Construction Junction: Where Construction Meets Accounting

Listener Q&A How to Accurately Allocate Overhead in Construction Job Costing

Hey, welcome back to the Construction Junction. I am your host, Tnya Schulte, founder of The Profit Constructors, where, as always, we are helping you run with the big dogs. Well, here's something really cool. We had a listener named John from Texas reach out and send us a question. I had asked for you guys to reach out with your greatest needs. And so, John, thank you so much for listening, and thanks for sending over such a great question. I got to be honest, when Jennifer told me that you had sent it, I got all excited. Because this is exactly the kind of thing that I love to talk about and love to share. So I appreciate also that you shared your current method for handling your overhead, or as you had called it, which is a great term also, GSNA, right? So it's all of our administrative costs. And so John had shared that they have typically tended to handle calculating their overhead or their GSNA a certain way. And they've recently made a switch to a great friend of ours from the podcast Foundation, which is a great software. And a lot of you out in this world will probably have heard of it. And he was just kind of wondering, like, are they doing it right? And what is the way that other people do it right? And so he had mentioned, you know, obviously, there are a lot of different ways that you can get into doing this stuff when you're doing job costing, because job costing is what we call cost accounting. And so to be really clear, when we start talking about these different types of terms in the accounting world, one of my great thought leaders in the space, one of the folks that has taught me a lot, his name is Ron Baker. I would highly recommend that you reach out and listen to some of his podcasts as well. But he calls himself a recovering cost accountant because when we get into the world of cost accounting. Technically, what we're doing is we're making our best guesstimate of what's going to happen to kind of understand costs across a section of jobs, across a section of time, right? And so none of it is actually going to be down to the penny reconcilable to what actually did happen or what our actual direct costs are. Pretty common in the construction world to want to find a way to account for and be able to estimate for your overhead costs and to be able to really give your estimators and project managers a good tool to understand how their jobs are performing. And doing it as a percentage of labor costs, which is the approach that John had mentioned in his email to me, is actually pretty common in the construction world. In fact, it's our preferred method at the Profit Constructors. It's pretty common for companies that have a predictable mix of work and can reliably forecast your annual labor costs. So when you have work that's pretty steady and your jobs aren't changing, when your jobs have a consistent labor to materials ratio, this approach works really well. And it's straightforward to apply in estimating. So John, if you guys continue to do that, I don't think you'd see any problem with that. Where you're going to see some variation is when companies have a wider range of job types. If you don't have that same mix that we talked about, that labor to materials ratio, and things are kind of consistently changing over your job types, then it's going to be a little bit harder to kind of rely on that labor burden to actually carry you along through all of that. So some are going to base that on total direct costs, so they can recover their overhead evenly across labor-heavy and material-heavy jobs. Others tend to take a blended approach, so they'll use a higher rate for your labor-heavy work and a lower rate for your material-heavy work. And then some actually even use a fixed dollar per labor hour instead of a percentage. We prefer to kind of go that route a lot of times when there's sort of this weird mix, and so we'll help companies establish that. And then there are companies who prefer to recover overhead costs outside the job cost system altogether. And in this case, you'd be monitoring recovery at the company level while keeping your job cost reporting focused on direct costs and gross margin before overhead. And in that case, you're going to have to do a really good job of keeping your estimating and project management team in the loop as to what your current overhead percentages are and how you guys are calculating that on a very regular basis so that they know kind of what to estimate for, what to plan for, and how to track against how their jobs are doing, right? John, since you're on foundation now, I know that they offer three main ways to handle GS&A. So you can do it through the payroll module, through the job costing module, or through the general ledger module. Each one works just a little bit differently. I'm not really an expert in how each one of them works. The right choice is going to depend on your kind of your business model or reporting needs, but I would definitely recommend reaching out to your foundation rep so they can kind of walk you through those options and guide you towards the best choice. But ultimately, the method that you choose, I would say matters less than making sure that your estimating process and your job cost reporting speak the same language, right? So you're going to want to be sure that you're cross-training across all of your teams and everyone's on the same page. So if you recover overhead one way in your bids, your job cost reports should reflect that same method. And that's how you're gonna get gross profit numbers that you can trust and spot any overhead recovery issues before they snowball. So thank you so much, John, for that great question. This is one of my favorite things to do. Like I said, to answer questions like this from our great listeners. And if you have any others, feel free to send them our way. Thanks so much. Have a great rest of your day.

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