HOW TO KNOW IF YOUR CONSTRUCTION OVERHEAD RATE IS WRONG, FIVE TESTS.
Most contractors who carry an understated overhead rate don't know it. The symptoms are all there, with the company busy but not making money, jobs closing below estimated margin, and the line of credit growing alongside revenue, but the cause isn't obvious without running the diagnostic. There are five tests, ordered by speed. The first one takes 20 minutes, and if it fails, the overhead rate is wrong.
SPM runs this diagnostic on every new engagement, and most clients fail at least three of the five on the first pass. That's not a comment on how those businesses are run. It's what happens when a bid input gets set once and then every report downstream reads fine: the jobs perform, the gross margin holds, and the money still isn't there at the end of the year. Nothing in a standard P&L points at an overhead rate, which is why finding it takes a test rather than a review.
WHAT IT MEANS.
An understated overhead rate is a bid input that allocates less overhead to each job than the business is really incurring, which reads as lower than expected net margin even on jobs that performed in the field.
The reason this error survives is that it never looks like an error. Every job closes near its estimated gross margin, so the estimator looks right and the field looks right. The loss sits below the gross margin line, where an owner reading a P&L sees an overhead total and no way to tell whether the bids ever carried it.
THE SYMPTOMS WITH NO OBVIOUS CAUSE.
Busy and not making money
Every symptom is present and the cause stays invisible. The company is busy, the crews are working, and the money isn't there at the end of the year. Nothing in a standard P&L points at an overhead rate, so the owner goes looking at labor, at material prices, and at the market, and none of those is the problem.
Jobs close 4 to 8 points below estimate with normal field execution
When actual gross margin runs consistently 4 to 8 points below estimated gross margin and field execution was normal, the overhead rate is almost certainly understated. The projects performed as estimated. The overhead allocated to those projects was less than the overhead being incurred, and the difference reads as lower than expected net margin even when the jobs look profitable.
The line of credit grows alongside revenue
A business that grew revenue from $2M to $4M and also grew line of credit utilization from $150K to $320K is funding overhead from credit rather than from project revenue. Priced correctly, growing revenue produces growing cash rather than growing borrowing. When the line grows with revenue, the most common cause is overhead understatement in the bid rate.
Owner compensation was never in the rate
Most owners who take draws rather than a defined salary never put their own compensation into the overhead rate calculation. Pull the calculation and look for the owner compensation line. If it's missing, or below $100,000 at $2M to $5M of revenue, the rate is understated by the missing amount as a percentage of revenue.
WHAT IT LOOKS LIKE IN DOLLARS.
Multiply the understatement in points by annual revenue. A 5 point understatement on $3M of revenue is $150,000 a year of overhead that's never recovered from project revenue, and that $150,000 gets paid out of net profit, or out of the line of credit when net profit won't cover it. Over 5 years that's $750,000. The overhead rate error is the single most expensive financial control failure in most subcontracting businesses.
A contractor using 11 percent in bids whose real rate is 17 percent is underpricing by 6 points on every project. On $3M of revenue, 6 points of understatement is $180,000 a year. Nothing in the field caused it and nothing in the field can recover it.
HOW TO TELL IF THE RATE IS UNDERSTATING YOUR COST.
Pull estimated gross margin from the bid and actual gross margin from the job cost at closeout on the last five completed projects. If actual is consistently 4 to 8 points below estimated and field execution was normal, the overhead rate is almost certainly understated. This test takes about 20 minutes, and if it fails, the rate is wrong and the other four are confirmation.
Sum every fixed cost line item from the last 12 months of actual expenses, add owner compensation at market rate, and divide by last 12 months revenue. If that number is more than 2 to 3 points above the rate currently used in bids, the bid rate is wrong. A contractor using 11 percent in bids whose real rate is 17 percent is underpricing by 6 points on every project, and on $3M of revenue that's $180,000 a year of overhead that never gets recovered.
Compare revenue growth to line of credit utilization over the same period. A business that went from $2M to $4M of revenue while going from $150K to $320K of utilization is funding overhead from credit and not from project revenue. If the business were priced correctly, growing revenue would produce growing cash and not growing utilization.
Pull the overhead rate calculation and find the owner compensation line. Most owners who take draws rather than a defined salary never included it in the first place. If it's missing, or below $100,000 at $2M to $5M of revenue, the overhead rate is understated by the missing amount as a percentage of revenue.
At your current gross margin target and your current overhead rate, work out what net margin ought to be. Compare that to actual net margin over the last 12 months. If actual is more than 3 points below the theoretical figure, the overhead rate used in bids is below the overhead rate the business is incurring.
Step one, calculate the correct rate from current actual costs and not from last year's number or from an estimate. Step two, update the bid template immediately, before any new bids go out, and not at year end. Step three, monitor win rate for 60 days, because a 3 to 5 point overhead rate correction typically doesn't change win rate materially, since competitors are absorbing the same cost out of their own margin. The market price hasn't changed. Only your pricing structure has.
If the correct overhead rate produces bid prices that lose all competitive work, the market is pricing below true cost across every competitor. That's a different problem, and it calls for scope selection, market repositioning, or overhead reduction rather than accepting the old rate. In most commercial markets, correcting an understated rate by 4 to 6 points leaves a win rate that's still competitive, because competitors are also absorbing the shortfall out of margin.
FLAT MONTHLY FEE. NO SURPRISES.
Three tiers, priced by your trailing twelve month revenue. Which one you're in depends on how much of the work you want off your desk. No hourly billing, no payroll, and no add-ons.
Pricing
| Last 12 months revenue | Monthly fee |
|---|---|
| Up to $1M | $1,900 to $2,900 |
| $1M to $3.5M | $2,600 to $3,900 |
| $3.5M to $6.5M | $3,800 to $5,700 |
| $6.5M to $9.5M | $5,100 to $7,100 |
| $9.5M to $12.5M | $6,100 to $8,500 |
| $12.5M to $15.5M | $7,400 to $11,000 |
| $15.5M to $18.5M | $9,400 to $13,500 |
| $18.5M+ | Quoted individually |
Range reflects the three tiers below. Which one you're in depends on how much of the work you want off your desk. No payroll. No hidden line items.
You stop guessing.
You get the CFO work. Job costing built against the way you estimate, a 13 week cash forecast, monthly WIP, and a meeting every month that ends in decisions rather than a report.
Your bookkeeper keeps doing the books.
You stop touching the books.
Everything in Core, and we run the bookkeeping and the controllership as well. Nobody in your office is answering coding questions or chasing a reconciliation at month end.
We do the books. No payroll.
Every job shows its margin while it's still running.
Everything in Executive, plus the job costing and WIP platform set up, loaded with your cost codes, and managed for you every month. You never have to learn it.
We do the job costing.
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