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Overhead Recovery Rate Formula

Overhead is the silent killer of project-based businesses. These are the expenses that are the most likely to be missed when quoting a project because they are not attributed to any one single project. These are the expenses that keep the lights on in the business and are not left behind on any one job site.

This includes things like administration, professional fees, software costs, marketing, uniforms, rent, utilities, tools, equipment, maintenance, insurance, licensing, etc. These need to be incorporated into every quote going out the door otherwise these expenses will eventually add up and sink your business into debt and eventual bankruptcy.

So, how do you add these expenses into projects without attributing them to specific projects? There are several overhead recovery systems that calculate how much overhead gets attributed to any given project and we are going to explore them.

Overhead Recovery Methods

Below we discuss the various overhead recovery methods along with their pros and cons of each.

  • Factoring

  • Factoring involves multiplying Materials plus Labor (or even worse one of those variables) by a multiple. The justification for this is that if you subtract materials and labor from your Revenue, you are left with your Gross Profit. So depending on what you want your Gross Profit to be, you would adjust that multiple to get to that margin.

    For example, (Materials + Labor) x 2 would provide a 50% Gross Profit Margin. Unfortunately for those that think so, this is not the case. What Materials should be replaced with is Cost of Sale items. In that case it would cover Rentals, Deliveries, Disposal, Subcontractors, etc. In that case you would get closer to that 50% Gross Profit Margin, but even still that depends on how well you calculate your labor and the inefficiencies and hidden costs that come with labor.

    There are so many problems with Factoring…

    The easiest example to give are materials that cost different and take different times to lay. For example, a small paver that costs $2.50 per square foot takes longer to lay than a larger paver that costs $5.00 per square foot. However, if we choose to quote that $2.50 per square foot paver we will make LESS money than we would with that $5.00 per square foot paver based on Factoring and take MORE time.

    Additionally, this does not provide you with the data required to job cost at the end of the project to see if you went over or under on labor hours and individual Cost of Sale items.

  • Measurement-Based Pricing

  • Square foot pricing (or measurement-based pricing), consists of taking a measurement and multiplying it by a dollar amount to provide the total amount for that project. In the case of a patio it is square feet, but for a wall it would be face feet, and a curb in linear feet.

    The problem with square footage pricing is in the inaccuracy based on the variables of custom projects. Placing a flat square footage price on any project regardless of these variables will lead to some projects being financially successful (assuming your pricing factor is high enough) while others lag. The projects that lag are those that are not adjusted to variables including whether the project is a front yard or backyard, patio or driveway, raised patio or on-grade patio, the differences in paver prices, access to the backyard, etc.

    Unless you have a square footage price for all of these different variables, you are not calculating your quotes accurately enough. And if you do have a square footage price for all of these factors, then you may as well just have production rates to calculate your labor time in hours instead so that you can accurately job cost your project when it is completed to see whether you were high or low on hours while also separating materials from that equation to determine if you were high or low on materials as well.

    Measurement-based pricing is good for market-based pricing which is only beneficial for providing a pricing range to your client if they do not know what to budget for their project. This is perfect to qualify whether or not a lead is worth the time to meet with them for a consultation. However, just because your market is priced at a certain amount per square foot on average does not mean that is what you should charge. Instead you should add perceived value to help your company stand out from the rest in order to be able to charge above the market rate. This however is inapplicable to commercial work which is generally lowest-bid.

  • Single and Multiple Overhead Recovery (SORS and MORS)

  • Single Overhead Recovery (SORS) is a system of recovering overhead that applies a single percentage markup on Labor, Materials, and Subcontractors.

    Multiple Overhead Recovery (MORS) is a system of recovering overhead that applies different percentage markups on Labor, Materials, and Subcontractors.

    The largest flaw with SORS is that it assumes that Labor, Materials, and Subcontractors are created equal based on the same percentage markup on all factors. This is why MORS is a better system than SORS because the markup percentages vary based on the management expense (part of overhead) that is associated to each of these factors. Labor would be the highest marked up factor based on the amount of management required, Materials less so because there is much less management applied to ordering and the logistics involved with materials, and Subcontractors even less so.

    However, it is never a good idea to recover overhead through your materials. This actually goes back to our Factoring example. Installing small pavers will take more time and cost less in materials than larger pavers that take less time and cost more. In this example, the small pavers will not make you back the same amount of money for your overhead based on the percentage markup but it will take you more labor time to complete that project. We can take this a step further with retaining wall block. Leveling the initial course of retaining wall blocks takes the same time for non-machine installed product, yet retaining wall block will vary widely in cost. The percentage markup on materials will recover you less for the cheaper block and more for the more expensive block despite the labor time taking the exact same.

    Additionally, calculating your markup percentages is complicated and time consuming. A major reason why consultants love MORS. More time for them to bill you. In order to calculate your percentage markups you need to project what your Material, Labor, and Subcontractor cost will be for the year. This is fine if you do the EXACT same project day in and day out. That is likely not any hardscape business. For example, some projects may require a subcontractor and some do not. So what happens if you create a budget for a subcontractor on every project, but you end up not needing them for half of those projects through the year? Well, you would be out that overhead recovery for that. Same thing with Materials, that is difficult to put an exact dollar amount if you are doing custom work that can vary from project to project or with material pricing increases through the year.

    Labor is likely the easiest to create a budget for and that is why we prefer a Labor Rate recovery method for overhead and is the easiest way to ensure you are recovering your overhead.

  • Labor Rate

  • Labor Rate recovery assumes that you recover 100% of your overhead through your labor based on how long it takes you to complete a project divided by the amount of time you have in your season.

    This calculation is the total time to complete the project divided by the total time you have in your season to provide you with a percentage. If a project is going to take you 100 hours and you have 1,000 hours in your year, that project is going to take you 10% of your season. You then know that you need to apply 10% of your overhead to that specific project.

    Now you can get more complex with this and recover this through crews or number of employees. You can divide your overhead amongst your crews so that if you have 2 crews working they are each recovering 50% of your overhead for the year. Or you can do the same calculation with number of labor-producing employees so that if you have 10 employees you can recover 10% of your overhead in a year through each of those employees.

    We are working on a system that instead allows you to recover that overhead at a graduated rate depending on the seniority / position of your employees. For example, you can recover a larger percentage of overhead through your foremen and a smaller rate through your laborers. This assumes you foremen are likely more experienced and efficient and that your laborers are more likely to have a higher turnover rate in your business. This addresses the main con of labor rate recovery where it can be difficult to keep the number of employees in your business consistent to recover that overhead and can vary through the year.

Labor rate is our preferred method of overhead recovery and is what we use in the Headquarters Software. This software allows you to create a budget and build quotes from that budget to be able to incorporate your expenses into your projects to recover your overhead. It also has several other features for your business including Time Tracking, Scheduling, CRM, LMS, and many more features.

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