How Contractors Should Allocate Overhead

For many home improvement contractors in Colorado Springs, the hardest part of running a profitable business is not finding work. It is pricing that work correctly. While most contractors keep a close eye on materials and direct labor, many forget about the quiet costs that keep their business running: overhead. These hidden expenses often decide whether a job is profitable or not. Without a clear system of overhead allocation, contractors can unintentionally underbid, erode their margins, and struggle with cash flow.

What Counts as Overhead

Overhead is everything you spend to keep your business running that cannot be tied directly to a specific project. While direct materials and labor go into the estimate for each job, overhead is the glue that holds the company together. Examples include:

• Insurance (general liability, workers comp, auto, bonding)
• Vehicle costs (fuel, maintenance, repairs)
• Office rent or home office costs
• Utilities and phones
• Software subscriptions
• Marketing and advertising
• Tools and equipment not tied to a single job
• Salaries for office staff or owner’s administrative time

When contractors fail to account for these costs, they appear profitable on paper but struggle to cover bills in reality.

Why Overhead Allocation Matters

The construction industry runs on slim margins. National studies show that the average net profit for small contractors hovers around 5 percent. That means a small mistake in estimating can wipe out months of effort. If overhead is not included in job pricing, contractors may be winning bids but losing money on every project.

Consider a contractor who bids jobs at cost of materials plus labor plus a modest markup. If their monthly insurance, truck payments, and office expenses total $10,000, those costs must be spread across jobs. Without allocation, the contractor may finish projects on time, with happy customers, but never see the profits they expect.

Methods of Allocating Overhead

There are several ways to allocate overhead in a construction business. The best method depends on the size of the company, the types of projects, and the accounting system in place.

Percentage of Direct Labor

One common method is to calculate overhead as a percentage of labor costs. If annual labor is $200,000 and overhead totals $50,000, then overhead is 25 percent of labor. Every estimate should then add 25 percent on top of direct labor to cover overhead.

Percentage of Direct Materials

Some contractors prefer to tie overhead to material costs. For example, if materials total $300,000 per year and overhead is $60,000, then overhead is 20 percent of materials. This method works best in trades where material costs dominate, such as roofing or flooring.

Rate Per Hour

Another option is to assign overhead per billable labor hour. If overhead is $120,000 per year and crews work 12,000 billable hours, then the overhead rate is $10 per hour. Each estimate should add $10 for every labor hour expected on the job.

Hybrid Approaches

Larger contractors may use blended approaches or allocate overhead differently for different types of work. The key is consistency and transparency.

How Poor Allocation Hurts Contractors

When overhead is not allocated correctly, contractors run into predictable problems:

• Chronic underbidding: Jobs look profitable in estimates but lose money once overhead is paid.
• Cash flow crunches: Bills for insurance, fuel, or equipment come due, and profits vanish.
• Unclear financials: Owners cannot see which jobs are truly profitable, making it hard to scale.
• Stress and burnout: Contractors feel like they are working nonstop but never getting ahead.

Example: A Remodeling Contractor Without Overhead Allocation

A Colorado Springs remodeling contractor bids a kitchen renovation at $30,000. Materials are $15,000, labor is $10,000, and he adds a $5,000 markup. On paper, the job shows $5,000 in profit.

But when he accounts for $2,000 in monthly insurance, $1,200 in truck payments, $800 in software, and $1,000 in utilities and office expenses, the margin shrinks. Spread across several jobs, the overhead eats almost all the markup. What looked like a 16 percent profit ends up closer to 2 percent.

Bookkeeping and Overhead Tracking

Bookkeeping plays a central role in solving this problem. A bookkeeper can:

• Track overhead expenses accurately by category
• Separate direct job costs from indirect overhead
• Calculate monthly or annual overhead rates
• Advise on which allocation method fits best
• Provide reports that show true job profitability after overhead

With this information, contractors can bid with confidence, knowing that overhead is covered.

Strategies to Control Overhead

While allocation ensures costs are recovered, reducing overhead strengthens margins further. Contractors can take steps such as:

• Leasing instead of buying equipment when appropriate
• Negotiating lower insurance rates through industry associations
• Reducing downtime by better scheduling crews
• Automating administrative work with bookkeeping software
• Reviewing subscriptions and unused services quarterly

Every dollar saved in overhead is a dollar added back to profit.

Conclusion

For home improvement contractors, overhead allocation is not just an accounting exercise. It is the difference between barely breaking even and running a profitable, sustainable business. By identifying overhead costs, choosing a consistent allocation method, and relying on accurate bookkeeping, contractors can ensure that every bid reflects the true cost of doing business. When overhead is properly accounted for, the business can grow confidently, support its team, and thrive in a competitive market like Colorado Springs.