The end of the year is a great time to examine your overhead costs, and that’s what we’re discussing this week. Find out how to calculate overhead, why it seems to only go up, and what you can do to control those expenses and take home more of the money that comes in.
Topics we cover in this episode include:
- Why you should look at your overhead as a percentage of your real revenue, and how to calculate both
- How to review and analyze your profit vs. expenses
- How looking at overhead as a percentage of real revenue helps you see things clearly even with fluctuations in your business
- Strategies for reducing expenses and how Proft First helps
- The benefit of tying employees bonuses to efforts to reduce overhead
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[00:00:00] Rob Williams: Welcome to the Contractor Success Forum. Today, we are discussing overhead in our construction businesses. At the Contractor Success Forum, we discussed financial strategies for running a more profitable, successful construction business. Check out our show notes and rate us, give us a big five star rating for the Contractor Success Forum.
And our hosts today: in one corner, we have Stephen Brown. He’s providing construction risk control through bonding and insurance. Stephen stays relevant through a career dedicated to solving the needs of his clients and offering solutions that work for his customers, with over $500 million of bonds approved in just the last five years. Stephen is poised to help you take your business to the next level. Stephen is with McDaniel Whitley bonding and insurance agency.
And Wade Carpenter in the other corner is with Carpenter and Company CPAs, and he is helping contractors nationwide to become permanently profitable for over 30 years. And Wade provides us with accounting, auditing, bookkeeping and consulting with tax matters in the construction industries.
And then I’m Rob Williams, your profit strategist with IronGate Entrepreneurial Support Systems, helping you drive profits in your businesses with decades of experience as a contractor. Guys, overhead today.
[00:01:38] Stephen Brown: Talking about overhead is about as exciting as reading insurance policies.
[00:01:42] Rob Williams: Yeah, it’s going to be exciting because we’re going to learn how to control it though, right, Wade?
[00:01:46] Stephen Brown: We were going to control it.
[00:01:47] Rob Williams: How much how much overhead should we control? Do we have the typical business where we just budget it out?
[00:01:57] Stephen Brown: I can say I have a number of customers that don’t bid the price overhead into their bids. It’s there, but it’s not there.
[00:02:05] Rob Williams: Yeah. What is overhead, Wade?
[00:02:07] Wade Carpenter: Yeah. Overhead is not a sexy topic and I think we could probably do a whole show on what overhead is and the definition, the accounting GAP standpoint versus the owner versus a project manager trying to get a bonus. But for today’s purpose, can we just say overhead is all the costs that you’ve got that are not job costs. That have had nothing to do with jobs. Is that fair?
[00:02:31] Rob Williams: That of sense to me.
[00:02:34] Stephen Brown: I heard a story about someone going into a store and there was a rude salesperson. And they reminded him, I’m the profit margin and you’re the overhead. know, So you know, it’s not glamorous. Profit is glamorous. Making and keeping profit, that’s the sexy stuff. But part of making profit and keeping profit is controlling your overhead and understanding how to account for it. Right, Wade?
[00:02:59] Wade Carpenter: Yeah, absolutely. And again, nobody really wants to talk about it, but it’s, overhead is something that never ever seems to go down unless you have a catastrophic event like The Great Recession and people have to make big cuts or something in their organization. Here at the year end, we’re kind of reviewing that with a lot of people.
And kind of looking at that. So I’ve got some tips for that we can talk about later on.
[00:03:23] Rob Williams: Yeah. You know, Wade, that is a big thing. I remember I was always projecting out in a spreadsheet, you know, the future growth, especially in these growth times. And it was easier to make the numbers look good when I would get some permanent costs in there. The permanent costs are usually cheaper on the spreadsheet than the variable cost. But the problem is when things go back down again, they’re still there. So that spreadsheet that was for an idealistic situation didn’t necessarily look too ideal a couple of years later when it doesn’t disappear anymore. It just keeps growing and it doesn’t come off.
[00:04:00] Wade Carpenter: Right. I’m reminded from 10 years back or 12, with The Great Recession, one of my favorite types of construction is the heavy equipment guys, the guys are digging the dirt. They have tons of money and heavy yellow iron.
A lot of my client base was decimated in that. A lot of them did not survive. And the ones that I remember that survived were the ones that kept their overhead low. Sometimes they’d run it out of their kitchen table, versus having this really nice office and having, very nice spread for, you know, showing off. Those are the ones that survived.
And so I’m kind of like, especially with current situation, with inflation, the cost of labor and materials going up, I’m reminding people that well, maybe you should be thinking about a healthy business right now. Not, how much can I save on taxes?
[00:04:50] Rob Williams: Yeah, I can remember. I think I had bought, it wasn’t heavy equipment. We had our development company that we had that, but most of that seemed to be kind of paid for. But I remember about ’06, ’07, is getting seven or eight trucking rigs to control all of our shipping and stuff so we could bring it in house because we couldn’t get that volume up to meet the demand without bringing it in house. Because we had to have our own trucks to get it in there.
Boy, it, ’09, they really looked ugly. We were negotiating payoffs with the companies for those. That was really ugly. But we thought, you own your own equipment, you do this stuff to get in there. One, you had the control over it, but there’s also this thing of kind of a misconception of owning your own equipment and you get your costs down.
But I think paid-for equipment would have been the best thing. I remember another company, a lumberyard that we almost bought, that had a lot of trucks, but I think most of his were paid for. So they did a little bit better in the recession than some of the other ones did. Even though they had a lot of equipment, I don’t think it was financed.
[00:05:57] Wade Carpenter: Those heavy yellow iron guys, when things stop with a great recession, they still have those notes to pay on.
[00:06:04] Rob Williams: Yeah.
[00:06:04] Wade Carpenter: $100,000 machines and stuff like that. That’s great, when you’ve got tons of money coming in, but when the music stops, it’s really tough to make those payments. And unfortunately, people were dumping their equipment and there was so much on the market. You could snatch it up cheap, but you know, if you can’t make use of it, it’s just overhead.
[00:06:26] Rob Williams: Oh, yeah. Still gotta pay that, not only the interest, you usually have to pay the principal too. So that’s ugly.
[00:06:33] Wade Carpenter: Yeah.
[00:06:34] Stephen Brown: Okay. So what else is generally considered overhead expenses? I mean, you know, you’ve got your office, right? And you’ve got your bookkeeping staff. You’ve got your electricity.
[00:06:44] Wade Carpenter: Yeah, we could drill into specific line items. A lot of mine you talk about cutting your accounting, stuff like that, I’ve had a lot of people try to cut expenses or by outsourcing their accounting and outsourcing some project management. Bidding, sometimes you can take a look at do some of those things. But you know, if you want to talk about specific line items, we can, but–
[00:07:05] Rob Williams: Well, I think a lot of it is the process of what you do. That’s what I was thinking about. Because most of these items, it’s not something that you think of. I was just actually going over my monthly thing. It’s the first of the month here. And I was just looking at mine this morning, before this podcast. And there was a lot of line items and things that I had to look up. I didn’t know what it was. And I was like, what is that? I had to search it on the internet and say, oh, that’s what that was.
They creep up. You have to just go down. You got a page of these things. Or pages of these things. You have to go down every one of them, all these subscriptions that you’ve got, the things, and those are smaller items, but they really end up adding up to a lot of money over time.
[00:07:47] Wade Carpenter: Well, I’ve got five different tips. Here at the end of the year is a good time to review that stuff. So start by looking at it globally, overall. Pull the last five years of your profit and loss statements and, see what that line item is at the bottom and G&A expenses. And if you look at it year over year, the reason I say five years, you’re probably going to look at that and say every year that number has gone up in total.
So after we do that, then let’s take a look at, just this year versus last year on a category by category basis. So, did it go up or did it go down? Most of the time it’s going to go up, but how much, you know, after that, just look at the dollar value increase category by category. And then go in and look at a percentage increase, in category. Did it go up or go down and finally, just to kind of wrap that up, take a look at that overhead line by line as a percentage of revenue that you took in.
And a lot of times that little percentage of revenue is going to fluctuate depending on, did your revenue go up or go down. But if you see that number going up, you’ve kind of lost ground, if that makes sense. If your revenue either even stays the same or whatever, if that percentage went up, you’re going the wrong way.
[00:09:09] Rob Williams: Yep. We never really looked at our line items in our overhead as dollar amounts. We always had the percentages. Back then we wrote our software and we always had the number, and then we had the percentage. And I always looked at the percentage. I think we were much more aware of that percentage number.
It was a percentage of revenue and it wasn’t real revenue. We’ve got some advanced ways that we look at that now that I didn’t have back in those days.
[00:09:38] Stephen Brown: And as a bond underwriter, we were taught as a general rule of thumb, 12% of your sales or under is okay for overhead expense, but that varies depending on the contractor, right, Wade?
[00:09:51] Wade Carpenter: Oh, absolutely. If you’re a commercial general contractor versus a heavy yellow iron guy versus a subcontractor, it’s going to be different for different types of construction. But you know, going back to something Rob just said, that is a better way to look at it. If you take a look at your percentages of overhead as a percent of your real revenue, that really is I better, you know–
[00:10:13] Rob Williams: And define real revenue again for us.
[00:10:15] Wade Carpenter: So, from Profit First, it’s, your revenue minus your subcontract stuff, plus your materials.
Rob, you can explain why we picked those out, but once we subtract that it’s not cost of goods sold. It’s a different definition.
[00:10:32] Rob Williams: And I just had that argument with somebody yesterday. Do you mean cost of goods sold? No, this is was not the same thing.
[00:10:39] Wade Carpenter: So Rob, you want to explain why we break it out like that?
[00:10:42] Rob Williams: Yeah. So just to repeat what he said: you take your revenue and then you take out your subcontractors and your materials, so subtract those out. And then that leaves you your real revenue. The real revenue is the money you have left over to run your business. And when you have subcontract labor, it’s going to go out. They’re not really in there with you. They have overhead that they are taking for those guys. And so you’re putting that number in there with that. When you have your own labor, you have a lot of overhead, which we just said that is associated with that labor, or burden– may not be classified as overhead in construction because it may be a burden on there.
You’ve got to have all the additional things for that when you bring that in there. And then that’s when the percentages make a lot more sense. Because if you’re doing a percent as total revenue, then that’s also the percent of the materials and the subcontractors. You shouldn’t have a large percent burden on that. Where everything else, you have a lot larger percentage problem. That leftover revenue, we’ve got standards across, even outside of these industries that seem to work a lot more. They stay in line as benchmarks so much more closely than when you’re comparing these construction companies. They’re just all over the place. But once you take that subcontract and material out, these benchmarks that we have seem to be a real good guideline for the successful companies.
Everybody’s not right, but it gives you a good point. A good starting place. And that’s what attracted me to Profit First. It’s just seeing that it’s like, God, I had been trying to work this out for decades. And when I saw that and I was like, oh, that’s it. That the number. That’s the way you look at all these companies.
You can compare them to each other and see if they’re good. Taking a percent of the real revenue. Now I have not seen financials reported that way with percentages. I don’t think it’s gotten that far. Have you, Wade?
[00:12:48] Wade Carpenter: GAP would probably, they would never allow something like that, but internally, expand on what Rob said, the short definition of what he said is subcontractors and materials are money that’s going out, that’s not going in your pocket.
[00:13:02] Rob Williams: Oh yeah.
[00:13:03] Wade Carpenter: It went in somebody else’s pocket. And I just had this conversation last week with a plumbing contractor, that they had a very different mix this year. They had increased their top line significantly, but the gross profit had fell. And mainly because they were subbing out a bunch more. So looking at your overhead as a percentage of real revenue kind of takes out those fluctuations when you did a different type of work or you were subbing things, or you had jobs that had heavier on the materials.
Does that make sense, guys?
[00:13:38] Stephen Brown: It does, you take that out and you’re saying you get the real revenue and then you look at that percentage of overhead over the last five years. And you look for trends that are increasing, that don’t make sense? that it? What are you looking for?
[00:13:54] Wade Carpenter: Well, I think there’s several things we can talk about what we’re looking for and, as long as you’re getting value for what you spend, that’s what we’re trying to do. But, we also obviously want to decrease waste. And I just had this same conversation with another contractor that they don’t feel like they waste any money, but they will, at this time of year, they’ll go buy a whole bunch of equipment or another pickup truck.
And they don’t think they’re wasting it because it’s like, I’m reinvesting in the business. There are tools and things like that that are going to wear out, that profit, once it’s gone, it’s gone. Does that make sense?
[00:14:30] Rob Williams: Yeah, you know, one point is, how can you control this overhead? We were talking about identifying it, but before we get through with this episode, I’d like to talk kind of briefly about that because, it’s just like your home budget.
Things make sense when you look at them on an individual basis, it’s, okay, it makes sense to go buy this thing. And you can justify it, but where is that in the overall picture? Because you can justify 20 things, but each one of them may make sense. But getting all 20 of them don’t add up. Then your overhead is way over the percent. There’s some kind of disproportion there when you start justifying multiple items.
So you have to have a total bucket. And so what we do in Profit First is take that real revenue that we were just talking about and find that percent of it. And then that goes in that separate account and everything has to be paid for from that operating expense account. Even if that individual item makes sense, but they don’t make sense as a whole, it doesn’t make sense to do that. Maybe it’ll make sense to do it next year, something like that. But you can’t go over that because then your whole profits are done. That’s kind of where my weak link was is I individually assessed a particular item and a profit and it looked good. But when you had all these people selling you stuff, 20 of them just doesn’t make sense.
[00:16:01] Wade Carpenter: Yeah.
[00:16:02] Rob Williams: Can you word that better than I did, Wade?
[00:16:04] Wade Carpenter: Well, I don’t know if I can do that, but reducing expenses is hard and I was going to actually come about it from the Profit First angle in a minute. But you know, a couple of other things that happened to me when I first started doing this, it was somewhat by dumb luck that I actually had a credit card compromised.
And that may sound like the stupidest thing that’s ever come out of my mouth, but I had so many recurring charges on my credit card that, they canceled the card because of fraud, I had traveled and somebody got ahold of the card. But I had to go through and set it up on a new one and that process was like, hey, do I really need this expense? And that was kind of a blessing in disguise.
And the other thing that happened to me when I was implementing: I was trying to implement Profit First with the bank I had, that I had for 15 years. And number one, they were not very accommodating, but at some point I finally said enough’s enough.
And I also figured out that when I changed banks, that I had a ton of ACHs coming out of my operating account that I never really thought about. So I took that occasion to like, say, hey, do I really need this expense? Do I need to really set it up? Or can I just go ahead and cancel it?
And my final tip on that part is, in general, some people believe in open book accounting. A lot of people are very guarded about their accounting. But one of the things that I’ve done and I’ve actually gotten a lot more open book myself, but, even if you have certain people on your team and you only show them, say your overhead items.
And show them hey, this is what this year versus last year, and did it go up. And tie your employees’ performance bonus or something like that to, let’s keep overhead down. Well, number one, I hate to say it this way, but they’re going to bust your balls about doing that. And there’s some pros and cons to that because you, as the owner are probably going to get very defensive about, I spend money for this and this is why I need it. But it’s a great way to do a self check, gut check, on what you’re spending.
[00:18:17] Rob Williams: Yeah. One good point. I don’t think I’ve ever had employees guess high on what the expenses were, the overhead. When you talk to them. So when they see those, every time they’ve been shocked at how high they were. We think the opposite. They think we’re making a lot more money than we’re making. Almost always.
But the overhead thing is, yeah. If they see that one account that they can control, they just think all this money’s coming in and they can spend it. When it’s in that small plate that we talk about in Profit First, it really sheds a light on them. And then they help you do that. A lot of the guys, they actually want to help. We think when they don’t have that control, they kind of tend to– at least for my experience, they tend to see how much they can get away with to get the latest tools and stuff, because they didn’t have any skin in the game. It’s all, can I have these things? Can I have this? Can I have this? Can I get the new truck? But when they see that, boy, it puts a whole new perspective and they usually want to help.
[00:19:15] Wade Carpenter: Yeah, they do. And I didn’t think I’d go down this road today. If you guys remember, maybe you’ve read this book might be haven’t, but there was a guy named Jack Stack that wrote the Great Game of Business. And I actually did this about six months ago with my team, but there’s a little exercise in there.
We actually counted out like a hundred pennies. And we said, how much of these pennies do you think we’re taking home as owners? And inevitably people think it’s a lot higher than– and then I broke it down, like how much do you think we spend in overhead? And just moving a hundred pennies around, it was kind of comical, but you know, it taught my team a lesson and I’ve done it with a couple of contractors, and it’s amazing to see the disconnect between what the team thinks we’re taking home versus what we all actually get to take home.
[00:20:08] Rob Williams: I had done that with a two by four, I guess it was 10 feet long. I can’t remember the specifics. But I did two drills with it. One, they were wasting a lot, so they could get their labor down. This was in the truss manufacturing plant. And then when I showed them, I started writing every foot. How much every foot of that two by four cost. They realized, boy they were saving a few cents in the labor and costing $10. It was 10 to one ratio.
But then also the other way, I don’t think I was as successful that, was taking that board and then color-coding the board to how much of that board went to overhead and how much actually came out. It was a little bitty piece.
I think we might even been losing money at the time. So I think that made the drill kind of hard when you’re losing money. It’s like, where’s the extra board? But I tried to quantify that in wood instead of pennies.
[00:21:00] Stephen Brown: Too expensive! I suggest you use pennies.
[00:21:04] Rob Williams: Yeah, well, we were wasting all the wood. We had it sitting over in the corners and in the dumpster, I was able to get it out of it. I probably used a crooked board, instead of a straight one.
[00:21:15] Stephen Brown: Well, you should’ve had a circular saw and cut off each section and threw it at whoever was spending that section.
[00:21:23] Rob Williams: I will say I finger jointed it together to form one long board with all my scraps. How about that? I glued–
[00:21:29] Stephen Brown: It sounds, it sounds better. And then afterwards you used it at a construction job.
[00:21:33] Rob Williams: Right. That’s–
[00:21:34] Stephen Brown: Okay. So that’s a great tip, Wade. You said you had some more.
[00:21:38] Wade Carpenter: Well, going back to the Profit First stuff. The Profit First methodology, by putting it in the buckets, if you put it in a bank account and this is your Op Ex and even though you got a ton of money sitting there, we’ve got it in one bucket. And if we look at that bucket and that’s all we got to spend, that is a natural way to say, hey, I don’t have the money for this. And you’ll stop justifying a lot of those things that you’ve spend money on.
[00:22:06] Rob Williams: I agree. I agree. You got to get it in the bucket and see where you are in the overall picture. Not each thing can’t just make general sense. That’s I keep thinking my home life on that too. My wife and I, she doesn’t listen to this podcast, so I can say that. It’s about the emotion of the spending. It’s not about how much is left in the bucket.
[00:22:27] Wade Carpenter: Just a couple of other things I was going to throw out there. Yes, if we do Profit First and we put a bucket to spend in our Op Ex, but if we put stuff on our credit card or we run up our line of credit to do it, we’re defeating the purpose. So stop using credit cards as a crutch and try to run it from a cash basis standpoint.
[00:22:45] Rob Williams: Yeah. So when it doesn’t make sense– you just reminded me of something I was going to say. When you’re looking at those items that make sense individually, well, maybe it’s something that’s needs to be subcontracted out and you don’t have that savings this month. But eventually keep that in mind, and when you can work it back in there, then work it out. You just can’t do everything at once. So just maybe subcontract. Well, we were talking about buying equipment, maybe that you have to subcontract this or subcontract the trucks out or whatever you can until you can afford to pay for it. It looks like it’s opportunity lost, but really it’s not because the bottom line is what your whole company bottom line is making, not what that one little project is. And it seems like it would all add up, but it just doesn’t. And you just have to see that. The emotions that you put in there. And the justifications got to go out the window. I know it seems counterintuitive, but look at the bucket and stick to your buckets.
[00:23:44] Wade Carpenter: Yep. Final tip. We recently did a show on what to do after Profit First is in place. But when you put those percentages in place, they are not set in stone and they’re not designed to be set in stone. And next quarter, increase your percentage or your owner’s comp take home or whatever. By pushing those up, it naturally pushes down. There’s not as much operating expense category leftover, so that naturally pushes you to continue to keep that overhead low.
[00:24:12] Rob Williams: Yeah, that’s Parkinson’s law. So, whatever is there and that you’ve put in there, it’s going to be spent.
It’s just going to find its way to justify, that psychological justification I was just talking about. So you just gradually wean that down.
[00:24:27] Wade Carpenter: Yep. That’s all I’ve got.
[00:24:29] Rob Williams: That was great! Stephen, what’d you think about that?
[00:24:33] Stephen Brown: Well, I thought it was very interesting. I like that idea of tying employees’ salary increases partially to overhead, which means you’d have to give that particular employee a budget for their expenses. Maybe not all of the expenses, but just what they have oversight of.
[00:24:53] Rob Williams: Yep. Well, that’s great. Well, these have been some really good ideas today about overhead on the Contractor Success Forum. Lots of good ideas on here. Give us a five star rating down there at the bottom and come listen to our next show.
We are Stephen Brown with McDaniel-Whitley bonding and insurance company and Wade Carpenter, Carpenter and Company, CPAs.
And I’m Rob Williams with IronGate Entrepreneurial Support Systems. Glad to see you here and check out our next show.