Figuring overhead and profit (O&P) is the most challenging step in creating a bid for a construction project. By contrast, estimating direct costs of construction—namely the costs of labor, material, and trade partners (subs)—is relatively straightforward. You provide your material suppliers and subs with lists, plans, and walk-throughs and get back written quotes. For labor costs, if you have developed a file of labor productivity records, you need only count and multiply to reliably project costs. (If you are not up to speed at figuring direct costs of construction, see my book Nail Your Numbers: A Path to Skilled Construction Estimating and Bidding and my earlier JLC articles about the creation of labor productivity records and other tools of estimating.)
In this article, I will turn to calculating overhead and profit charges for a project.
For several reasons, those calculations are not as simple as figuring direct costs. To begin with, overhead and profit charges are not as tightly linked to the project at hand. The studs you buy for an addition are for that project and none other. And their cost is a cost of that project and none other. Overhead costs for items such as equipment, office supplies, and owner’s pay for running the company, however, are spread across many projects. Questions then arise: How do you best apportion overhead to each of your projects? Likewise, how can you best determine the amount of profit to aspire to on each project?
Starting Out with Fixed Percentages
When we are starting out and still naïve about business, we tend to respond to the challenge of charging for overhead and profit by ignoring it. We commit the thinking error of “overhead obliviousness.” We are spending steadily for equipment and supplies. We are working late into the night and on weekends at estimating and administrative work. But we don’t yet appreciate that we need to get reimbursed for the expenditures and paid for our time.
As for profit, we think that’s the payment we collect from our customers for our jobsite work—which we are likely charging for at a rate less than our former bosses charged for our labor at their projects. We find ourselves working 60 or more hours a week between our jobsite and office tasks. Yet we are keeping less money in our pockets than when we worked 40 hours in someone else’s company. At that point, many of us, exhausted and poor, give up. We retreat to employee-hood or perhaps, as did certain friends of mine, move into window sales or peddling Tupperware.Read More