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Managing Indirect Costs Calls for a Keen Eye ... and a Plan

Many construction company owners feel that, based on experience, they know their indirect costs—those expenses not specifically allocated to a job, such as depreciation, repairs and training (also known as overhead). Yet, the money you're spending on indirect costs might surprise you.

It's all too possible that your overhead is up—way up—and your profitability is suffering. What you need to better manage these costs is a keen eye for details ... and a plan.

Step 1: Calculate what you're spending

As mentioned, when contractors review their finances, indirect costs all too often get the short end of the stick. A good place to start dealing with them is in your chart of accounts—it should break down indirect costs into enough categories to provide as much insight into these expenses as possible without being cumbersome or confusing.

After organizing your indirect cost information, you can analyze it in a variety of ways such as performing a budget-to-actual analysis.

This involves setting a budget amount (usually annually) through a review of previous years' costs, planning for the coming year and comparing the budgeted amount to your actual costs regularly. Ideally, you want to set up the budget using up-to-date accounting software so you can run the budget vs. actual comparison at any time.

If you're more interested in practical measures than numbers, you could try benchmarking your company's indirect costs to a peer group. Trade organizations you belong to might perform annual financial surveys that provide such information. Or, you can work with a construction consultant who has access to a large database of contractor data.

By gaining a better understanding of the levels of indirect costs your peers are incurring you'll, at the very least, get a better idea of how big a problem indirect costs are for your company.

Step 2: Look at projects, staffing

When you know what you're spending and, perhaps, how those numbers compare to your budget or to numbers from similar construction companies, you can start working to cut your indirect costs.

Before you do anything, however, look at your company's history. Using the data you've gathered, determine how each indirect cost contributes to your projects. Then identify which costs are fixed, which are variable and which are a little of both.

In addition, analyze how changes in your job types or volume affect your indirect costs. There might be some indirect costs that are more directly affected by the type or volume of your projects than you previously thought.

Follow a similar approach for staffing costs. If you find several employees performing redundant functions, you might need to trim your work force. Then again, don't start laying people off just for the sake of cutting payroll—inappropriate cuts could ultimately cost you in terms of quality, efficiency and ability to take on new jobs.

Step 3: Reassess your vendors

After looking inside, take a look outside to see whether you're incurring unnecessary (or unnecessarily high) indirect costs. This means reviewing the amounts you're paying vendors for items for various expenses.

Of course, there's a limit to how much time you should spend trying to lower vendor costs. You don't want to be constantly trying to bid out all of your indirect services just to save a few dollars. Nonetheless, stay on the lookout for better and possibly cheaper ways of procuring these necessities.

Another thing to consider is whether any personal relationships you've established with vendors are hurting your bottom line. Granted, the vendor relationships that contractors build over the years often play a huge role in their companies' success. Still, you need to make sure you're spending your indirect dollars wisely.

For example, joining a trade organization that provides group purchasing power for goods and services might be able to get you the same quality of supplies and services at a lower cost. Many contractors have joined group workers' compensation programs to lower premiums without sacrificing coverage.

Food for thought

If you haven't given much thought to your indirect costs in a while, we hope we've provided some food for thought. Saving even a percentage point or two of indirect costs annually could give your bottom line a boost.  

Questions about indirect costs? 
Contact Larry Ginsburg at 312-980-2939.

What about direct costs?

Like most contractors, you probably do a good job of tracking direct costs, such as labor, subcontractors, materials costs and equipment. How can you not? Nonetheless, it doesn't hurt to review your cost-tracking options occasionally to make sure you're not overlooking anything.

Among the easiest methods of tracking direct costs is to simply assign every job a number and record that number with every cost incurred. On a more sophisticated level, you can use job-costing software to help you crunch the numbers with minimal effort and generate detailed profitability reports.

Keep in mind, however, that any report is only as good as what it's used for. If you don't use your direct cost documentation proactively to better manage your finances, it's only so much paper and ink (or, as the case might be, bytes on a hard drive). Profit and loss, job cost, accounts receivable and accounts payable are examples of key reports that you should review each month. Look for places where you're over- or underbudget and adjust as needed.
 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.