What Is Overhead?

At the grocery store, you get in line to check out. After the cashier scans all your food, she asks if you want a receipt. You say “yes” and look it over. Then: 

“Wait a minute . . . I don’t see your store overhead line itemed out here.”

“Our what?" 

“Your overhead! I don’t see how much it costs to run this store. Why is that not on here?”

Think for a minute. When have you had a conversation about company overhead with any transaction you’ve had in recent memory? Even other services such as house cleaning, childcare, and landscaping services don’t address this, much less a grocery store. It’s all just built into the price you pay.

So why does the construction industry have such a focus on it? It goes back to New York in 1847. A law was passed to combat a corrupt system of awarding construction jobs. Public works projects were not competitively bid on, which led to all sorts of shady contracts being approved. 

Competitive bidding eventually became the standard for all government contracts. To be competitive, you needed to organize your budgets as accurately as possible. This led to breaking down your bid proposals and showing all possible costs of the project. These concepts found their way into residential and multifamily bidding. 

What Overhead Is Not

Most people are familiar with the budget in their bid proposal or schedule of values. Drywall, plumbing, electrical, and so on. These are all obvious scope items needed for most construction projects. 

But then, at the end, you see something along the lines of '10% overhead, 10% profit.' You may even think that 10% overhead is standard for the construction industry. The insurance industry demands it across the board. Indeed, many property management groups want contractors to show a 10% overhead in their bids. 

Because it's seen everywhere, it's common not to think about the reason behind it. The 10% standard overhead is a big lie, and it's perpetuated by a general lack of understanding of what overhead even is.

What Overhead Actually Is

Overhead, oversimplified, is what a company needs to pay for to operate, regardless of sales. For a typical construction company, it is much of the following:

Insurance: General liability, auto, and many others

Vehicles

Office building/rent

Admin Staff, AR/AP

Employee benefits, health care, 401K match, vacation, bonuses

License and bonds

Marketing and advertising

Legal and professional services

Equipment maintenance/use

Office maintenance

Vehicle maintenance

Employees' taxes, Medicare, and Social Security

State and federal unemployment tax

Workman’s compensation

Employee uniforms and clothing

Employee training and continuing education

Employee recruitment and advertising

Holiday parties and other company team-building events

Overhead is calculated as a percent of sales. One easy formula you can use to figure it out is Overhead Rate = Revenue/Overhead costs. Every single construction company has a different overhead than another. If you buy a truck, the overhead for the month will jump because now you have a truck payment, gas, and insurance to pay monthly, whether you have a profitable job or not. 

The fact is that most construction companies have a 15–25%+ overhead. It’s even higher if you are a specialized MEPF (mechanical, electrical, plumbing, and fire sprinkler) contractor.

Multifamily Overhead Vs. Residential Overhead

Overhead is managed much differently on multifamily projects than it is for residential. Multifamily bid proposals separate out a majority of what residential calls overhead and assign them as costs to the job. General Requirements and Conditions are not overhead. A well-organized budget will use the CSI Division Codes to allocate budgets. I talk a lot about these in my budget articles. The CSI codes used by a majority of the industry do not directly tackle overhead. This is because the overhead is unique for each and every company, and it is the accountant’s job to understand the overhead burden of the company. 

In multifamily projects, much of what would be overhead on residential is captured in the construction pricing. These projects can take years, and you need to understand these costs intimately. Nothing can be arbitrary in an apartment project because the risk is so much higher than a kitchen remodel.

In residential, there is less risk. Bids are completed quickly because of the volume and our ‘free estimate’ culture. Overhead is a much higher percentage of the project generally. The smaller the project, the higher the markup from a percentage standpoint.

So, having residential bids be pigeonholed into a 10% overhead is the number one reason general contractors go out of business: not charging enough to cover their expenses. What ends up happening is that residential contractors that do understand their overhead spread that cost into other line items like concrete or drywall that are hard for most homeowners to interact with. Don’t blame the contractor for this. If a contractor presented a bid with a 23% overhead and a 15% profit on your kitchen remodel, I’d bet they’d never get the job.

Now that you know what overhead is, you may feel more comfortable asking questions that come up during the bid process. I hope the takeaway is that you focus less on what the contractor is listing as overhead and more on their communication, detail, and bid presentation. Maybe then, we can help change the culture and allow contractors to put the actual overhead they need instead of 10%.