Skip to main content
Skip to main content

Overhead Allocation Methods

Document Type: Procedure
Version: 1.0
Last Updated: February 2026
Distribute To: CFO, Controller, Estimators

Purpose​

Establish procedures for allocating overhead costs to jobs for accurate profitability analysis, pricing decisions, and financial reporting.

Why Overhead Allocation Matters​

Importance:​

  • Accurate job profitability
  • Competitive but profitable pricing
  • Identify true cost of doing business
  • Informed decision making
  • Financial statement accuracy

Construction Overhead Reality:​

  • Overhead is real cost of being in business
  • Must be recovered through job pricing
  • Underallocation = hidden losses
  • Overallocation = lost competitiveness

Understanding Overhead​

What is Overhead?​

Costs not directly tied to a specific job but necessary for operations:

Administrative Overhead:

  • Executive salaries
  • Accounting/admin staff
  • Office rent
  • Professional fees
  • Insurance (GL, E&O)
  • Office supplies
  • Technology

Operational Overhead:

  • Equipment manager
  • Shop/yard costs
  • Small tools & equipment
  • Safety program
  • Training
  • Estimating

Marketing/BD Overhead:

  • Business development
  • Advertising
  • Proposals/bids
  • Entertainment

What is NOT Overhead:​

Direct costs chargeable to specific jobs:

  • Project labor
  • Project materials
  • Subcontractors
  • Project equipment
  • Project-specific insurance

Overhead Rate Calculation​

Annual Overhead Rate:​

================================================================
         OVERHEAD RATE CALCULATION
================================================================

Fiscal Year: _______________

================================================================

TOTAL OVERHEAD COSTS:

Administrative:
  Executive compensation: $________________
  Admin salaries & wages: $________________
  Payroll taxes & benefits: $________________
  Office rent: $________________
  Utilities: $________________
  Insurance (GL, E&O): $________________
  Professional fees: $________________
  Technology: $________________
  Office supplies: $________________
  Other admin: $________________
  SUBTOTAL ADMIN: $________________

Operational:
  Equipment overhead: $________________
  Shop/yard: $________________
  Small tools: $________________
  Safety program: $________________
  Training: $________________
  Estimating: $________________
  Other operational: $________________
  SUBTOTAL OPERATIONAL: $________________

Marketing/BD:
  Business development: $________________
  Advertising: $________________
  Proposals: $________________
  Entertainment: $________________
  SUBTOTAL MARKETING: $________________

TOTAL OVERHEAD: $________________

----------------------------------------------------------------

ALLOCATION BASE:

Option A: Direct Labor Cost
  Projected direct labor: $________________
  Overhead rate: $________ ÷ $________ = _____%

Option B: Direct Labor Hours
  Projected direct hours: ________________
  Overhead rate: $________ ÷ ________ = $______/hour

Option C: Total Direct Cost
  Projected direct cost: $________________
  Overhead rate: $________ ÷ $________ = _____%

Option D: Revenue
  Projected revenue: $________________
  Overhead rate: $________ ÷ $________ = _____%

================================================================

SELECTED METHOD: _______________________
OVERHEAD RATE: _____%

================================================================

Allocation Methods​

Method 1: Percentage of Direct Labor Cost​

Formula:

Overhead Rate = Total Overhead ÷ Total Direct Labor Cost

Job Overhead = Job Direct Labor × Overhead Rate

Example:

Total Overhead: $500,000
Total Direct Labor: $2,000,000
Rate: 25%

Job A Labor: $150,000
Job A Overhead: $150,000 × 25% = $37,500

Best For:

  • Labor-intensive contractors
  • Similar labor rates across jobs
  • Traditional construction

Pros:

  • Simple to calculate
  • Easy to apply
  • Common in industry

Cons:

  • Distorts if labor rates vary significantly
  • May underallocate to capital-intensive jobs

Method 2: Direct Labor Hours​

Formula:

Overhead Rate = Total Overhead ÷ Total Direct Labor Hours

Job Overhead = Job Direct Hours × Overhead Rate per Hour

Example:

Total Overhead: $500,000
Total Direct Hours: 50,000
Rate: $10/hour

Job A Hours: 3,500
Job A Overhead: 3,500 × $10 = $35,000

Best For:

  • When hourly rates vary significantly
  • Better reflection of supervision/support effort

Pros:

  • Reflects effort regardless of pay rate
  • Good for mixed workforce

Cons:

  • Requires accurate hour tracking
  • May not reflect complexity

Method 3: Percentage of Total Direct Cost​

Formula:

Overhead Rate = Total Overhead ÷ Total Direct Costs

Job Overhead = Job Total Direct Cost × Overhead Rate

Example:

Total Overhead: $500,000
Total Direct Costs: $8,000,000
Rate: 6.25%

Job A Direct Costs: $600,000
Job A Overhead: $600,000 × 6.25% = $37,500

Best For:

  • Material/subcontractor-heavy work
  • When all direct costs reflect job complexity

Pros:

  • Captures all job activity
  • Simple to apply

Cons:

  • Pass-through costs (subs) don't really drive overhead
  • May overallocate to material-heavy jobs

Formula:

Split overhead into:
- Labor-related overhead (apply to labor)
- General overhead (apply to all direct costs OR revenue)

Example:

Labor-Related Overhead: $300,000
Total Direct Labor: $2,000,000
Labor Rate: 15%

General Overhead: $200,000
Total Revenue: $10,000,000
General Rate: 2%

Job A:
Labor: $150,000 × 15% = $22,500
Revenue: $750,000 × 2% = $15,000
Total Overhead: $37,500

Best For:

  • Mixed work types
  • Accurate cost allocation
  • Sophisticated operations

Applying Overhead to Jobs​

Job Cost Sheet with Overhead:​

================================================================
         JOB COST SUMMARY
================================================================

Project: _______________________  
Contract: $________________

================================================================

DIRECT COSTS:
  Labor: $________________
  Materials: $________________
  Subcontractors: $________________
  Equipment: $________________
  Other direct: $________________
  TOTAL DIRECT: $________________

OVERHEAD ALLOCATION:
  Method: _______________________
  Rate: _____%
  Allocated overhead: $________________

TOTAL JOB COST: $________________

GROSS PROFIT: $________________ (____%)

================================================================

Real-Time vs. Period-End Allocation:​

ApproachDescriptionUse When
Real-timeApply rate as costs incurJob monitoring, progressive billing
Period-endTrue up at month/year endAccurate reporting
BothApply estimated, true up actualBest practice

Special Situations​

High Subcontractor Content:​

When jobs have significant subcontractor costs (over 50%), consider:

Option A: Exclude subs from allocation base
  Direct costs for allocation = Labor + Materials + Equipment only

Option B: Lower rate for sub content
  Full rate on own work
  Reduced rate (2-3%) on subcontractor costs

Option C: Fee-based recovery
  Allocate overhead based on contract value, not cost

New Business Lines:​

When starting new work types:

  • Separate overhead tracking initially
  • Establish baseline costs
  • Develop specific rates
  • Monitor for profitability

Overhead Analysis​

Overhead Efficiency:​

================================================================
         OVERHEAD ANALYSIS
================================================================

Period: _______________

Planned overhead: $________________
Actual overhead: $________________
Variance: $________________ (____%)

Overhead as % of revenue:
  Planned: _____%
  Actual: _____%
  Industry benchmark: _____%

----------------------------------------------------------------

VARIANCE ANALYSIS:

Over budget items:
| Item | Budget | Actual | Variance | Cause |
|------|--------|--------|----------|-------|
|      |        |        |          |       |

Under budget items:
| Item | Budget | Actual | Variance | Cause |
|------|--------|--------|----------|-------|
|      |        |        |          |       |

================================================================

Overhead Recovery:​

Overhead Applied (to jobs): $________________
Actual Overhead: $________________
Over/(Under) Applied: $________________

If under-applied: Jobs were undercharged, profit overstated
If over-applied: Jobs were overcharged, profit understated

Bidding with Overhead​

Markup vs. Overhead:​

Bid Calculation:

Direct Costs: $________________
+ Overhead (_____%): $________________
= Total Cost: $________________
+ Profit (_____%): $________________
= Bid Price: $________________

Example:
Direct Costs: $500,000
+ Overhead (8%): $40,000
= Total Cost: $540,000
+ Profit (6%): $32,400
= Bid Price: $572,400

Overhead Recovery Check:​

If we win this job at planned margin:
  Revenue: $572,400
  Direct costs: $500,000
  Overhead applied: $40,000
  Profit: $32,400

Does this cover our overhead?
  Job duration: 6 months
  Our monthly overhead: $41,667
  Job needs to cover: $250,000 of overhead

  Allocated: $40,000 (short by $210,000)

PROBLEM: Job doesn't cover proportional overhead!

Solution: Need sufficient volume at adequate margins

CFMA Benchmarks​

Industry Overhead Ranges:​

Contractor TypeOverhead % of Revenue
General contractor6-10%
Specialty contractor8-14%
Heavy/highway5-8%
Residential10-18%

Overhead Components (% of Total Overhead):​

CategoryTypical Range
Personnel (indirect)50-65%
Facilities10-15%
Insurance8-12%
Technology3-6%
Professional fees3-5%
Marketing/BD3-8%
Other5-10%

Updating Overhead Rates​

Annual Review Process:​

  1. Gather actual overhead data (prior year)
  2. Project overhead (coming year)
  3. Project allocation base (labor, revenue, etc.)
  4. Calculate new rate
  5. Compare to prior year and industry
  6. Adjust bidding/pricing as needed
  7. Communicate to estimators

Mid-Year Adjustment:​

Consider if:

  • Volume significantly different than projected
  • Major overhead changes (staff, facilities)
  • Competitive pressure requiring review
  • Profitability issues on jobs
  • Job Costing Procedures
  • Estimating Standards
  • Budget Preparation
  • Financial Reporting

Template provided by support.construction. Overhead is a real cost—allocate it or lose money without knowing why.