‘Simple and stupid’ overhead recovery

August 4, 2014 -  By

Three contractors and a consultant stand by recovering overhead in labor rates.

With plenty of arithmetic already ingrained in design/build projects, from consultative estimates to property measurements, contractors prefer to spend little time on operational calculations like how to recover overhead.

That’s probably why many of them—three for three, in this case—are loyal to recovering it in their labor rates.  

Their formula, roughly, is three pronged:

  • Project your annual overhead and annual labor hours.
  • Divide the overhead cost by the labor hours.
  • Add the quotient, your hourly overhead recovery rate, to the hourly labor rate you charge the client.

It’s a way to keep things “simple and stupid,” Steven Cohen says. The principal business consultant at GreenMark Consulting Group in Richmond, Va., coaches his clients to use this method and refers to it as the “labor cost overhead recovery method” (see bottom).

“The labor cost overhead recovery method adds an estimated flat dollar amount to your labor rate to ensure your overhead is covered in your pricing,” he says. “This method works well if you have a company with relatively consistent material, equipment or subcontracting requirements across different types of jobs.”

Still, with different companies and varied markets comes altered approaches to the method. Here’s how three contractors fit it into their firms and why they say it’s a sure-fire way to recover overhead.

Projecting, bookkeeping annual costs

With a decade’s worth of overhead and labor costs in QuickBooks, Ainsley Waken has the historical data to project those costs year by year.

The owner of Atlanta-based Awaken Landscape Designs, which is 90 percent design/build and 10 percent maintenance, says projecting the labor hours every year is the “trickiest” part of the overhead recovery formula. For her, that part typically ends with a “best guess” based on the amount from previous years. 

Waken’s loyalty lies in the labor cost overhead recovery method, though, because it’s never disappointed.

“It has the least amount of guesswork than any other method I have come across,” she says. “It’s worked out pretty well for the last 10 years. Oddly, my addition to the labor has remained about the same as I’ve grown.”

The company, which has an annual revenue of $275,000, grows a steady 20 percent per year, Waken says. Her crew’s average wage is $15 per hour, and she adds $25 for overhead recovery, charging the client a $40 per hour labor rate.

Fitting the firm to the formula

Andy Sykes also began using the formula a decade ago when he adopted it from Jim Huston of JR Huston Consulting. 

“I got his book and the CDs and just worked through it,” says Sykes, owner of Garrett Churchill, an $850,000 firm in Willow Grove, Pa., which is 90 percent design/build and 10 percent maintenance. “It was over the winter. I sat down and was able to figure it out over a week or so.” 

Sykes also includes a labor burden fee in his overhead recovery rate, which covers the costs to keep an employee on the payroll, including insurance benefits and taxes.

The challenge of the method comes after he’s solidified his overhead recovery rate for the year. He’s taxed by limiting sales to fit his overhead projections.

“That’s really the biggest issue: keeping the sales volume where it should be so you’re working the correct number of hours,” he says.

Diligently weeding out unqualified leads helps with this challenge, he says. The formula also forces him to put a budget together and be more cognoscente of his sales volume. Plus, it allows him to charge a fair amount to customers and still make a fair profit—his labor rates have increased from $35 to $45 since using the method.

“I really wasn’t using much of a method before that. I had a flat hourly rate that I guessed was receiving all of my overhead,” he says. 

Material mark-ups, too

John Kazalonis, a former design/build company owner and now an independent designer and consultant in Lemon Grove, Calif., complements his labor cost overhead recovery method by marking up material and supply costs, adding 30 percent mark-ups to those.

He’s done this for almost 30 years and says it’s never made him fall short on overhead since he’s covering almost all facets of a job: labor and materials.

“The benefits are total control over overhead costs,” he says. “The downside is it requires meticulous record keeping and data entry.”

Kazalonis uses QuickBooks for bookkeeping.

“Once I started faithfully entering everything in QuickBooks, it became easy to tweak the overhead recovery numbers,” he says. “It will take a little time to set this up, but once done will add only a few keystrokes to your data entry. The reports you can generate on this information will be eye-opening.”

By a consultant’s calculations…

Steven Cohen, principal business consultant at GreenMark Consulting in Richmond, Va., breaks down the labor cost overhead recovery method.

“To calculate a labor cost recovery rate, review your previous year financials and your budget forecast for the upcoming year. Take your total indirect overhead costs from last year and divide them by the total number of direct labor hours you’re forecasting for the upcoming year. The result is an estimated flat dollar amount for overhead you can add to a specific cost code such as labor hours.

Here’s a simple example of how the labor cost overhead recovery works. Let’s assume you’re working with your hardscape construction department and have three guys doing fieldwork at $18 an hour. You can bill the three guys out at 40 hours per week, 50 weeks per year, for a total of 2,000 billable annual hours per employee per year. Let’s assume your annual overhead expense is $120,000. We would divide $120,000 by 6,000 (2,000 man-hours x 3=6,000), and our overhead recovery rate would be $20 per man-hour. If you add an assumed labor rate of $18 to your overhead, you would have a rate of $38.

Next, add your labor burden and profit to this. To continue the formula with a labor burden of 25.4 percent, that would add another $4.57 to my direct labor cost of $18, making my labor cost with labor burden and overhead $22.57 ($18.00 direct labor + $4.57 labor burden). Add $20 for overhead for a direct cost of $42.57 less your desired profit.

My biggest advice is to know your costs and manage your business by the numbers. Numbers don’t lie, and while gut assumptions or good intuition are good, I prefer to use an accurate financial statement coupled with good intuition. Gaining a more accurate understanding of the true costs to run your business will help you better control your bottom line and help you increase your profitability.”

—as told to Sarah Pfledderer

About the Author:

Former Associate Editor Sarah Pfledderer is a West Coast-based contributing editor for Landscape Management.

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