Successful contractors combine a keen sense for the costs of doing business with strong management skills to complete the work on time and within budget. Yet even the best of the best can wind up leaving money on the table when their front office estimating and negotiating professionals get out of alignment with their back office accounting staff.
In an ideal world, each contract provides for recovery of all reasonable costs associated with the job. Job costs fall within one of three categories:
- Direct costs that are specific to the job, such as direct labor, materials, equipment rentals, and subcontractor costs
- Indirect costs associated with the job but not exclusive to it, such as estimating, job supervision, non-job chargeable time (e.g., shop labor, vacations, holiday, sick leave, benefits), consultants and third party providers, small tools and supplies, depreciation on shared equipment, and liability insurance
- Overhead expense, such as general office and administrative expense, advertising, travel and entertainment, and professional licenses
Direct costs are the easiest (and largest) expenses to track as they’re identifiable as being directly associated to the job. Yet indirect costs and overhead can represent a significant outlay. They frequently include elements that fail to be covered in bids. If such costs aren’t considered before signing on the dotted line, they can’t be recovered after the fact. For instance, how much are you willing to spend on pre-contract costs without considering how they may be recovered from a prospective client? Should they be considered a sunk cost of overhead (cost of doing business), or could pre-contract costs be included as part of the negotiated contract price?
In addition to direct costs, the company needs to determine the means through which it will allocate your indirect costs and overhead to specific jobs. Common allocation methods include:
- Assigning a fair market hourly, daily, or monthly rate to a cost, or pool of costs, resources (e.g., estimating labor, general liability insurance, etc.) and applying that rate based on a reasonable allocation base, such as labor dollars/hours or machine hours.
- Recapture historical operating and ownership costs of your equipment (depreciation, maintenance, repair, licenses, insurance, etc.) to determine usage rates and applying them to the actual machine hours recorded on the job.
- Distributing actual costs incurred based on the percentage of time the resource was assigned to each project during the period.
- Apportioning costs based on the percentage of revenue or costs attributed to the job relative to the company’s aggregate revenue or costs.
Some contracts dictate how costs are allocated; others simply require that a fair and reasonable method be employed subject to certain limits. Companies generally opt for a straight-forward allocation methodology when the associated line items are relatively small. If the line item expense is significant, it may merit a more sophisticated methodology. For example, some contractors may assign a set fee for use of small tools and supplies because the cost of tracking outweighs any financial gain. A large industrial construction contractor might send a pre-loaded container with tools and supplies to each job site for which the job is charged a monthly fee. When the container is returned at the end of the job, a physical inventory of the remaining assets determines the final adjustment to job costs.