Today I’d like to reply to a question we received. 
I have a question about estimating and job costing. I am an assistant to a remodeling contractor and lately some of our jobs are taking longer to complete than normal and the contractor starts complaining about our overhead eating up all our profit on the job.
I follow your system and we have a 1.6 markup. My question is how to best calculate out job cost based on the time it takes to complete and the best way to determine if jobs are taking longer and eating up profit because of overhead. I hope that make sense.
I will do my best to answer this question as I understand it.
I’ve seen contractors try to apportion overhead on a daily basis when compiling their estimates. Others try to apportion overhead on a weekly, monthly or per job basis. I don’t recommend any of those approaches. If a job takes longer than estimated, you get the scenario outlined in the note above.
Overhead doesn’t stop. You might have a few days or a week without any jobs running, but your overhead bill won’t take any days off. If you apportion overhead by the job, will you assign more overhead to the next job to make up for the down days? That’s one reason I think it’s more appropriate to apportion overhead on a percentage basis.
If you perform an annual review and planning for your business, the number crunching that’s involved will tell you your overhead expenses for the past year. That figure helps you estimate your overhead expenses for the coming year. Use your projected overhead, along with your projected volume, to calculate your markup or gross margin.
When you know your markup or gross margin, apply it to estimated job costs for each project to apportion overhead on a percentage basis. For remodeling contractors and most specialty contractors, if you can build the volume of jobs you projected you’ll have enough revenue to pay your overhead expenses and achieve your profit goals. It won’t matter if some jobs run long.
You also need to estimate accurately. I won’t go into how to estimate here (if you haven’t already, read “Construction Estimating: The Basics“), but the only way to know how accurate your estimates are is by comparing actual costs to your estimated costs. You should be doing this comparison (called job costing) on all the jobs you build.
In my experience, and I started estimating with my father back in 1954, inaccurate labor estimates are by far the most common mistake that will cause you to lose money on jobs. That’s why labor estimates should always be checked by a second person. No excuses: get a second opinion on your labor estimates.
Job costing lets you know how close your estimates are. It also helps you keep your database of estimating costs up to date, and that includes your estimated labor times. It’s possible you are underestimating labor time, but you won’t know without looking at every job after it’s built.
Once you pinpoint the problem, you fix it. Was there something unique about the conditions on this job that could have slowed down progress? That should have been identified and accounted for in the estimate. Do jobs get built significantly faster if the owner is working on the job site? You have to be reasonable about how much work your crew can get done in a given time, but you also don’t want them dogging it at work.
Employees will produce about 70% of the work that the owner of the company will do, day in and day out. That’s not always the case, but if you make that your assumption, your estimates can be far closer to reality. Better to figure a bit more labor than you need than to not have enough in the estimate.
Accurate estimating, watching your crews, and assigning overhead on a percentage basis through your markup or gross margin will keep you from having to fuss and worry about your overhead expenses on a given job, even if it runs over the projected estimate.
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations as needed.