The High Price of Underestimating Overhead
One of the primary causes for the failure of a contracting business is improperly pricing one’s services. And one of the primary causes for improper pricing is the failure to accurately identify and recover overhead expenses.
Overhead costs are those expenses that are not directly related to performing a service. In general, these are expenses that must be paid whether any service is provided or not. In contrast, direct costs, such as labor, materials and permits, are incurred only when a service is actually performed.
Every contractor has overhead, including those who use a spare bedroom for an office, store equipment in their garage, and do a little advertising. Insurance, office supplies, utilities, rent, depreciation, equipment maintenance, and more are all overhead expenses. Unless these costs are recovered in one’s pricing, the contractor will ultimately have to pay for them out of his own pocket.
Consider equipment maintenance and depreciation as one example. Over time, equipment will break down and need to be repaired or replaced. If this expense is not included in the contractor’s overhead, the cost of repairs, maintenance, and new equipment will have to come out of his pocket.
To illustrate, let us say that the contractor purchased a piece of equipment that will have a useful life of five years. At the end of that time, he will have to replace the equipment. If he includes the depreciation in his overhead expenses, the replacement cost will be built into his pricing and accumulated over time. If he doesn’t include that cost in his overhead, ultimately he will have to bear the costs.
All overhead costs should be recovered through the labor rate charged to the customer. As an example, let us say that a spray rig is purchased for $1,200 and will last five years (60 months). Let us also say that the contractor works by himself and spends 1,800 hours per year actually applying paint. Over five years, this will equal 9,000 hours. By dividing the cost of the rig by the hours available (and rounding up), we find that he needs to add 14 cents to his hourly rate to recover the cost of the rig during its useful life.
Fourteen cents may not sound like much, but if we consider all of the other equipment that a professional painting contractor needs—ladders, vehicles, power tools, pressure washers, etc.—these costs can become significant. If he doesn’t include all overhead costs in his pricing, he can literally nickel and dime himself out of business.
Identifying and recovering overhead costs will not guarantee business success. However, the failure to recover those expenses is an almost certain guarantee of financial difficulties.
Brian Phillips has owned a contracting business for 28 years. He has taught classes for numerous trade associations and paint manufacturers, and he has written extensively on business practices for contractors. His web site OutoftheBucket.com offers practical advice to contractors seeking to build a better business.