Would you recognize an indirect cost if you saw one?
Indirect costs can have a substantial impact on a construction company’s financial picture and bottom line. But they’re not always the easiest things to “see.” Let’s zoom in to bring indirect costs better into focus.
Viewing the numbers
It helps to first define project costs in general. The Financial Accounting Standards Board recommends that construction companies treat job costs just like manufacturers treat inventory costs, calling them “the sum of the applicable expenditures and charges directly or indirectly incurred in bringing [a job]to its existing condition and location.”
Which costs are indirectly incurred? Generally, there are two identifying criteria.
- First, an indirect cost is identified with more than one job, such as workers’ compensation insurance.
- Second, it’s a cost that’s only indirectly related to the on-site construction, such as field cell phone charges.
Distinguishing from overhead
It’s important to not include overhead costs, such as office rent, when identifying indirect costs. To prevent this, identify costs that apply to more than one job. These typically consist of benefits for field workers, workers’ compensation insurance (as mentioned), jobsite liability insurance and builders’ risk insurance.
Fleet-related costs can often be found here, too, such as gasoline costs, vehicle maintenance and repair expenses, and equipment depreciation. Also look at rental costs for items attributable to more than one project, as well as repairs and maintenance for an on-site warehouse, trailer or storage yard.
It’s also important not to confuse costs that indirectly pertain to on-site construction with overhead costs. Common examples of these indirect costs include project manager salaries and benefits, cell phone bills, union dues, vehicle tracking and monitoring systems, and employee pension plan costs.
Using a cost driver
You can systematically allocate indirect job costs using a “cost driver.” Two common cost drivers are labor hours and dollars.
For example, suppose liability insurance for a construction company’s jobs costs $100,000 annually. So, that amount divided by 365 is $274 a day, or $8,333 a month. To follow the allocation process through to completion, you would tabulate the labor hours of each project on a monthly schedule. Then, perhaps with your accountant’s help, you could divvy up that $8,333 each month to put those dollars onto that month’s active jobs pro rata. Now that $100,000 is no longer overhead — those dollars are indirect job costs.
This isn’t the only approach. Many construction companies pool their indirect costs and then do the calculation and allocation instead of just doing it at the line item level. However you do it, once indirect costs are allocated and included in job reports, you and your team can discuss how to avert upcoming cash flow problems while you’ve still got time to make corrections.
For example, let’s say you notice an unusually high allocation for vehicle costs on one of your jobs. A closer look reveals a sizable outlay for a vehicle tracking and monitoring system you’re not using. In such a case, you could contact the software vendor and cancel the contract, lowering your company’s indirect costs.
Keeping an eye out
It’s easy to get hyper-focused on direct project costs. But indirect costs matter, too, and they can go unnoticed for much of the year. Be sure to keep an eye out.