact your profit margins and overall business growth.
• Effective strategies to reduce overhead costs include careful planning, budgeting, monitoring equipment usage, outsourcing tasks, delaying transactional taxes, auditing expenses, and leveraging technology and automation.

What Are Overhead Costs in Construction?

Overhead costs in construction refer to the ongoing expenses that are necessary to operate a construction business but are not directly tied to any specific construction project. These costs are essential for the overall functioning of the business and can significantly impact the profit margin.

What Counts as Overhead Costs?

Overhead costs can be broadly categorized into direct and indirect costs. Here are some examples:

• Administrative Overhead: Salaries for office staff, office rent, utilities, office supplies, and office equipment.
• Legal Fees: Costs associated with legal advice and services.
• Insurance Costs: Various insurances are required for the business, including liability insurance.
• Equipment Expenses: Maintenance costs, equipment rental, and vehicle expenses.
• Payroll Taxes: Taxes associated with employee salaries.
• Indirect Costs: Costs that are not directly tied to a specific project but support overall operations, such as marketing expenses and general office supplies.

These are some of the examples of overhead costs that businesses may incur, but it is important to note that every business may have different types of overhead costs depending on their industry and size.

How to Calculate Overhead Costs in Construction

Calculating overhead costs in construction is essential for understanding the true cost of running a construction business and making sure there are accurate project estimates and project profitability. Here’s a five-step guide on how to calculate these costs:

1. Identify Overhead Costs

First, identify all the overhead costs that your construction business incurs. These can be divided into two main categories:

• Fixed Overhead Costs: These are expenses that do not change with the level of production or business activity. Examples include rent, salaries of administrative staff, insurance, and property taxes.
• Variable Overhead Costs: These expenses fluctuate with the level of production or business activity. Examples include utility costs, office supplies, and equipment maintenance.

2. Categorize Costs

Once you have identified all overhead costs, categorize them into direct and indirect overhead costs:

• Direct Overhead Costs: These are costs that can be directly attributed to a specific project but are not part of the direct materials or labor. Examples include project management salaries, site office expenses, and equipment rental specific to a project.
• Indirect Overhead Costs: These are costs that cannot be directly linked to a specific project but are necessary for overall business operations. Examples include administrative expenses, marketing costs, and general office supplies.

3. Allocate Overhead Costs

To allocate overhead costs accurately, you need to distribute them across different projects. This involves:

• Direct Allocation: Assign direct overhead costs to specific projects based on actual usage or a predefined rate.
• Indirect Allocation: Spread indirect overhead costs across all projects using a consistent method, such as the percentage of direct labor hours, percentage of direct costs, or a fixed overhead rate.

4. Calculate the Overhead Rate

The overhead rate is calculated to distribute overhead costs evenly across projects. Use the following formula:

For example, if your total overhead costs are $200,000 and your total direct labor hours are 10,000, the overhead rate per labor hour would be $20 ($200,000 / 10,000 = $20).

5. Apply the Overhead Rate

Apply the overhead rate to each project based on its direct costs or labor hours. This ensures that each project absorbs its fair share of the overhead costs. For instance, if a project requires 1,000 labor hours, the overhead cost allocated to that project would b  $20 x 1,000 labor hours = $20,000.

6. Regular Review and Adjustment

Overhead costs and business activities can change over time, so it’s essential to review and adjust your calculations regularly. Conduct periodic reviews of your overhead costs, allocation methods, and overhead rates to ensure accuracy and relevance.

Why Is It Important to Keep Overhead Costs Low?

Keeping overhead costs low is crucial for businesses because it directly impacts the company’s profitability. High overhead costs can eat into a business’s revenue and reduce its overall bottom line. This means that even if a company has high sales figures, its profits may still be low due to excessive overhead expenses.

In addition, having high overhead costs can also make it difficult for businesses to stay competitive in the market. When a company’s expenses are too high, they may have to raise their prices to cover those costs, making them less attractive to customers who are looking for more affordable options. This could result in losing potential sales and ultimately hurting the business’s growth and success.

Moreover, having low overhead costs allows companies to have more financial stability and flexibility. It makes it easier for them to weather any unexpected financial challenges or downturns in the market. By keeping overhead costs low, companies can also have more resources available for investing in growth and innovation.

7 Ways to Reduce Overhead Costs in Construction

Here is the part where we will discuss various strategies that construction companies can use to lower their overhead costs and become more competitive in the market.

1. Plan, Plan, Plan

Effective planning serves as the cornerstone of reducing overhead costs in construction. Meticulous planning for each project allows anticipation of potential issues, optimization of operations, and more efficient resource allocation. Detailed project management aids in avoiding unexpected expenses and keeping the project on track. Key aspects to consider include:

• Develop comprehensive project plans: Outline every phase of the construction process, from initial design to final completion. This involves identifying all necessary resources, setting realistic timelines, and establishing clear communication channels. Profit planning should also be included in this stage.
• Identify potential risks early: Create contingency plans to address these risks, helping to prevent costly delays and disruptions.
• Allocate resources effectively: Ensure labor, materials, and equipment are used in a way that reduces waste and maximizes productivity in a resource allocation plan. 

Effective planning in these areas significantly impacts overhead costs, contributing to the overall success and profitability of construction projects.

2. Make a Budget and Adhere to It

Creating a detailed budget for each project and adhering to it is vital for controlling overhead costs. This includes estimating both direct costs and indirect overhead costs. Regularly reviewing the budget helps in identifying areas where costs can be trimmed without compromising on the quality of work.

Breaking down the budget into specific categories ensures that all potential expenses are accounted for, such as:

• Labor costs
• Material costs
• Overhead expenses

Conducting regular budget reviews to track actual spending against the budget is also important. Identifying any discrepancies and taking corrective action to keep the project on budget is essential. Implementing cost control measures such as approval processes for expenditures, regular financial reporting, and cost-saving initiatives can further aid in maintaining financial discipline.

3. Keep Tabs on Unused Equipment

Unused or underutilized equipment drains resources significantly. Regularly auditing your equipment inventory helps identify items that are no longer needed. You can also sell or lease out unused equipment which reduces maintenance costs and frees up capital. By maintaining a detailed and updated inventory of all equipment, you stay aware of its current usage. This knowledge allows you to make informed decisions when it comes to investing in new equipment or replacing old ones.

4. Outsource Certain Tasks

Outsourcing non-core tasks, such as accounting, IT services, or specialized construction tasks, helps manage overhead costs more effectively. This approach leverages specialized skills without the full-time cost associated with hiring additional staff.

First, determine which tasks can be outsourced without impacting the core operations of your construction business. Often, these tasks include administrative functions, IT support, and specialized technical services.

Selecting reputable outsourcing partners with a proven track record and the ability to deliver quality services is crucial. Establishing clear contracts and performance metrics makes it so that outsourced tasks are completed to your satisfaction. 

5. Delay Transactional Taxes

In some cases, delaying transactional taxes by taking advantage of tax deferral options improves cash flow and reduces immediate financial burdens. Consult with a tax professional to understand the best strategies for your specific situation.

Using tax deferral to improve cash flow and provide additional working capital for your construction projects reduces the need for short-term financing and lowers overall financing costs. This can also be helpful for managing seasonal fluctuations in cash flow. Additionally, consider negotiating payment terms with vendors and suppliers to align with the timing of your project milestones.

6. Audit Expenses Regularly

Regular audits of your expenses reveal inefficiencies and areas where costs can be cut. This includes scrutinizing administrative expenses, vehicle expenses, and other overhead costs. Implementing cost-saving measures based on audit findings leads to substantial savings.

You can get expense tracking systems to monitor and categorize all business expenses to help identify areas of overspending and opportunities for cost savings. Based on audit findings, implementing cost-saving measures such as renegotiating vendor contracts, reducing discretionary spending, and eliminating unnecessary expenses significantly reduces overhead costs.

This is true not just in construction, but in adjacent industries like architecture. It is important to keep track of KPIs in architecture if you want your architecture business to grow.

7. Use Technology and Automations

By leveraging technology and automation tools, you can significantly reduce administrative overhead. This includes project management software, financial process automations, and other digital tools that simplify operations, reduce errors, and save time, ultimately lowering overhead costs.

Using project management software like Deltek Vantagepoint to plan, schedule, and monitor construction projects improves communication, coordination, and efficiency, reducing administrative overhead. This reduction in administrative overhead translates to more streamlined operations. The software’s automated billing systems simplify invoicing and payment processing, reducing errors, speeding up payment cycles, and improving cash flow.

Additionally, Deltek Vantagepoint’s digital collaboration tools enhance communication and collaboration among project teams, facilitating real-time information sharing and reducing the reliance on in-person meetings and paper-based communication. The software’s robust data analytics and reporting capabilities provide valuable insights into project performance, helping you identify areas for improvement and optimize resource allocation.

Last Take on Overhead in Construction

As you can see, overhead can have a significant impact on construction projects, both in terms of time and money. However, with the right software solutions like Deltek Vantagepoint, you can effectively manage and reduce overhead costs, allowing you to streamline operations and improve project efficiency.

So next time you hear the term “overhead” in the context of construction, remember that it encompasses all the behind-the-scenes costs that go into completing a successful project. And by utilizing software like Deltek Vantagepoint, you can better manage these costs and ultimately achieve greater success in your construction projects.

Frequently Asked Questions