Whatever you do, don’t be like Larry.
Today, the hero of our story will be Larry, the new CFO at T-Rex Roofing, a fictional commercial roofing contractor based in Dallas.
Ever since Larry joined 9 months ago, T-Rex Roofing has been on a tear. It’s winning new jobs at a breakneck pace and completing most of them with a healthy gross margin. The owners are thrilled: T-Rex is on track to becoming the leading roofer in Texas, leaving its competitors in the dust.
But Larry is puzzled. Despite the growth of the business, T-Rex Roofing’s operating income is flat, leaving the business with little capital to continue growing.
The root cause of Larry’s woes is simple: his estimates, bids, and job costs reports are based on unburdened labor costs instead of fully-burdened labor costs. This means that Larry is systematically underestimating T-Rex Roofing’s labor costs, leading to bids that are too low and gross margin estimates that are too high.
In this guide, we’ll outline how construction owners, CFOs, and controllers can avoid Larry’s fate by using fully-burdened labor costs when calibrating bids and calculating job costs.
Unburdened vs fully-burdened labor costs
Larry is committing one of the cardinal sins of job costing: he uses direct or unburdened labor costs instead of fully-burdened labor costs. Unburdened labor costs refer to an employee’s direct, gross pay. If your employee’s hourly rate is $25/hour, their unburdened hourly labor cost is $25/hour. Simple enough.
To accurately calibrate bids and measure job costs, Larry should use fully-burdened labor costs, which include both an employee’s direct gross wage AND indirect/overhead costs.
The table below outlines some of the most common and significant indirect labor costs. By definition, indirect labor costs are hard to allocate to specific jobs and cost codes. It’s not always clear, for example, how employer Social Security taxes should be allocated across the various jobs and cost codes you’re working on.
But just because indirect costs are tricky to allocate doesn’t mean Larry should ignore them. These indirect costs typically represent 10-30% of total labor costs, so if they’re ignored, T-Rex Roofing is underestimating its job costs by up to 15%, leading to inaccurate bids, estimates, and project economics.
Calculating fully-burdened labor costs
This section outlines two use cases in which fully-burdened labor costs are extremely helpful: (1) estimating and bidding, and (2) job costing, accounting, and financial reporting. Each use case requires a different method for calculating fully-burdened labor costs.
Estimating and bidding
The simplest way to estimate labor costs is to multiply expected labor hours by the hourly pay rate. In order to ensure your labor costs are fully-burdened, you’ll need to make sure your hourly pay rate is fully-burdened.
To calculate the fully-burdened hourly rate, you’ll need to sum the hourly rates for both direct and indirect labor costs. Here’s a simple example showing the unburdened vs fully-burdened hourly rates for Mario, an installer at T-Rex Roofing. Mario’s hourly rate is $25/hour, and he’s eligible for T-Rex’s health and retirement benefits:
You’ll notice that Mario’s fully-burdened hourly rate includes both his direct hourly wage in addition to taxes, workers’ comp, benefits, and travel and mileage. Once these indirect cost items are factored in, his fully-burdened rate is a whopping 31% higher than the unburdened rate. 31%!
Many employers simply use a “burden rate” to calculate fully-burdened labor costs, applying a multiplier - usually around 1.2x - to the unburdened hourly rate. While this method is easier than itemizing and calculating the hourly rate for each indirect cost, it often ignores significant differences across your employees and can lead to inaccurate estimates. Use with caution!
Once Larry estimates the fully-burdened hourly rates for T-Rex Roofing’s workforce, he can multiply these rates by labor hours to estimate fully-burdened labor costs.
Don’t forget salaried and administrative personnel
Larry’s transgressions don’t stop there. Larry also routinely ignores salaried and administrative personnel costs when calculating job costs.
Often, T-Rex’s salaried superintendents and administrators spend significant time on specific jobs. Last month, for example, Superintendent Sophie spent 50% of her time on one project. In these cases, it’s important to include these employees’ estimated and actual costs during the estimating and financial reporting processes.
These employees’ costs can be harder to allocate to specific jobs, especially since many employers don’t keep accurate timesheets for their salaried or back-office team members.
Job costing, accounting, and financial reporting
While multiplying labor hours by a fully-burdened hourly rate is helpful for estimating, Larry will need to use a different method for accounting and financial reporting. For these tasks, Larry can’t rely on rough estimates; he needs to be exact. Specifically, he needs to allocate all realized indirect labor costs to a job and cost code, down to the last cent.
He can do so in three simple steps:
- Calculate the % of an employee’s gross pay earned on each job
- Allocate each indirect cost item (e.g., employer taxes, benefits, etc) to various jobs using the percentages from Step 1
- Sum the direct and indirect labor costs for each job
This method will ensure that job cost reporting can be reconciled down to the last cent with the general ledger - an awesome way for Larry to impress T-Rex Roofing’s owners!
To sum it all up
Because our friend Larry has prepared estimates and calculated job costs using unburdened instead of fully-burdened labor costs, T-Rex Roofing has suffered a few negative consequences:
- Larry has underestimated its labor costs, leading to estimates and bids that are too low
- Larry has overestimated its job profits and gross margin %
- T-Rex Roofing’s operating income is lower than expected due to higher overhead costs
Luckily, Larry can get back on the right track by using fully-burdened labor costs for (1) estimating and bidding and (2) financial reporting and accounting.
How Miter can help
Miter is the #1 time-tracking, HR, payroll, and job costing platform built for construction. Contractors of all sizes use Miter to track hours, earnings, and indirect labor expenses by job and cost code in just a few clicks.
If you’re looking for an easier way to do estimating and job costing for your business, sign up for a demo to see if Miter could help!
The Miter Team
The Miter team is passionate about bringing Construction HR & Finance into the 21st Century. We're a team of builders, engineers, compliance specialists, and HR specialists united by the goal of creating robust, simple software solutions for some of the hardest problems facing construction today.
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