I'm not sure just where I got this from, but it made me stop and think about just what overhead was and how to account for it and profit. (we don't need no stinken profit! grin). Anyway, just food for thought:
OVERHEAD AND PROFIT
The total amount of expenses from your income and expense statement compromises the overhead for the business. A proper amount must be added to each job to cover this expense of doing business. Otherwise, the contractor will not obtain the profit he had figured for the job, or, if the profit margin is too thin, he will have done the work at a loss. The importance to the contractor of knowing his overhead should be obvious.
Examples of expenses (overhead) include (but are not limited to) the following:
Salaries (even if self-employed you still have to act like you are paying yourself)
Advertising
Auto & Truck – Gas & Oil
Auto & Truck – Repairs & Maintenance (tune ups, repairs, tires, etc.)
Contributions
Depreciation
Dues & Subscriptions
Insurance - (General business, liability, medical, dental, disability, LTC, etc.)
Interest
Legal, accounting, & bookkeeping
Miscellaneous
Office Expenses - (fax, postage & delivery, stationary & paperwork, printer, pens/pencils/markers/etc., files and folders, forms, computers, software, etc.)
Payroll Taxes & Insurance (other than direct labor payroll)
Sales Tax
Tools & Equipment
Taxes & Licenses – General
Telephone – Office & Cell
Utilities (electric, water, gas, trash, etc.)
Rent – Office, office equipment, furniture, etc.
Tools and equipment
Bad debt
Marketing and advertising
The logical source from which to obtain the amount and percentage of overhead is the income and expense statement. Therefore, if a contractor has not had an accurate income and expense statement prepared at the end of a period and established his true overhead to apply during the next period, he is bidding completely in the dark. If he is not applying enough to cover his overhead on each job during the period, the error will be multiplied by the number of jobs installed and the statement at the end of the next period will most likely show a net loss. Also, if this contractor does not have and income and expense statement prepared more often than once a year, he may (and many have) find himself in serious financial trouble, or bankrupt, at the end of the year. You should prepare and use your financial statements at least quarterly and monthly if possible.
The most accurate method for determining an overhead percentage is to arrive at this percentage in terms of the selling price.
The following example shows how to arrive at the correct overhead percentage:
Assume a contractor’s income and expense statement for the year showed sales to have been $15,000 and overhead expenses as $3,750. The overhead percentage of sales for that year is computed by dividing the dollar amount of overhead ($3,750) by the dollar amount of sales ($15,000). In this case overhead would be 25% of sales ($3,750 ÷ $15,000 = 25%).
The following steps would be followed to arrive at the correct selling price for a job, once the overhead percentage has been established:
This contractor wants to bid on a job on which he has established his total direct cost (direct labor, direct labor burden, material used, etc.) to be $1,000. He knows his overhead percentage is 25% and he wants to make a 5% net profit on this job. First, add the overhead and profit percentages:
Overhead 25%
Profit 5%
Total 30%
Next, subtract this total (30%) from 100%, which represents the selling price. The remainder of 70% is the percentage which the total direct costs for the job are of the selling price.
Then, divide the total direct coast ($1,000 by .70 (70%) and the correct selling price will be $1,428.57 ($1,000 ÷ .70 = $1,428.57).
If you were to just add 30% to the direct coast, you would come up with $1,300which is $128.57 less than you should actually charge.
As you can see, if you do not accurately account for your overhead and profit, you will short change yourself a great deal over the course of a year.
