How to calculate overhead costs: Construction contractor guide

Direct costs are easy to remember: They’re what construction companies need to get the job done, like crew wages or project-specific materials. Overhead costs are easy to overlook, but contractors need to remember that they’re just as important to business success.

Overhead costs are the indirect expenses of running a business, like office rent, insurance payments, or marketing budgets. Instead of calculating them per project, business owners and financial managers must account for overhead on an annual or monthly basis. If firms don’t track overhead correctly, they put profit margins in jeopardy.

To help contractors better understand how to calculate overhead costs, this guide gives examples of different types of expenses and offers tips for managing them.

What are overhead costs?

Most companies split expenses into two categories: direct and indirect costs. 

Direct costs are closely associated with a specific project, like on-site wages, equipment rental, and purchasing materials. Indirect costs, also known as overhead costs, result from the everyday running of the business but don’t directly tie to a project or activity. 

Here are some examples of common overhead costs in construction:

• Facilities and utilities: Office rent, yard space, storage, utility bills
• Equipment: Vehicle maintenance, equipment maintenance
• Tools and technology: Purchasing general tools and equipment for use on more than one project, construction software, project management tools, payroll software
• Insurance and bonding: General liability, workers’ compensation, surety bonds, professional liability
• Indirect labor overhead: Management and administrative salaries, non-billable corporate staff
• Professional services: Accounting fees, legal fees, marketing budgets, licensing fees

These expenses apply even when a business isn’t actively generating revenue, making them more difficult to plan for. Calculating overhead accurately gives contractors the visibility they need to bid jobs that cover all costs and protect margins. 

Types of overhead costs

There are three main types of overhead costs: fixed, variable, and semi-variable. Knowing which expenses fall into each category makes it easier to accurately price jobs and allocate capital across projects and departments. 

Fixed overhead costs

Fixed costs generally stay the same month-to-month, only changing on occasion, such as annually. Common examples include lease payments, general liability insurance premiums, and payroll for salaried employees.

Variable overhead costs

Variable overhead expenses fluctuate with workload. Fleet fuel and vehicle repairs are a common example: Costs run low in slower months and spike when crews are running long miles between active jobs.

Semi-variable overhead costs

A semi-variable overhead cost typically stays the same, but might change seasonally or have additional associated charges. Common examples include field crew cell phone plans that incur overage charges in busy stretches and shop utility bills that climb during hot summers or hard winters.

Why calculate overhead rates?

Calculating overhead rates is helpful for a few reasons. Here are a few of the most important.

More accurate bids

When contractors bid based on vague estimates, it leads to tight budgets and overspending. Failing to account for overhead costs means profit margins might not be high enough. For example, if a bid would earn a contractor 10% profit, but they failed to account for 15% overhead, they’d lose 5% on the job. 

Calculating overhead costs per year, working out a percentage rate, and applying this to projects leads to more accurate and confident bids. 

Benchmarking comparisons

Comparing overhead rates to industry averages from sites like CFMA, ABC, and AGC can reveal over or under-spending. It also shows where there’s room to tighten before submitting a bid. 

Discrepancy detection 

The better a company understands how much they should be spending per job, per quarter, and year over year, the faster it can spot cost overruns and address them. 

How to calculate overhead costs in construction

In construction, overhead generally falls into two buckets: G&A costs like office rent, admin salaries, and insurance, and indirect job costs like site supervision or temporary facilities that aren’t tied to a specific line item. 

To calculate how much they spend on indirect expenses, contractors should follow this simple overhead costs formula: 

Overhead cost = Indirect materials + Indirect labor + Indirect G&A expenses

How to calculate overhead rates

Calculating how much a business spends on overhead costs is only the first step. Here’s how to calculate overhead as a percentage: 

(Total overhead costs / Total revenue) × 100 = Overhead rate (%)

For example, if a company makes $1.5 million in annual revenue and spends $200,000 in annual overhead, the formula would be: 

($200,000 / $1.5 million = 0.13) x 100 = 13%

Common mistakes when calculating overhead

Keep in mind that these formulas are only helpful if contractors already know what their indirect costs are. Some businesses make the mistake of confusing their overhead rate with a markup percentage. Markup is the amount of money companies add to a project to cover any projected costs. 

Another common error is assuming they’ll need to add roughly 15% on to each project to account for overhead costs. Instead of cutting corners and just multiplying project budgets by 1.15, companies should use this calculation to estimate how much they need to bid to break even, factoring in overhead: 

Direct costs / (1 − overhead %) = Break even price

Add your target profit margin on top to get the bid price you actually want to submit.

For instance, if a project’s direct costs are $300,000, multiplying by 1.15 would give $345,000. But with the second formula, the final number is $352,941. That extra $8,000 could make a big difference to a project’s final budget.

4 tips for managing overhead costs

Calculating overhead rate is just the first step in building better business practices and profit margins. Here’s how contractors can make the most of these numbers:

1. Be consistent: One-off rate calculations only tell half a story. Track overhead regularly (such as monthly or annually) and compare periods to spot budget discrepancies. A rolling 12-month calculation is a good place to start.
2. Audit fixed costs: If overhead rates are rising steadily, assess fixed expenses. In many cases, bills like insurance premiums and equipment leases are often negotiable. Try to consolidate software subscriptions and tools with overlapping functionality.
3. Separate billable and non-billable labor: Time spent on a specific job belongs in direct costs. Time spent on estimating, admin, ownership, or general supervision is overhead. Without that split, you’ll either overstate job profitability or understate your real overhead rate. Accurate time tracking tied to cost codes makes the division visible and feeds job costing you can actually trust.
4. Build overhead recovery into every bid: Apply average overhead costs to future bids and estimates. Working out overhead rate percentages over different periods helps contractors understand how much overhead they need to recover in each bid.

Why accurate overhead starts with accurate field data

Overhead costs are essential. Without admin and management salaries, GL and workers’ comp insurance, software, vehicles, and a place to run the business, your company can’t function. But overhead is only half of the cost picture. Contractors need accurate direct-cost data too, which is where job costing comes in. 

But relying on pen and paper or simple spreadsheets for expenses and time tracking is no longer good enough. Every payroll mistake and miscalculation risks causing a job to go over budget.

Miter’s field time tracking, expense management, and daily reports lead to accurate job costing without hours of work. Contractors gain visibility into every number and get job-level cost reporting that actually reflects their spending. As a result, bids are more accurate, and jobs are more profitable.