Understanding overhead and profit (O&P) calculations is fundamental to sustainable construction business success. Proper O&P ensures you cover all costs while generating returns that grow your company.
Understanding Overhead Types
Company (Home Office) Overhead
Fixed costs of running your business regardless of projects:
| Category | Examples | |----------|----------| | Facilities | Office rent, utilities, maintenance | | Personnel | Admin salaries, executive compensation | | Insurance | General liability, professional, umbrella | | Professional services | Accounting, legal, IT support | | Marketing | Advertising, website, business development | | Technology | Software, equipment, communications | | Vehicles | Non-project fleet costs | | Finance | Interest, bank fees |
Project (Job) Overhead
Costs specific to a project but not direct labor or materials:
| Category | Examples | |----------|----------| | Supervision | Project manager, superintendent | | Temporary facilities | Trailer, fencing, signage | | Utilities | Temporary power, water, phone | | Safety | Safety equipment, training, inspections | | Quality | Testing, inspections | | Insurance | Project-specific coverage | | Equipment | Non-production equipment | | Administration | Project-level clerical, supplies |
Calculating Company Overhead
Annual Overhead Budget
Sample Company Overhead:
| Category | Annual Amount | |----------|---------------| | Office rent | $48,000 | | Utilities | $8,400 | | Admin salaries | $180,000 | | Executive compensation | $150,000 | | Insurance | $65,000 | | Professional services | $35,000 | | Marketing | $25,000 | | Technology | $18,000 | | Vehicles | $24,000 | | Miscellaneous | $16,600 | | Total Annual Overhead | $570,000 |
Overhead Rate Calculation
As Percentage of Direct Costs:
Overhead Rate = Annual Overhead / Annual Direct Costs
Example:
Annual Overhead: $570,000
Annual Direct Costs: $4,500,000
Overhead Rate: 12.7%
As Percentage of Revenue:
Overhead Rate = Annual Overhead / Annual Revenue
Example:
Annual Overhead: $570,000
Annual Revenue: $5,500,000
Overhead Rate: 10.4%
Overhead Allocation Methods
| Method | Description | Best For | |--------|-------------|----------| | Direct cost % | Based on direct costs | Simple, consistent work | | Revenue % | Based on contract value | Mixed contract types | | Labor hour | Allocated per labor hour | Labor-intensive work | | Activity-based | By specific activities | Complex operations |
General Conditions (Project Overhead)
General Conditions Categories
Division 01 - General Requirements:
| Item | Description | |------|-------------| | Project staff | Supervision, management | | Temporary facilities | Office, storage, utilities | | Safety | Programs, equipment | | Quality control | Testing, inspections | | Site security | Fencing, guards | | Cleanup | Ongoing and final | | Temporary protection | Weather, security |
Calculating General Conditions
Time-Based Items:
Item Cost = Duration × Rate
Example:
Superintendent: 12 months × $12,000/month = $144,000
Project trailer: 12 months × $1,500/month = $18,000
Lump Sum Items:
Mobilization: $25,000
Final cleanup: $15,000
General Conditions Percentage
Typical ranges by project type:
| Project Type | GC Range | |--------------|----------| | Simple projects | 6-10% | | Standard projects | 8-12% | | Complex projects | 10-15% | | Fast-track | 12-18% |
General Conditions Template
| Item | Unit | Qty | Rate | Total | |------|------|-----|------|-------| | Project Manager | Month | 10 | $14,000 | $140,000 | | Superintendent | Month | 12 | $12,000 | $144,000 | | Project Engineer | Month | 8 | $8,500 | $68,000 | | Field office | Month | 12 | $1,500 | $18,000 | | Temp utilities | Month | 12 | $1,200 | $14,400 | | Safety program | Month | 12 | $800 | $9,600 | | Total GC | | | | $394,000 |
Profit Determination
Profit Fundamentals
Profit is return for:
- Business risk assumed
- Capital invested
- Management expertise
- Entrepreneurial effort
Profit Target Factors
| Factor | Impact on Profit Target | |--------|------------------------| | Project risk | Higher risk = higher profit | | Competition | More competition = lower profit | | Complexity | More complex = higher profit | | Relationship | Repeat client = may accept lower | | Market conditions | Strong market = higher profit | | Company needs | Growth goals, capacity |
Typical Profit Margins
| Contract Type | Profit Range | |---------------|--------------| | Hard bid competitive | 3-8% | | Negotiated private | 6-12% | | Design-build | 8-15% | | CM at-risk | 4-8% fee | | Cost-plus | 10-20% |
Profit Calculation Methods
Percentage of Direct Costs:
Profit = Direct Costs × Profit %
Example:
Direct Costs: $1,500,000
Profit Target: 8%
Profit: $120,000
Percentage of Total Costs:
Profit = (Direct + Indirect) × Profit %
Example:
Total Costs: $1,800,000
Profit Target: 6%
Profit: $108,000
Target Margin:
If you need 8% net margin:
Sell Price = Total Costs / (1 - 0.08)
Example:
Total Costs: $1,800,000
Sell Price: $1,800,000 / 0.92 = $1,956,522
Profit: $156,522
Combined O&P Calculation
Build-Up Approach
DIRECT COSTS
Labor: $500,000
Materials: $650,000
Subcontractors: $800,000
Equipment: $150,000
Total Direct: $2,100,000
GENERAL CONDITIONS
(12% of direct): $252,000
COMPANY OVERHEAD
(10% of direct): $210,000
PROFIT
(8% of all costs): $205,000
TOTAL BID: $2,767,000
Markup Approach
Combined Markup = Overhead + Profit Markup
Example:
Direct Costs: $2,100,000
Overhead rate: 12%
Profit target: 8%
Combined markup: 20%
Bid Price: $2,100,000 × 1.20 = $2,520,000
Contract O&P Provisions
Standard O&P for Changes
Many contracts define O&P for change orders:
| Level | Typical Allowance | |-------|-------------------| | Contractor (self-performed) | 15-20% total | | Contractor (sub work) | 5-10% on sub | | Subcontractor | 15-20% total | | Sub of sub | 10-15% |
Breakdown by Cost Type
Some contracts specify: | Cost Type | Overhead | Profit | |-----------|----------|--------| | Labor | 10% | 10% | | Materials | 5% | 5% | | Equipment | 5% | 5% | | Subcontracts | 5% | 5% |
Overhead and Profit Strategies
Competitive Strategies
| Strategy | When to Use | |----------|-------------| | Low overhead + low profit | Must-win situations | | Standard overhead + standard profit | Normal competition | | Full overhead + premium profit | Strong position | | Reduced overhead + higher profit | Efficiency advantage |
Project Selection Impact
Match O&P to opportunity:
| Scenario | O&P Approach | |----------|--------------| | High-value relationship | May accept lower | | High-risk project | Increase profit | | Efficient execution expected | Standard overhead | | Complex project | Full overhead |
Continuous Improvement
Reduce overhead through:
- Technology investment
- Process efficiency
- Outsourcing non-core functions
- Volume leverage
Financial Health Metrics
Key Ratios
| Metric | Healthy Range | |--------|---------------| | Overhead ratio | 10-15% of revenue | | Gross margin | 15-25% | | Net margin | 3-8% | | Profit per employee | $20,000+ |
Break-Even Analysis
Break-Even Revenue = Fixed Costs / Contribution Margin %
Example:
Fixed (home office) overhead: $570,000
Contribution margin (gross margin): 20%
Break-even: $570,000 / 0.20 = $2,850,000
Common O&P Mistakes
| Mistake | Consequence | |---------|-------------| | Underestimating overhead | Working at a loss | | Inconsistent allocation | Inaccurate job costing | | Ignoring indirect costs | Missing true costs | | No profit discipline | Unsustainable business | | One-size-fits-all | Mismatched pricing |
Documentation Requirements
For Each Bid
Document:
- Overhead calculation basis
- General conditions breakdown
- Profit rationale
- Any project-specific adjustments
Historical Tracking
Maintain records of:
- Actual vs. estimated overhead
- Job-level profitability
- Overhead trends
- Market pricing data
Related Articles
- How to Calculate Construction Bid Markup
- Construction Bid Cost Breakdown Structure
- Construction Bid Risk Assessment Techniques
Frequently Asked Questions
What's the difference between markup and margin? Markup is added to costs. Margin is profit as percentage of selling price. A 25% markup equals about 20% margin.
How do I determine if my overhead is too high? Compare to industry benchmarks (typically 10-15% of revenue). If consistently higher, look for efficiency improvements or revenue increases.
Should I include owner's salary in overhead? Yes, reasonable owner compensation should be included. Your profit should be return on investment, not your salary.
How do I handle overhead recovery during slow periods? Options include reducing overhead, accepting lower margins temporarily, or adjusting volume targets. Avoid chronic under-recovery.
What profit margin should a new company target? New companies often need higher margins (10-15%) to build capital and cover learning curve inefficiencies. Adjust as efficiency improves.
