To price services and projects effectively, a construction company needs to have a firm grasp on its costs. Direct costs are the costs specific to a single project, whereas indirect costs are incurred for all projects. Construction companies must allocate indirect costs to individual projects to know the total expense incurred for each project.
Direct costs are costs that can be directly traced to a cost object. For a construction company, direct costs are the costs incurred for a specific construction project. Potential direct costs are:
- Materials -- like wood, cement, gravel and sand -- used for the project.
- Other supplies used on the job, such as machine parts, as long as the machine is only used for a specific project.
- Temporary utilities, sanitation facilities, enclosures and office facilities at the project site.
- Project-specific salaries -- including wages and payroll taxes -- for construction workers, foremen, supervisors and schedulers.
Indirect costs are expenses that benefit more than one product or project. These are also called overhead costs. Potential indirect costs for a construction company are:
- Executive, administrative, marketing, sales, accounting and human resource salaries.
- Salaries of supervisors and managers who work on multiple construction projects.
- Marketing and sales materials.
- Corporate office rent, utilities and property taxes.
- Depreciation of buildings and construction equipment.
- Professional fees.
- Travel and entertainment expenses.
Allocating Indirect Costs
To price contracts well, the construction company must devise a way to assign indirect costs to individual projects. The first step in allocating costs is to understand what's driving the cost. By doing that, the construction company can customize an allocation schedule for different sorts of expenses. For example, it may keep records of supervisor and manager work logs and allocate salaries based on actual time spent on the project. For the cost of insurance or taxes, the company may allocate indirect costs based on the direct costs the project incurs. Other allocation metrics could be the total sales price of the project or the number of labor hours incurred on the project.
If a company prices its contracts based on direct costs alone, it's underestimating the true cost of the project.