Benchmark Table

The key to making big money in any industry is growing revenues faster than overhead. The way you do this is to manage organizational overhead dollars. Organizational overhead is defined as the payroll for all employees other than the foremen and crews. The reason we focus on these dollars is because they comprise 60% of all overhead costs in contracting companies.

It's important to measure the relationship between revenues and overhead using the overhead leverage ratio. This ratio has the greatest potential impact on net profit. The ratio is calculated as revenue dollars divided by overhead dollars. The higher your ratio, the better.

Overhead Ratio Calculation and Growth Effect

The larger chart below is an example showing the calculation of the ratio and the effect faster revenue to slower overhead growth has on the bottom line. I am assuming 10% revenue growth and 8% overhead growth. You can see that even with zero growth in gross margin, the bottom line increases substantially. In other words, overhead growth is bad only when it is faster than revenue growth.

The question is, what are the high profit benchmarks for this overhead leverage ratio? The Benchmark Table below outlines the high profit performers by industry segment.

Maintenance has the lowest ratio because this business is more service-intensive, requiring a larger staff for a given level of revenue. It also generates less revenue, selling materials and subcontractors.

To improve this ratio, establish a sound organization structure — where each position is responsible for a single aspect of the delivery process. Beyond $1 million in annual revenues, the idea that everyone "wears a lot of hats" decreases the ratio.

Second, use the ratio in the budgeting process to quantify the upper level of overhead spending in relation to projected revenue dollars. This will force you to produce a "real" budget, rework your structure and focus on building systems instead of hiring more people. There are never enough people to get the work done — just ask your people. So you might as well manage to the right level of overhead.

— The author is the owner-manager of Kehoe & Co. Contact him at kkehoe@earthlink.net
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