Allocate, Then Recover Overhead Before Focusing on Annual Profit

Here is a point you must understand: You can make money on every job you perform but still lose money as a contractor. Some contractors don't understand what job costing really is. Job costing takes the original estimate of costs to do a job and compares it with the actual costs to do the job. This is done at the level of costs – that's why it's called job costing. Some contractors take job costing to another level. They add overhead to costs and subtract costs with overhead from the contract amount to see if they have made a profit. That is no longer job costing, it is generating a financial statement or a profit-and-loss statement on each job.

Now, I don't mind if a contractor does that, but he must understand the basic principle of job costing. You see, each of those financial statements on individual jobs are just snapshots. The company and its profitability are a collage made up of those pictures. Individual pictures may look pretty, but the company collage can look really ugly. Why does it look ugly? Because there aren't enough pictures in the collage with enough overhead allocated in them to cover all the company's overhead. In order to fill the holes of unrecovered overhead, you must take profit from the jobs you did to pay for the unrecovered overhead. That is why you can make money on every job you perform, but still lose money as a contractor.

Why not just add more overhead to the work the company is bringing in? Because, there is a fine line of the right amount of overhead for the kind of company doing certain kinds of work in certain areas. The goal is to find the fine line that both gets you work and recovers your overhead.

For now, think of it this way: Contractors make all their profit in four to six weeks. From January through mid-November they are just recovering overhead. Sometime in mid-November they start making profit – everything they do in that last four to six weeks of the year is their profit.

I had a contractor call me just before Christmas one year. His company had broken even the first of October, which left them eight weeks in their business year. He said that he billed more work during those eight weeks than any other eight-week period of the whole year and drove their profit into the high six figures.

That's something to remember when your season is winding down. You have worked hard to recover your overhead and are finally making a profit, so don't put your plane on autopilot just when you could be getting ahead.

Involved in the construction industry for more than 40 years, Charles Vander Kooi writes, speaks, and consults on numerous construction management topics. Reach him at vanderkooi@starband.net, via phone at 303-697-6467, or visit his website, www.vanderkooi.com.