CONSTRUCTION Accounting Article -
Exceeding Your Expectations - How to Analyze and Streamline Your Indirect Costs

Target Audience: General Contractors, Cost Accounting Interest, Construction Companies

Whether you call them indirect, administrative, overhead or back office costs, you probably deal with them every day. They’re the expenses not directly related to your projects — and they can have a marked effect on your bottom line.

Contractors often establish their indirect cost base over a number of years and accept the expectation that they need to, at minimum, make that certain percentage each year before they can begin adding to their bottom lines.

Yet having a mindset like this could mean that you leave a percentage or two of profit on the table or, even worse, seriously inhibit your construction company’s profitability. By paying closer attention to your indirect costs, you might just be able to exceed your expectations in this area.

Analyze continually

Along with monitoring your job costs, analyzing indirect costs should become part of your regular management review process. For the analysis to be meaningful, however, make sure your chart of accounts provides sufficient detail of each indirect cost. In other words, you don’t want to break down your indirect costs into too few categories. (Ask your CPA for help with this process.)

Once you establish a meaningful breakdown of your indirect costs, there are several ways you can analyze them:

Budget to actual analysis. This involves setting a budget amount (usually annually) through a review of previous years’ costs, planning for the coming year and comparing the budgeted amount to your actual costs regularly. Ideally, you want to set up the budget using up-to-date accounting software so you can run the budget vs. actual comparison at any time.

Compare yourself to a peer group. Here you take a more informal approach, basically meeting with others in your niche from outside markets and comparing notes. A national or regional builder’s association meeting, for instance, may provide an ideal setting.

Your goal is to gain a better understanding of what levels of indirect costs your peers incur and get (and share) some ideas about how to handle these expenses more effectively.

Benchmarking. A more formal process, this approach involves joining a trade organization that performs annual financial surveys or working with a construction consultant who has access to a large database of contractor data.

Either way, the premise is the same: You’re comparing your operations to others in the construction industry to determine whether you’re where you should be.

Streamline smartly

After thoroughly analyzing your indirect costs, the next step is to look for ways to streamline those expenses and improve your bottom line.

When doing so, it’s important to consider your construction company’s history. For instance, an analysis of your indirect costs and their relationship to your operating results can help you determine which costs are fixed, which are variable and which are a little of both.

Also look at how changes in your job types or volume affect your indirect costs. There may be some indirect costs that are more directly affected by the type or volume of your projects than you had previously thought.

Apply the same outlook when looking internally. Continually evaluate your staff’s performance and try to identify ways they could work more efficiently. If you find several employees performing redundant functions, you may even need to trim your workforce.

On the other hand, if your staff is about as efficient as it can get, move on. There are plenty of other areas of your business that could use attention.

Look externally

Of course, you must also assess the indirect costs that you’re paying outside vendors for items such as uniforms, utilities and technology consulting. Continually challenge the value you’re receiving from these providers.

This doesn’t mean you should be competitively bidding out all of your indirect services all the time. But stay on the lookout for better and possibly cheaper ways of procuring these necessities.

That said, it’s important to separate your personal relationships from your indirect costs. A large part of contracting is the relationships that your company builds over the years with vendors. So while you’re taking a hard look at your indirect costs, it doesn’t necessarily mean you should forsake these relationships. But you do need to make sure that you’re spending your indirect dollars wisely.

In some instances, joining a trade organization that provides group purchasing power for goods and services can get you a bigger bang for your buck. For example, you could become a member of a group workers’ compensation program that allows you to lower your premiums.

Profit punctually

Many contractors spend more than half of their operating year trying to make enough gross profit to cover their indirect costs. Yet, while a focus on profitability is, of course, paramount, don’t forget to look at ways to streamline those indirect costs and reduce the time it takes your construction company to start making a real profit!

Sidebar: Outsourcing for contractors … seriously?

When you read the word “outsourcing,” it may call to mind some huge multinational corporation setting up a high-tech call center on the other side of the world. But outsourcing can work for contractors, too, though usually on a smaller scale.

For example, vendors that provide payroll services have gotten pretty good at handling the complex nature of payroll processing for construction companies — particularly when managing payroll in multiple jurisdictions. Your CPA can probably help you find a reputable provider in your area.

Outsourcing this function will likely not completely replace your internal payroll responsibilities. But the time saved could free up your payroll clerk to assist in other areas and, thereby, further streamline your indirect costs.

Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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