What should be included in my overhead? Fuel, all equipment costs, truck maintenance, labour, and advertising?
Great question. So many small business owners know what overhead is… as a definition. But most small to medium sized business owners are losing money because they haven’t done the simple work of categorizing their expenses properly. It is so critical to classify your expenses accurately. Why? Because some expenses get recovered directly in your estimates (like your material costs) while others have to get recovered as overhead.
…and if you don’t know exactly what your overhead costs are, then you can’t possibly be sure that your prices are covering all your company costs. Unfortunately for most contractors, profit is less than it should be - because they’ve never taken the time to calculate exactly what their overhead costs are.
The answer to your question is not exactly straight forward, but the explanation of the answer is. Overhead expenses are not consistent from company to company. What might be overhead for me is not overhead for you, and vice versa. Confused? Don’t be. The answer is simple. Here’s why:
Overhead expenses are all your expenses that are not included when estimating/pricing a job
Overhead expenses are all your costs that do not get estimated, or included directly, when you put together a price for your jobs. You asked about labor and that’s a perfect place to start.
- The costs of wages for your landscape crews is probably not overhead. I’m doing a bit of assumption here – but I’m assuming that when you estimate and price a job, you estimate how many hours it’s going to take your crews, then you multiply those hours by your hourly rate and include that figure in your estimate. When you’re doing this, you are costing and billing the labor costs directly to this job. Therefore, it’s not an overhead expense, it’s a direct (also known as variable, or cost of goods sold) expense.
- But let’s say you have an office manager? What about their wages? You certainly didn’t try to estimate how much time they’d spend on this job and work that into the estimate. Your office manager’s wages were not factored on the estimate and therefore their wage costs need to get recovered as an overhead (or fixed) cost.
You can keep your expenses pretty clear by thinking about overhead like this:
Expenses that get recovered when you cost/price an estimate are direct expenses. Expenses that aren’t directly included in estimates have to get recovered as overhead costs.
What might be an overhead cost for me might not be an overhead cost for you. My estimates might include an hourly cost (and price) for my crew trucks. Maybe you guys don’t include costs for your crew trucks when you estimate. For me, my crew trucks would be a direct cost. Your crew trucks would be an overhead cost. My customers are paying my truck costs directly - because I’m building the costs of my trucks directly into their estimate(s). If you’re not including an hourly (or daily) rate for your trucks in your estimates, then you must recover your truck costs as overhead.
A NOTE FROM BILL: It doesn’t matter how you’re showing your prices to your customer - you might just show them a total price for the job. However, when you are calculating your cost to do the work, if you are including say, $10/hr or $100/day in your estimated job costs to cover truck costs, then your truck costs are direct (not overhead). If you’re hoping your truck costs are covered in your labor rate (and so many contractors are…. simply hoping they’re covered somewhere), then you’re not actually charging truck costs to your job – and your truck costs are overhead. What you show the customer on the estimate is irrelevant. We both might show the customer one lump sum price for the job – the difference is that I counted my truck costs as an hourly cost to the job.. and you hoped your truck costs get recovered by marking up other costs like labor and materials.
Lets go through a couple of the costs you asked directly about and explain each one, and see if you can spot the pattern that emerges. Once you do, you’ll learn exactly what’s overhead, and what’s not, for your business.
Fuel Costs
Fuel costs depend on how you estimate your work. Do you charge an hourly rate for your equipment directly to your jobs? We have hourly or daily rates for our equipment that include the costs of purchase costs, insurance costs, maintenance costs and fuel costs. (To see how I calculate those rates, click here to watch this video) The fuel for that equipment is charged directly then, to my customers’ jobs. On the other hand, my truck (the owner’s truck) doesn’t get charged to jobs and therefore my fuel is an overhead cost.
If you charge equipment rates, that include the cost of fuel, directly to your jobs when you’re building estimates, then fuel is a direct (not overhead) cost. If you don’t use an hourly or daily rate for your equipment (that includes the cost of fuel) then your fuel is an overhead cost.
All Equipment Costs (and Maintenance Costs)
Again, all the costs relating to my equipment get recovered in my hourly rates, including insurance and maintenance. (To see how I calculate those rates, click here to watch this video). If you’ve calculated an hourly or daily rate that includes these costs – and you include costs and prices for your equipment directly in your estimates, then your equipment is a direct cost. If you don’t add up equipment costs when building estimates, then the only way to ensure your equipment costs are getting recovered is as overhead costs.
Now, if I had some equipment that never got included in estimates – like the owner’s truck or a loader that stays parked at the yard, then those particular costs need to get recovered as overhead costs.
Labor Costs
Most labor costs are direct costs. Labor is, for most contractors, estimated in hours and charged right into your proposal. Maybe you show your customers your hourly rates and maybe you don’t – it doesn’t really matter. As long as you add up how many hours it’s going to take to do the job and multiply those hours to come up with a cost (and price) for the job, then you’re recovering the cost of those hours as a direct cost, not an overhead cost.
But don’t forget, not all labor gets included on your estimates. I’m sure you don’t include the time spent by your office admin, or your bookeeper, and quite possibly the time the owner spends on that job. All those costs, since they are not recovered directly in your estimates, are overhead costs. Although most contractors don’t, it’s best that you have 2 accounts in your chart of accounts for payroll. One is for field payroll – this is a cost of goods sold account and is not tracked as overhead. The other account is for administrative payroll and this is an overhead account. Your field payroll costs get recovered directly in your estimates. Your administrative payroll costs get recovered as overhead.
Advertising Costs
Most definitely overhead. You’re never going to be able to calculate the cost of advertising for one specific job, and your estimator certainly isn’t building it in to the specific costs of the job. Therefore, advertising is always overhead.
I hope that helps. For a lot more information, you could always watch our tutorial videos on budgeting – which includes instructions on how to classify expenses as direct, or overhead. Watch the video on the screen, then move through the videos on the right hand side to learn more.
You can find those videos free on YouTube by clicking here.
Tags: advertising, expenses, fuel, labor, labour, maintenance, overhead, overhead recovery, pricing
