Managing overhead requires a deliberate series of allocation and recovery decisions that affect the flexibility of your pricing strategy for each project. Periodically, you should re-evaluate how you price to recover overhead costs and allocate actual expenses through your job-costing system.
Overhead rates are generally based on historical data. You know what you have spent each year to generate and support your revenue, and you use that data to generate a predetermined overhead rate for future years. An overhead percentage is then assigned to each unit of material and/or labor as jobs are priced.
Most electrical contractors mark up each labor hour with a percentage of overhead to be recovered by the revenue from the work installed during and billed for that hour. If you plan to recover all your overhead by attaching it to the hourly price of labor, you will have greater flexibility in pricing your materials. This strategy often produces material prices low enough to discourage owners from trying to save money by purchasing their own. Controlling material purchasing and delivery greatly reduces the risk of delays due to late ordering, miscalculated quantities or inappropriate substitutions that don’t meet design specifications or comply with building code requirements.
Now you need to decide which overhead costs are time-based (period costs) and which are variable (occurring only when the work is performed). These decisions are not as simple as they appear. Is it better to categorize all IT/communication expenses as period overhead, or should cell phones, laptops and tablets be classified as direct project costs? Expenses to store, insure and maintain equipment exist even when it isn’t being used to generate revenue. Do you split out those costs and assign a monthly portion as period overhead but apply the cost of fuel and loan payments as variable costs of specific projects? Since the useful life of each piece of equipment is calculated based on a predictable number of hours of use, some costs should be attached to hours of actual operation.
If the equipment is still functioning after the end of its predicted useful life, you will have recovered the purchase cost. If you continue to include it in your pricing while the actual overhead decreases, you will reap a windfall. However, you will also need to plan for a future expenditure to replace the equipment when it is no longer functioning, so how you manage the replacement cost will affect cash flow differently whether you lease, purchase through installment payments, or buy outright with reserve funds.
Field installation hours are a direct cost of projects, but what about training days or times when electricians perform maintenance work or upgrades of your company facilities? That’s overhead. Project manager compensation may also be assigned to individual projects, with a residual amount lumped into general or time-based overhead. Job trailers, support staff working in them, and the related office furniture and supplies are direct costs of specific projects, but when they are idle or not used for those projects, they also are part of time-based overhead.
Long-term revenue growth and workforce development plans also affect your pricing strategy. Workforce reduction is costly. You may lose key people permanently if the layoff is lengthy, you create distrust, and you add the cost of hiring and training new people with no guarantee that their learning curve will match your needs or that they will perform as well as the experienced people they replaced. Remaining employees are often demotivated or resentful as they scramble to cover new tasks, and the work environment deteriorates for everyone.
Avoiding that situation drove my decision to plan based on retaining our company’s most valuable field and shop employees, as well as all of my operations staff, and treating the related cost as a permanent minimum level of overhead.
Strategically, the company was only viable if we were able to produce sufficient work to achieve the revenue we needed to maintain this level of staffing. Downsizing beyond a certain point is business suicide; you will never reduce overhead to zero or you’ll have no resources to support your operation, and it won’t matter what happens in the field.
Your analysis will generate a variety of additional questions. Will you include general liability insurance in your labor rate or just worker’s compensation? Will your overhead rate be adjusted by job size, risk level or customer value? Will you try to recover most of your overhead throughout the year or from earlier projects that can absorb most of the cost? What role will efficiencies related to repeat projects, customers who pay promptly or your marketing strategy play in your decisions? Ultimately, your overhead system will function most effectively when it is unique to your company’s vision and flexible enough to respond to changing conditions.