If you want to be successful as a contractor or home builder, even if only on your personal home, you have to understand the difference between profit and overhead. They are not the same thing and should never be considered interchangeable.
In order to grow a construction company, monthly expenses must be paid and reserve accounts must be filled. Of course, making a profit is necessary too as a business without profit is not a smart business. When building your own home, you may not be as concerned about the word “profit” but make no mistake, what a professional would call profit, you will call savings. The money is still there, and it is up to you how you utilize it. Being able to balance these requirements comes from an understanding of profit and overhead and how they impact your bottom line.
Overhead is money used to pay everyone except for you. That is a pretty simple explanation but it serves the point. Examples of overhead expenses include insurance, specific rentals, attorney fees, cell phone, etc. This is a list that can grow and grow until you are not making any money at all, so be careful about what you include. I suggest you include the items you have to have as well as some long term planning accounts like attorney fees and other items used only on rare occasions.
I like the inclusion of the rainy day accounts because finding yourself in a subcontractor lawsuit with no money to pay an attorney is a nasty place to be. By having the account in place and contributing small amounts each week to the fund, the financial impact will be greatly reduced should such an occasion arise. Take a good look at your situation and decide what things are immediately necessary and what things might be a concern in the future. Of those potential line items, decide which ones need to be planned for and which can be funded, as necessary, at the last minute. The first two concepts, immediate use and planned potential items, make up your overhead column.
The old adage that profit and overhead for contractors should be 15% is not always correct. Although most people expect to see 15% profit and overhead in their construction contracts with general contractors, higher rates are not unheard of in specific situations. Find out what is appropriate and factor in the necessary money. For a homeowner, the same is true. Find out what the contractor fee would be for your job should you hire it out and include that money in your loan amount. As my mother used to say: “a penny saved is a penny earned.” Yup, in this case she is absolutely right!
Use an overhead calculation spreadsheet to start defining and estimating your overhead costs. Use the form as a template and expand or contract it to meet your specific needs. The most important thing is to realize that a “one size fits all” approach does not work in relation to overhead. Overhead of 7.5% to 10% are not unheard of. The profit line item will stay fairly consistent until you get into either very small jobs or very complicated jobs. In general, a rate of 7.5% for new construction and 10% for remodeling jobs is accepted. Once again, plan ahead and see what the job details are before you assign a profit number to the job.
Profit, as opposed to overhead, is used to pay the company and the owner. The first place the profit should go is to a company account that is separate from the expense account. If your profit stays in the same account as the overhead and accounts payable money, it will easily get absorbed into the cost of running your business. To avoid this, set up a separate account that manages company profit. As soon as you are paid by a client, transfer the appropriate amount of profit into this account and get it away from the nibbling teeth of your invoices!
For a homeowner, consider taking the 7.5% to 10% “profit” and separating it out into a contingency fund. It will be there if you need it, and if you don’t use it during the construction, you can use it to buy down the mortgage.
I prescribe to the belief that you must pay yourself first as a business owner. Most self employed people tell the story of never being paid because their employees, suppliers, and subcontractors eat all of their money before they get a chance to pay themselves. Two things are going on here. First, either they did not estimate the cost of the job properly or they are over budget. This is something to look into before bidding the next job. The second thing at play is the inability to risk paying your self first. It is detrimental to you personally, even if you aren’t running a construction business, because the money you are saving by contracting the home yourself needs to be considered money earned. Use it how you see fit, but don’t run it off paying overhead costs.
To take this a step further: take percentages of your profit or money saved and separate it out into more accounts. Have an account for long term savings, one for spending cash, one for gifting charitable organizations or causes and one for increasing your personal financial portfolio. At each payday, send 10% of your total salary payment to each of those accounts. The remaining funds should be used to pay for your personal expenses. If you cannot afford to move 10% into each account, transfer less, but always transfer something. The action of saving money and building a portfolio will have an emotional impact on you that will expand and create prosperity in your life.
To be clear, the account for spending cash is not for paying bills. It is your fun money to be spent on evenings out with the family, days at the amusement park, or other personal treats. You have plenty of money in your other accounts to cover expenses so create an account to help you have fun!
By planning ahead for expenses and creating accounts to fund them, you can create financial success within your business and/or project. In addition, by separating out your money into numerous accounts, you can better track it and ultimately pay yourself first. From those payments, you can begin to grow your financial portfolio while still having money for fun, charitable giving, and your monthly expenses all without stressing your immediate financial position. After all, owning a business or building a house can be stressful enough without adding the stress of chaotic money management. Take a straightforward and calculated approach to estimating, charging, and managing your profit and overhead and you will find success to be more relaxing in both the short and long run.