While the economic tides may be starting to turn towards growth, the need to maximize
profitability remains vital, particularly following the recent prolonged weak landscape
within the construction industry.
Tight competition and rigid profit margins translates into no allowance for costly
mistakes; as such billing rates must be “right on the money.”
For a construction company to properly determine its billing rate for each class of
employees, it must first establish its burden rate, followed by the fully-burdened cost per
hour worked by employees and the overall average for each class of employees.
Defined as the total amount of indirect contract costs, burden rate is calculated as a
percentage of the construction company’s direct labor. Translation – for every dollar of
direct labor allocated to a contract, burden is applied as a percentage of the direct labor.
The burden rate can be accurately calculated only if all contract costs assumed by the
contract company are fully accounted for and factored into the final burden rate equation.
Two classifications of contract costs exist – direct and indirect. Direct or prime
contract costs are all expenditures directly associated with the project…for example,
subcontractors, direct labor, materials and supplies, equipment rentals, bonds and
permits.
Less obvious are indirect contract costs, including workmen’s compensation, general
liability and automobile insurances, motor vehicle and equipment repairs and
maintenance, depreciation, field communications expenses. And don’t forget employee
benefits such as health, life, disability, profit sharing, bonuses and 401(k) match and
payroll taxes. Furthermore, all costs associated with paying employees, including FICA,
unemployment and Social Security should be calculated as part of labor.
The indirect contract costs list continues with vacation time, holidays, sick days, training,
safety and clothing and the replacement cost of small tools that are lost, stolen or
abandoned.
Variable overhead should also be factored into the overall mix. This category includes all
costs directly related to employees that cannot be divided accurately between jobs, like
fuel and cell phones.
Depending on the benefit package involved, employee related costs will typically account
for 24% to 33%, for a non-union contractor. For a union contractor, the burden rate for
employee related costs will range from 60 % to 70%. Take note – the rule of thumb is to
use a 1.0 workmen’s compensation modification rate if the contractor’s rate is more than
1.0.
Burden rates for open-shop contractors will vary, based on employee benefit packages,
SUI rate, workmen’s compensation modification rate, depreciation on new equipment
and automobile insurance.
Companies that are equipment intensive – such as small paving contractors – should
include all equipment and related operational costs as part of its labor burden rate since
the same equipment is consistently used. Since larger paving contractors that primarily
fulfill public contracts typically utilize the services of a separate equipment company,
their burden rate should be based on a calculation of the estimated average cost per
hour for each pool of equipment based on the estimated and known costs divided by the
estimated annual hours the equipment will be used.
Labor burden calculations should be reviewed about every six months – regular
assessments will open eyes to adjusted costs that might otherwise be forgotten, such
as changes in the company’s insurance rates. And don’t forget to add in anticipated
employee raises for the upcoming year in advance of bidding on projects that will be
completed over the next twelve months when that raise is in effect.
Software packages are readily available to calculate and affix indirect contract costs to
the total job cost as each labor dollar is applied. The resulting detailed reports can help to
accurately bill a job, gauge future estimates, and keep management informed of the true
costs of a project. Only then can an authentic measurement of the operation’s burden rate
be taken, leaving no aspect underestimated…or worse, overlooked.
(Editor’s Note: Jack Ganley, CPA, Shareholder and Director of Construction Services
of Kirkland, Albrecht & Fredrickson, LLC, has over thirty years experience providing
audit and business advisory services to the construction and other related industries.
Jack has written articles and presented seminars on topics such as burden rate analysis,
working capital analysis, financial statements for contractors, modern financial ratios
for contractors, the contractor’s business model and systems of internal controls
for contractors. The company, located in Braintree, MA, is one of the leading CPA
firms in the Boston area, offering expertise and insight needed to develop innovative
solutions to all of their client’s financial needs. For more information, please visit
www.kafgroup.com or call 781-356-2000.