As seen in the Boston Business Journal
Contractors often have questions ranging from operational queries to tax planning. With small and startup contractors, however, it seems the main question is always, “How come my bottom line is not reflective of how I bid my work?” Nine times out of ten, the answer is the same: burden.
Burden is the cost of contracts, which is much harder to track and estimate than typical job costs. Most contractors understand their direct job costs and their standard overhead costs, but the concept of burden is usually not something that is understood when starting a construction company.
If, for example, you bid a job at 20 percent gross profit and your standard overhead runs at 10 percent, you would expect that at the end of the day you should see a net profit of around 10 percent. Many times contractors in this situation ask why their net profit is only 5 percent. In that scenario, it is most likely that there are additional burden costs of around 5 percent. What is burden?
Burden is essentially job overhead. These are the costs that go along with performing contracts, that are not directly related to any single contract. Typically these costs are expenses like insurance, equipment depreciation, down time, etc. If these costs are not tracked separately, it can cause two issues:
- your job profitability will be “overstated” on the work in process (WIP) schedule and
- you may be underestimating your work and losing valuable profit on each job.
To handle burden properly there are a few exercises and report changes that are helpful. The first exercise is to look at your income statement and segregate your costs into three buckets:
1. Your “direct” cost of goods sold. Direct costs are costs that are specific to a certain job. These costs are generally made up of material, subcontractor, equipment costs, etc. Direct costs are easy to track and are posted to jobs accordingly.
2. Your “indirect” cost of goods sold. These are your burden costs and are typically the costs noted above like insurance and depreciation. These are costs that would go away if you stopped doing work, but are not job specific.
3. Your standard “overhead” costs. These are costs that remain, regardless of whether or not you perform work. Typically this includes expenses like office salaries, advertising, etc.
Once you have your income statement segregated, there are a few ways that can help make tracking burden and tying out your work in progress (WIP) schedule much easier.
First, group and label these accounts on your income statement. By having headers “Direct Cost of Goods Sold,” “Indirect Cost of Goods Sold,” and “Overhead Costs” with subtotals, it allows you to track each of these cost groups and use the totals for tying out the WIP and calculating your burden and overhead rates. In order to fix the burden issue, these indirect costs will need to be “burdened” to the job as either a percentage of total billings, or as a percentage of labor.
Once you have your income statement segregated, you can now see that lost 5 percent directly on the income statement under the “Indirect” subtotal. By understanding the total cost in that bucket, you can decide how you want to burden those costs to the jobs.
One easy, effective way is to take the total “Indirect” costs for the month and apply them to each job based on the total amount of billings for each job that month. This is more of a proration approach.
Another approach is to evaluate this total for the prior period and divide the total by the number of direct labor hours in the prior period. This method gives you a dollar per hour of burden costs. You would then apply this dollar amount per labor hour to each job.
To apply these costs to jobs, you will need to set up two new accounts on your income statement. The account for your debit to apply the costs will be “Direct – Burden Applied” and will be grouped in your “Direct Cost of Goods Sold” bucket. The account for your credit will be “Indirect – Burden Applied” and will be grouped in your “Indirect Cost of Goods Sold Bucket.”
Keep in mind, if you are using an estimated rate, such as the labor method, you will now be able to track your over- or under-applied burden directly on your income statement. If your “Indirect” subtotal turns negative, it means that you are over-applying costs to your jobs. If it remains positive, it means you are under-applying costs to your jobs. In either case, you will need to be aware of these rates when estimating new work.
Burden can be the detriment to many small and startup contractors. Burden should be understood and evaluated quarterly to ensure that jobs are being estimated properly.
Burden is especially important during large growth phases, as the amount of burden can change drastically from quarter to quarter. If you are not evaluating these costs, you will be fighting an uphill battle for profitability.