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Contractors often say with pride that they make a 20% margin or more on every project they perform. But when we look more closely at the numbers, we find margins are often much lower.
The culprit often is a failure to properly capture indirect job costs in the job schedules.
Indirect costs like equipment depreciation, equipment repairs, salaries and benefits for estimating and project management, fuel, and insurance, are examples of costs that are often not properly captured as part of total job costs.
The ramifications of not capturing these costs are significant, as the proper reporting of indirect costs is critical to construction accounting, impacting revenue recognition, individual project profitability, project bonuses, etc. Moreover, underreporting of indirect costs perpetuates inaccurate future bids since top management, project supervisors, and estimating teams do not fully understand the true cost of completing the work.
Over time, comparing line item costs from one job to another can tell the story. If your profit margins are low or are slipping over several reporting periods, running a profit fade analysis that looks at both direct and indirect costs provides a roadmap for corrective action that can be taken.
Avoid Profit Fade
If indirect costs are contributing to your profit fade – a gradual reduction in profitability over time – documenting and analyzing them consistently enables you to factor them into your bidding, billing costing, and project management practices. This will improve your forecasting and job costing and help bolster overall and project-based profitability.
It’s important to account for and allocate indirect costs in a timely manner, as they are incurred throughout the year to account for seasonal shifts. It may change the way you estimate and bid jobs if you’re not capturing indirect costs properly.
If you are not tracking indirect costs consistently, here are a few strategies:
- Start tracking indirect costs quarterly. You can ramp up to monthly later if necessary.
- Identify indirect costs and allocate them on a project-by-project basis.
- Consider obtaining a profit fade analysis to help identify issues with indirect costs.
Unfortunately, digital accounting platforms generally do not have the ability to code indirect costs in the context of job estimating, so accounting for them requires attention and an understanding of what does and does not qualify as an allocable indirect cost.
We’re here to help
Capturing indirect costs is a key strategy to improve construction accounting practices, boost profitability and address cash flow issues. If you have questions about how to start tracking indirect costs on your construction projects, JLK Rosenberger can help. For additional information, call us at 949-860-9902, or click here to contact us. We look forward to speaking with you soon.