OVERHEAD ANALYSES

IN CONSTRUCTION
BUSINESS
HOW TO IMPLEMENT OVERHEAD COSTS
Abstract
In business, overhead or overhead expense refers to an ongoing expense of
operating a business; it is also known as an "OPERATING EXPENSE".
Overheads are the expenditure which cannot be conveniently traced to or
identified with any particular cost.
Ref: PMO- Projects management Directory
www.pmhut.com

I dedicate this Document to my daughter Rayan for her support & assistant with the researches I had in
this Paper.

Eng. Abdul R. SABRAH

Ar.sabra@me.com

TABLE OF CONTENTS
1. DEFINITION
2. INTRODUCTION

2
2

3. OBJECTIVES AND METHODOLOGY

4. OVERHEAD TYPES, ANALYSES & RELATION WITH UNIT COST

PRESENTATION OF TYPES OF CONSTRUCTION OVERHEAD

1.1 ANALYSES OF OVERHEAD CALCULATIONS
1.1.1 BASIS FOR ALLOCATING OVERHEAD COSTS
1.1.2 PROBLEMS IN MANAGING OVERHEAD COSTS
1.1.3 BASIS OF ALLOWING FOR GENERAL (CORPORATE) OVERHEAD IN TENDERS
1.1.4 DIFFERENTIATING BETWEEN CORPORATE AND SITE OVERHEADS
1.2 BUDGETING FOR SITE OVERHEADS
1.2.1 PLANNING AND BUDGETING FOR CORPORATE OVERHEADS
1.2.2 THE BASIS ON WHICH CONTRACTS CONTRIBUTE TO CORPORATE OVERHEAD PRO RATA BY VALUE, PRO RATA BY

3
4
4
4
4
5
5
5

TIME OR OTHER
1.3 CLEAR CLASSIFICATION OF THE COSTS THAT CONSTITUTE OVERHEADS

5
5
6
6

1.4 CONCLUSIONS
1.5 REFERENCES
NUMERICAL APPLICATION OF ABC COMPANY

pg. 1

DEC 2015 A. R. SABRA

1. DEFINITION
In business, overhead or overhead expense refers to an ongoing expense of operating a business; it is also
known as an "operating expense". Overheads are the expenditure which cannot be conveniently traced to
or identified with any particular cost unit.
Therefore, overheads cannot be immediately associated with the products or services being offered, thus
do not directly generate profits.
However, overheads are still energetic to business operations as they provide the required operations for
the business to carry out profit making activities.
Overhead expenses include but not limited to accounting fees, advertising, insurance, interest, legal fees,
labor facilities, rent, repairs, supplies, Shipping, telephone bills, travel expenditures, and utilities.
In construction, overhead costs results from the organization structure, size and form of the enterprise,
some apply more directly to site operations and some may lie somewhere in between.
Overhead costs largely represent the enterprises operational capacity, including aspects of both physical
capacity such as plant and equipment and intellectual capacity such as data, records, expertise, experience
and knowledge.
The fluctuating nature of the construction market periodically compels enterprises, for competitive and
survival reasons, to adopt shrinkage strategies.
These may include cost-cutting and downscaling of offices and other facilities and often represents loss of
capacity.
When markets again expand, replacing lost capacity is problematic. Budgeting for overheads when bidding
and recovering them from contract revenues in a dynamic market is a further challenging factor in optimally
balancing overheads against capacity.

2. INTRODUCTION
Unlike most manufacturing industries, the construction industry is unable, or only unclearly able, to forecast
its annual business volume, client base and profit performance for any longer than a relatively short term
into the future.
The competitive tendering system, by which the majority of construction work, becomes available
to open market, also does not assist Companies in regulating annual business volumes.
Construction Companies may experience unstable levels of activity, especially when upward or downward
trends occur in the construction cycle or, independently of industry conditions, because of varying success
in securing business by tendering or other means.
A Construction Companies production capacity (its capability to produce goods and services) and its cost
structure are inter-related.
Generally, costs are classified as fixed and variable costs, the latter being those directly incurred in
producing a unit of product (A Project) and therefore they vary in direct proportion to the number of Projects
they produce.
Construction Companies are constantly faced with the problem of having to adjust the level of their
overheads. In periods when predetermined volume targets are not reached, whether caused by low
activity in the construction cycle or because of unsuccessful bidding.

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DEC 2015 A. R. SABRA

Construction Companies may face severe financial difficulties, even bankruptcy, unless they reduce
overheads. This is usually done by means of cost-cutting, terminations, disposal of facilities or assets,
discontinuation of services, and non-maintenance of records and data bases.
Such measures may affect the firms ability to compete and, when a market recovery occurs, firms
having reduced overhead may find themselves at a disadvantage from both capacity and
competitive points of view.

3. OBJECTIVES AND METHODOLOGY

I start seriously this research when I attend a yearly management review meeting of Tendering and cost
control. As per discussion had placed for a long period was about the calculation of Overhead and the
percentage to be implemented on tenders to recover that cost.
This paper I prepared based on several researches, universities studies & my own experience in Tenders
& contracts management.
However, the references at the end could provide more studies for anyone like to read more about the topic.

4. OVERHEAD TYPES, ANALYSES & RELATION WITH UNIT COST

PRESENTATION OF TYPES OF CONSTRUCTION OVERHEAD

CONTRACTS
/ TENDERS /
INCOMING
BUSINESS

CONSTRUCTION
COMPANY

Business Costs
Not generating income

Costs of
Running the
Company
OH 1

Costs of
Supporting
the Contracts
OH 2

Costs
Managing the
Contracts
OH 3

FIXED
COSTS
NOT
RELATED
TO CONTRACTS

FIXED COSTS
RELATED TO
CONTRACTS

VARIABLE
COSTS
RELATED TO
CONTRACTS

Business Costs
Generating income
Contracts Costs
Generating income

RUNNING
CONTRACTS
GENERATING
INCOME

Figure 1Presentation of Company Overheads

pg. 3

DEC 2015 A. R. SABRA

1.1 ANALYSES OF OVERHEAD CALCULATIONS

1.1.1 Basis for Allocating Overhead Costs
In terms of AC 108, fixed production overheads should be systematically allocated to units of production
(contracts) on the basis of the normal capacity of the production facilities.
With traditional systems, fixed overheads are traced to products (contracts) for a predicted percentage from
company records.
Costs attributable to contracts activity in general can be allocated to a contract such costs includes
insurance, costs of design, Staff, labors, and technical assistance.
While not directly Costs related to contracts and Business operations costs such as construction payroll,
Administration costs, HR costs the Company should use methods that are systematic and rational based
on the normal level of construction activity.

1.1.2 Problems in managing overhead costs

A problem exists when overheads become too high; as the business grows, overheads grow
disproportionately high many small businesses have large overheads then managing overheads
becomes an issue; it is always a problem but it is managed budgeted and controlled; overheads are not
taken lightly.
The main problems were identified as:
a) The cyclic nature of the construction industry: if constant work volumes could be maintained,
managing overheads would be simpler;
b) different types of contracts require different resources and produce different levels of overhead;
c) Unbudgeted and unexpected items prevailing in the construction business climate, e.g., overseas
travel, tenders expenses for special presentations etc
d) overheads are a problem when they become too high and can easily escalate unless they are
constantly focused upon;
e) Work volume can alter widely for constant overheads;
f) late payments by clients result in increased overdraft and hence higher bank costs;
g) Problem contracts; constantly having to adjust to the market.
The factors causing problems in managing overheads seem to be the cyclic nature of the construction
industry, adjusting overhead adequate with work volume and the requirements of different contract types.

1.1.3 Basis of allowing for general (corporate) overhead in tenders

Allowing for corporate overheads by adding a percentage to total estimated project costs seemed to be the
approach followed by all Companies. The percentage, or portion thereof that provides for corporate
overhead, was viewed differently by Companies, as were the calculation and components thereof.
The percentage was influenced by historical data, a forecast of future activity, the ratio between main
contractors and sub-contract work, competitive conditions, the size, nature and duration of the project and
an evaluation of risk.

pg. 4

DEC 2015 A. R. SABRA

Corporate overhead budgets, for 1 to 3 years in advance, are based on a percentage of estimated business
volume. The percentage is a function of historical data, the estimated future market, business and strategic
plans and expected staff costs. Site overheads are budgeted in the sections of the tender document.
Corporate overhead includes key site staff and is recovered from site activity.

1.1.4 Differentiating between corporate and site overheads

Site overhead is specifically priced in the sections of the tender document. Corporate overhead has
to be recovered from the revenue produced by each contract.

1.2 Budgeting for site overheads

Site overhead is budgeted for (priced) in the Preliminary and General section of the tender document by
means of detailed analysis of such factors as pre-determined method, options and alternatives, the firms
and proposed site organization structure, time and schedule requirements, contract value, type of work,
calculated use of resources, extent of decentralization in the firm and extent of corporate services.
Companies differed on whether the site overhead budget should be adjusted, in relation to the degree of
competition, at bid finalization.

1.2.1 Planning and budgeting for corporate overheads

Overheads are planned on the basis of expected market conditions, for periods of 1 to 3 years ahead, with
varying interim updating frequencies.
Corporate overhead budgeting is for periods of 1 month up to 3 years in advance. Various bases or a
combination of bases are used. These include the business plan, people requirements, minimum support
functions and expertise to run the business. One recurring aspect is that estimated business volume and
an analysis of past overhead to establish a corporate overhead: business volume ratio are used as a basis.

1.2.2 The basis on which contracts contribute to corporate overhead pro rata by value, pro
rata by time or other
According to several Companies, contracts contribute on a pro rata basis according to contract value. The
time factor does or can also be considered and this is used to allow for particular circumstances. Some
Companies did not use a pro rata basis at all, but deducted corporate overhead from total gross profit
recorded for all contracts.

1.3 Clear classification of the costs that constitute overheads

A classification of overhead cost elements depends on internal accounting and costing systems and on
individual business modes. Companies identified the following:

pg. 5

Management and administration: Head office and site managers salaries.

Space: Rentals, services, computers, IT, office equipment, security, cleaning, water, electricity,
refreshments, printing and stationery.
Communication: Telephones, cell phones, faxes, postage.
Travelling: Vehicles (cars, trucks, etc...) accommodation, a cross-border activities, transportation
of staff.

DEC 2015 A. R. SABRA

Human resources: Training, skills development, occupational health and safety, salaries, medical
aid, pension, etc., industrial relations, holding costs of monthly and some hourly paid site staff,
retrenchment packages, protective clothing.
Financial: Auditing, asset ownership, subscriptions, legal fees, depreciation, bank and finance
charges, corporate insurances, professional membership fees, sponsorships, donations, group
fees.
Yard and workshops: Plant, equipment and maintenance.
Work procurement / marketing: Tendering, estimating, advertising, entertainment, sales promotion,
business development (research and development), special expertise in estimating, prequalification, presentations, design-and-construct bids.

1.4 CONCLUSIONS
Larger construction firms generally are clear about the nature and extent of their overheads and monitor
and manage their overheads carefully but may allow for both site and corporate overheads in bid prices
arbitrarily, for competitive reasons.
Managing overheads is affected by variations in business volume as result of fluctuations in the construction
cycle and in the success rate of obtaining work.
Reducing overheads and capacity by cost-cuttings and limiting other aspects of competitive advantage can
have negative effects on the firms market position.
Overhead budgets and allowances in tenders are based on past records, business strategy, market and
business volume forecasts and estimated resource needs.
Recovery of corporate overheads is done either on a Proportional pro rata basis according to contract
values, or on an overall company basis. Outsourcing does not appear to have an appreciable effect on
overheads. The effects of information technology on overheads have not been clearly identified as being
beneficial or harmful.

1.5 REFERENCES
Drury, C (2000) Management and Cost Accounting. 5ed. Thomson Learning.
Horngren, C T, Foster, G, Datar, S M and Uliana, E (1999) Cost Accounting in South Africa.
South Africa: Prentice Hall.
Jones, L F (1991) Product costing at Caterpillar. Management Accounting, 72(8), 39. In: Garrison, R H and
Noreen, E W (2000) Managerial Accounting. 9ed. USA. McGraw- Hill Higher Education.

pg. 6

DEC 2015 A. R. SABRA

A Company ABC has an overhead costs as follow s

1 Overhead of business operation
2 Overhead of Office contracts Support
3 Overhead of Contracts operations
Total Company overhaed / Year

1
2
3
4
5
6

Running Contracts
School Contract 671
Contract 620
Contract 622
Contract 624
Contract 632
Contract 634

Theoritcal Overhead %

AED
AED
AED
AED

Amount
12,000,000.00
5,000,000.00
40,000,000.00
57,000,000.00

%
21.05% Fixed OH1
8.77% Fixed OH2
70.18% Var. OH3

AED
AED
AED
AED
AED
AED
AED

Amount
120,000,000.00
45,000,000.00
395,585,698.00
527,862,788.00
121,876,196.00
174,960,053.00
1,385,284,735.00

%
8.66%
3.25%
28.56%
38.11%
8.80%
12.63%

Budget OH
FROM 7% - 12 %
Budget For Tender

Period
Budget OH Tender OH
18 Months
10.00%
7.02%
08 Months
11.00%
7.72%
28 Months
9.00%
6.32%
36 Months
11.00%
7.72%
16 Months
8.00%
5.61%
24 Months
7.00%
4.91%
Mean Avarage
6.67%

Work Done / Year

AED
80,000,000.00
AED
45,000,000.00

On assuption budget is equal cost

12.32% AED 1,748,549.07
6.93% AED
983,558.85

AED
AED
AED
AED
AED

26.11%
27.10%
14.08%
13.47%
6.59%

169,536,727.71
175,954,262.67
91,407,147.00
87,480,026.50
649,378,163.88

Part II How to achieve effective overhead with minimum corporate Cost.

AED 3,705,541.10
AED 3,845,808.28
AED 1,997,873.53
AED 1,912,038.99
AED 14,193,369.82

Balance

Contracts Charging

OH Amount/ Year
AED
5,614,035.09
AED
3,473,684.21
AED 10,707,582.80
AED 13,582,434.31
AED
5,131,629.31
AED
4,297,264.46
AED 42,806,630.18

AED

2,806,630.18

AED

14,193,369.82

As per project Nature

=T. OH - OH1 - OH2