Overhead and profit, part 1

At its elemental level, overhead is the money you would have to pay to keep your business operating when you had no one working in the field. It includes everything except material, labor and job expenses. Office expenses, salaries, sales expenses, office equipment, vehicles and similar expenses are considered to be overhead. (Note, however, that there are several different ways to calculate overhead, and strong opinions as to which is best.)

For electrical contractors, overhead generally runs at between 13% and 20% of total sales. The smallest contractors generally have the highest percentages of overhead, and very large contractors have the lowest percentages. Remember, however, that these are averages, and any particular company may have higher or lower percentages, depending upon what types of work they do, their methods of doing business and their activities for a specific accounting period.

Here are estimates of how all electrical contracting expenses break down. On the left are expense items, and the three columns to the right show the percentage of sales taken in each category by small, mid-sized and large electrical contractors:

SMALL MEDIUM LARGE Material 36.2% 35% 32.5% Labor 32.1% 37.2% 41% Overhead 21.6% 18% 15% Job Expenses 4% 4% 4.5% Subcontracts 3.8% 3.5% 4.4% Profit 1.8% 1.5% 1.7% Taxes 0.5% 0.8% 0.9%

As you must know, very few electrical contractors really charge 20% for overhead. Nonetheless, they remain in business. Here's how:

You are probably aware of the little “games” that we play while estimating. When figuring a new job, almost all of us hide extra money in the estimate by using inflated material prices. This is where the extra overhead money comes from. The truth is that if you look at certified financial statements, your overhead will probably be in the 13%-20% range, regardless of what percentage you tack onto your estimates.

In the best professional opinions, such methods of “willingly deceiving yourself” should be avoided. But beware since correcting these little games is a two-sided process. If you stop hiding some money in inflated material costs (to match reality), you will have to increase the overhead percentage you charge (to match reality). When you correct such overhead problems, you must correct both sides of the equation.

APPROPRIATE LEVELS OF OVERHEAD

Your overhead should be the minimum necessary to keep your people in the field working at maximum efficiency. There is no certain “correct” percentage. The figures that we covered above can serve as a guideline for you, but they should not be taken as law. If your figures are significantly higher or lower than the averages, you should take a good look, and see if something is wrong somewhere. (It may just be that your methods of calculating need help.)

You may find a problem with your calculations from this: We are expressing overhead as a percentage of sales. On most estimate summary forms, overhead is calculated as a percentage of cost. There is obviously a difference between the two, although it is frequently not noticed.

If you take your cost, and mark it up 15% for overhead, and then add 10% for profit, it might at first seem that you have your overhead covered. Not so. These calculations will actually give you enough overhead dollars to equal 11.9% of sales, giving you a deficit of 3.1%. Here are the numbers:

Total material cost $238,000 Total labor expenses $170,000 Total job cost expenses $92,000 Total cost $500,000 15% overhead $75,000 Subtotal $575,000 10% overhead $57,500 Bid price $632,500

Notice that the sale price is $632,500 and 15% of this amount should cover overhead. That would come to $94,875. However, we did not charge 15% of sales for overhead. We charged 15% of cost, and only came out with $75,000, leaving us $19,875 in the hole.

In this case, you would have to charge 18.975% of cost to leave you with an overhead equaling 15% of sales. Make sure that the overhead you charge as a percentage of cost, comes out to the right percentage of sales.

CALCULATING YOUR OWN OVERHEAD

The process of calculating your own overhead is simple, provided you have reasonably good financial records. Here are the steps that will take you through the process:

Pick the time period

Usually, year-end figures are the easiest to come up with. What time period you use is not near as important as the quality of your figures. Use whatever figures are best.

Get a total sales figure

Add up all of your sales for the time period in question. Come to a figure that represents all of the business you did during that period.

Find totals of all non-overhead expenses

You will have to get totals for all labor expenses (wages, FICA, fringe benefits, workman's comp. on electricians' labor and unemployment insurance), all material purchases, profit and all job expenses.

Deduct from total sales

If you can come up with the real figures for non-overhead expenses, all that is left for you to do is to subtract these items from total sales. Note that labor expense, materials and job expenses should include every expense that is caused by an electrical installation that you performed. Every job-related expense should be deducted from total sales. If you do this correctly, everything else (the final total after the subtraction) will be overhead.

In reality, any reasonable method of calculating overhead is acceptable, as long as you verify its accuracy with actual results, and then adjust it up or down accordingly. The important thing is that at the end of the year the amount of money that you charged for overhead matches your actual overhead fairly closely.

We will continue the topic of overhead and profit next month.