# Actual Overhead Percentage



## James1979 (Jan 15, 2011)

Can anybody tell me why you deduct your profit margin when calculating actual overhead percentage?
The calculation to determine overhead percentage is as follows:

Annual Turnover - Net Overheads - Profit percentage and risk(as a percentage of annual turnover) = Net turnover

Net Overheads/Net Turnover *100= Actual overhead percentage


Why do you deduct a profit percentage to get Net Turnover?

Cheers any help on this would be appreciated


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## piercekiltoff (May 28, 2009)

James1979 said:


> Can anybody tell me why you deduct your profit margin when calculating actual overhead percentage?
> The calculation to determine overhead percentage is as follows:
> 
> Annual Turnover - Net Overheads - Profit percentage and risk(as a percentage of annual turnover) = Net turnover
> ...


Because you should always make a profit.


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## Mike's Plumbing (Jul 19, 2010)

James1979 said:


> Can anybody tell me why you deduct your profit margin when calculating actual overhead percentage?
> The calculation to determine overhead percentage is as follows:
> 
> Annual Turnover - Net Overheads - Profit percentage and risk(as a percentage of annual turnover) = Net turnover
> ...


Well, it all depends on what your approach is, when you figure a bid you use a formula right? 

I don't use words like "net turnover" but profit is something you add to a bid, normally it's a percentage. Overhead is also something you add to a bid. When wanting to calculate my overhead for the quarter I make certain deductions to arrive at actual overhead. But in the end overhead is just part of the formula. I express overhead as a percentage of sales in my calculations so in order for me to arrive at a correct number I have to deduct profit. 

Does that make any sense?

Mike


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## thom (Nov 3, 2006)

Overhead, as a percentage of revenue will vary with different levels of profit margin but will be stable based on job costs. Knowing your overhead costs as a function of variable job costs will then give you more useful information. 

Put another way, you want to add your profit onto the total job costs, including overhead costs. In order to do that, you need to calculate your overhead costs as a function of variable (job) costs.


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## katoman (Apr 26, 2009)

Mike will probably get a kick out of this. My method - I know what my overhead is per month. I incorporate this into my rate. 

Whether hourly, daily or weekly, I know how much is going towards overhead. 

I keep it simple. What percentage it is is secondary. Who cares? As long as you know how much it is and include it in the quote.


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## Mike's Plumbing (Jul 19, 2010)

katoman said:


> Mike will probably get a kick out of this. My method - I know what my overhead is per month. I incorporate this into my rate.
> 
> Whether hourly, daily or weekly, I know how much is going towards overhead.
> 
> I keep it simple. What percentage it is is secondary. Who cares? As long as you know how much it is and include it in the quote.



Why would I get a kick out of it?

I still use an abacus for counting:laughing:


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## katoman (Apr 26, 2009)

Mike's Plumbing said:


> Why would I get a kick out of it?
> 
> I still use an abacus for counting:laughing:


I was under the impression you think I'm a little strange in the ways that I figure things out.

The business plan thing........... I think maybe I am a little strange. Don't tell anyone. :wacko:


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## Mike's Plumbing (Jul 19, 2010)

katoman said:


> I was under the impression you think I'm a little strange in the ways that I figure things out.
> 
> The business plan thing........... I think maybe I am a little strange. Don't tell anyone. :wacko:


I don't think your strange at all, I think Canadians are strange but that's a different thread.:laughing:

I'm a whole lot more old fashioned than you may think and your way of doing things is not that far off from myself except I depend on a different set of rules to arrive at "living the dream"

As long as we both get there that's all that matters.:thumbsup:

Mike


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## THINKPAINTING (Feb 24, 2007)

Sorry but most contractors have no idea how to calculate there actual OH why most are long gone in 2 yrs or less....:thumbsup:


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## mehtwo (Nov 14, 2010)

THINKPAINTING said:


> Sorry but most contractors have no idea how to calculate there actual OH why most are long gone in 2 yrs or less....:thumbsup:


Yessir, those are the kind that look at their *gross* income and feel that now they can afford that expensive lifestyle.:no:


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## mehtwo (Nov 14, 2010)

katoman said:


> Mike will probably get a kick out of this. My method - I know what my overhead is per month. I incorporate this into my rate.
> 
> Whether hourly, daily or weekly, I know how much is going towards overhead.
> 
> I keep it simple. What percentage it is is secondary. Who cares? As long as you know how much it is and include it in the quote.


That's a "cut and dry" way to figure it. It's nice to have a simple view to figure things.:thumbsup: I tend to overcomplicate things.:sad: So, if I'm reading this right katoman, there are some months that you will make more profit than others?


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## GettingBy (Aug 19, 2010)

This is supposed to work
http://www.missouribusiness.net/sbtdc/docs/calc_overhead_percentage.asp

Or not.


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## IXL (Jan 22, 2011)

I guess it would help explain it better if I knew what your were doing with these numbers. Or what kind of turn over your looking at. (Fixed... things like your truck, and gas, office stuff, etc. and things like thing, etc. / or variable, like the amount of wood or sheet rock or buckets of nails you need for a specific job.)

The reason why you take away your profit for either though (basically) is because in essence those equations are made for measuring how well you are using what you have. I have a feeling your maybe trying to take your basic expenses and develop a percentage to charge to come up with your rate? I'm not quite sure if you got them from a template or whatever, but those are basically financial ratios. (Which is why you remove the profit margin, to turn it into a ratio, as opposed to a physical number) Anyways, these formuals are more so for benchmarking how a business uses it's assents. Less so it's fixed assents - but more so it's variable ones. (Like inventory... because if your a huge company, it pays to have the "perfect" amount of inventory on hand. Less spoliage, less storage space to provide, and more money to do other fun stuff with.) So if you sit and play with variable assent turn over ratio's all day you can save loads of money.

To mesh back in with your question. I've really never been taught to use these ratios the other way around, that is to use your costs in these methods and try to make a structured fee around it. Not saying it can't be done, but I have a BA in finance and just never learned it. If I were you I'd just spent one long night developing a pricing scheme on paper listing the round abouts price of near everything you use so you have that handy to price out jobs/stuff to have on hand. Then think of all your tools and come up with how much those will depreciate every year and put aside a number of how much you'll have to spend. Add that to the amount monthly (divided by 12) that you spend on gas, coffee, smokes, etc!

Hope I could help.


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## CENTERLINE MV (Jan 9, 2011)

This may not pertain to the OP, but here is a cut and paste from one of my previous posts (this is a method I've been using that I learned from M. Stone's book, "Markup & Profit"--a great, easy read that I highly recommend)

Figure out a LOW RANGE # and a HIGH RANGE # for ALL of the following (and whatever else you can think of):

Advertising
Sales (if you have sales guys)

Staff
Rent
Office Expenses
Office Equipment
Office Supplies
Telephone
Computer
Internet
Vehicles including tax, registration, & insurance (use a depreciated value--estimate how long your vehicle is likely to last--divide the bluebook value by that number--that's the annual depreciated value. Calculate new vehicle replacement costs)
fuel for vehicles
Job supervision
Tools & equipment
service & callbacks
cell phones
general expenses
owners salary
workmans comp insurance
liability insurance
any other insurance
money contributed to an 'OVERHEAD CAPITAL RESERVE ACCOUNT'
TAXES (that alone is over 20%--so there is no way your overhead is only 20%)
bad debts
licensing & fees
Accounting fees
legal fees
education & training
NOBODY works 365 days a year, (week off for christmas, holidays, sick days, days or weeks in between jobs)--these all need to be factored in...as a new business I know I won't have work every day this year. I will probably have the equivalent of 2 months without work--so I need to figure this into my overhead or I won't be able to cover my expenses while I'm not working.


Now, say you plug in all of your numbers & calculate your annual overhead expenses come to $50,000 (don't forget to depreciate your tools. For example I estimate my table saw will last 5 years. Say it cost $500. I can deduce that I will spend $100 a year on table saws. Do this with your vehicle, equipment, etc..)


Now the tricky part is estimating how much business you will do for the year (this is the trouble I'm having, personally). The longer you are in business, the easier this may become. Let's say you figure you will do $150,000 of business for the year.

You want your company to profit, (plan on 8-10% for profit--this doesn't include your salary--pay yourself as an employee. This number is the profit for the company, not for you.)so let's say you want 10% 

HERE'S WHAT WE KNOW SO FAR:

ANNUALLY:
Projected Sales Volume: $150,000
Overhead expenses: $50,000
Net Profit: 10%

OVERHEAD ($50,000) + NET PROFIT ($15,000 or 10% of $150000)= $65,000

Now, you need to calculate PROJECTED job costs.

If your O&P is $65,000 and your projected sales volume is $150,000, then you know your projected job costs are the difference, or $85,000

The markup you need to charge ON ALL OF YOUR JOBS FOR THE YEAR is calculated with these numbers.

take the Projected Sales Volume of $150,000
divide this number by your job costs of $85,000

the number you get from this (1.78) is what you need to charge for markup.

Here's an example.

Say you sell a remodel (these numbers are all arbitrary)

You figure that the salary for you, your guys, subs, etc.. is $25,000.
you figure the materials are $50,000.
the remaining job costs are $25,000.

YOUR TOTAL JOB COSTS = $100,000
YOUR MARKUP THAT YOU CALCULATED IS: 1.78

Your quote has to be for $178,000 for this job to cover all of your overhead & profit. Anything less and begin to lose profit. Anything less than that, then you take the job at a loss!

YOU MAY HAVE REALIZED, the higher your sales volume, the lower percentage your overhead is in relation to it.

For example,
Say you project your annual sales volume at $500,000
say your overhead is the same: $50,000
and you want the same profit: 10%

OVERHEAD ($50,000) + PROFIT ($50,000 or 10% of $500,000)= $100,000
PROJECTED JOB COSTS (sales volume minus P&O) for the year= $400,000
MARKUP YOU NEED TO CHARGE ($500,0000/$400,0000)= 1.25

NOW, SAY YOUR PUTTING IN A QUOTE FOR THAT SAME JOB WITH YOUR NEW NUMBER.

You already figured the job costs are $100,000
YOU NOW CAN DO THIS JOB FOR $125,000

The whole point of these examples is that every contractor needs to charge what they need to charge. Asking what other contractors charge is completely irrelevant to your situation. Say you only work half of the year because you like to sit at home and watch Dr. Oz rather than going out to look for work. Now say, I'm your competitor (and have THE SAME OVERHEAD THAT YOU HAVE) & I bust my ass to get work. From the example above, you can see that I will outbid you by far every time.

TAKE HOME MESSAGES:

If you don't know your overhead, you can't accurately calculate your markup. 

Completely ignore what other guys charge--it has nothing to do with what you need to charge.


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## katoman (Apr 26, 2009)

Centreline - that is right on. I agree with you.

The problem arises when larger companies can do the job and their overhead is 10%. If you are quoting with a 30% overhead, you won't get many jobs.

In the commercial work I've done, cost plus contracts, the standard accepted markup and profit is 10 plus 10.

Whether we like it or not, that's the reality. If you can't function with those numbers, don't quote the job.


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## Electric_Light (Nov 25, 2007)

CENTERLINE MV said:


> Your quote has to be for $178,000 for this job to cover all of your overhead & profit. Anything less and* begin to lose profit.* Anything less than that, then you take the job at a loss!


Unless you hit luck with a business that involves very little cost, businesses don't start off profitable. (Like Facebook, Napster, etc) 




> *The whole point of these examples is that every contractor needs to charge what they need to charge.*
> 
> If you don't know your overhead, you can't accurately calculate your markup.
> *
> Completely ignore what other guys charge*--it has nothing to do with what you need to charge.


I completely disagree. I don't know what your target market is, but its smart to shop around. I'd say more than half the fate of a service business is determined in the business office. 

If you're MV's gas charging $4.00/gallon and you claim that's what you need to charge while Al's gas across the street is selling the same for $3.00/gallon, I just won't go to your place. You're not the only gas station in middle of the desert, so what other guys charge means everything. 

People go to the grocery store and buy a Hershey's brand item for $1.50 rather than supermarket value brand for $0.75, because it's a small ticket item and they're not shopping for value. When it comes to construction work, it doesn't work that way, unless you're a hot shot architect working with the rich and famous. 

Things like "depreciation" are virtual and only matters for taxes. While they're legitimate tax deductible expenses, they don't contribute zilch to incoming cash flow and what matters is that you don't let your REAL accounts payable get ahead of incoming cash flow. 

Loan payments, rent, payroll etc are REAL expenses. Depreciation is not. Any amount of incoming cash flow that exceeds your variable cost contributes to your business. Even if you're doing things at nearly cost, moving a lot materials means you may qualify for discount from your supplier.

Look at Jiffy Lube. The grease monkeys are on the clock for scheduled shift regardless of customer volume, so the payroll is a steady cash outflow. When they have idle bays, they'll send a guy outside holding sign "open bay, $20, now only". Of course, this covers the variable cost and may or may not cover the entire fixed cost, reducing cash outflow to $20/hr is better than having a cash outflow of $24/hour($8/hr x 3 employees idle) when nobody is coming in. 

You don't want to be the guy who is hiring people by the day since there are costs associated with hiring/firing, but you don't want to be like the 24 hour restaurant with more waiters than customers. 

There are times when it makes sense to simply give away material. If you have some funky color paint left over from a previous job that you'll have to PAY to dispose, but you find some woman who wouldn't mind that color for one of her kids room, charging just the labor brings in cash + cut the disposal expense... or you could quote a standard rate, get turned down and have idle time as well as paying to dispose that paint. 

Inventory that you're itching to get rid of(bulky, zero salvage value or costs money to dispose) that you don't have any use for is sunk cost and when you come to an opportunity to use them, I think that does not count towards variable cost.


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## CENTERLINE MV (Jan 9, 2011)

:drink:


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## LMN (Jul 11, 2011)

*Overhead Recovery*

Great discussion... thanks to all. A few pts...

1. You can win more profitable types of work by breaking your overhead recovery into 4 percentages instead of one. Many contractors will use one... but it doesn't take much work to calculate individual recovery factors for labour, equipment, materials, and subs. 

For most of us, labor is the most difficult to control, and requires the most overhead expense to manage. Materials, on the other hand require minimal management. Take $15,000 worth of materials vs. $15,000 worth of labor. We can manage $15k in materials in a few minutes with a few phone calls, but we'll spend weeks managing $15k in labor. Charge a higher overhead markup on labor and a lower markup on materials, equipment and subs and you can find your way into some profitable work. *Download a quick guide here*. 

The link to the Missouri method shows all overhead being put on labor hours - that's another way of doing it. Putting ALL overhead on labor might be a bit much for contractors that use significant materials (works better for service-heavy contractors)

2. Electric_Light - Some good thoughts there. Depreciation - althought not technically cash flow, has to be factored somewhere, otherwise you're going to be out-of-pocket come replacement time. Whether you count your equipment expenses as variable or an overhead cost - some cost recovery must be budgeted, even if its depreciation. Say you bought a truck with cash. You use it for 6 years, beat the useful life out of it, then you need a new one. If you haven't factored the cost of depreciation over the last 6 years then what you *thought *was profit the last few years is now going to need to be spent on a replacement truck. If you're counting for costs on owned equipment - whether they're financing or depreciation costs - you're paying your customers to use your equipment.


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## Electric_Light (Nov 25, 2007)

LMN said:


> some cost recovery must be budgeted, even if its depreciation. Say you bought a truck with cash. You use it for 6 years, beat the useful life out of it, then you need a new one. If you haven't factored the cost of depreciation over the last 6 years then what you *thought *was profit the last few years is now going to need to be spent on a replacement truck. If you're counting for costs on owned equipment - whether they're financing or depreciation costs - you're paying your customers to use your equipment.


Replacement cost obviously needs to be considered and for that purpose, but that is different from depreciation. "depreciation" is used strictly to make it less burdensome with tax liability. 

When you buy a $50,000 truck and you get 10 years from it, then you could use $5,000/year for replacement budget allocation, but depreciation is scheduled as below. The below are the amount that can not be exceeded. 

non-passenger trucks are 5 year asset and IRS allows deduction as follows
1/$11,160 2/$5,100 3/$3,050 4 and thereafter/$1,875

By the end of 5th year you've depreciated $23,060, then you can continue deducting at $1,875/year but the grand total can not exceed $50,000. If you end up selling it for $30,000 at end of year 5, then $3,060 becomes taxable gain. 

This method lets you claim $11,160 at the end of very first year as depreciation cost.


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## john elliott (Oct 23, 2005)

Electric_Light said:


> I completely disagree. I don't know what your target market is, but its smart to shop around. I'd say more than half the fate of a service business is determined in the business office.
> 
> If you're MV's gas charging $4.00/gallon and you claim that's what you need to charge while Al's gas across the street is selling the same for $3.00/gallon, I just won't go to your place. You're not the only gas station in middle of the desert, so what other guys charge means everything.



Some good stuff right there.:thumbsup:

Everytime I hear or read about pricing, quoting, profit, overhead etc being discussed most of the comments I read, what they are basically saying is how much you need to charge, as if all you have to do if you want enough money to make a good profit is to ask for it!

Be nice if business was that simple.


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