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19

General Overhead, Contingencies, and Prot

Copyright 2003 Marcel Dekker, Inc.

652 TABLE 19.1 Home Ofce (General Overhead) Estimate Summary


Planned
Home ofce expenses
Nonreimbursable salaries Exempt employees President Vice president Comptroller Estimating group Human resource personnel Nonexempt employees Secretaries Payroll clerk Accounts payable clerks Total ofce nonreimbursable salaries Benets @ 40% of total ofce salaries Ofce/shops rent Depreciation of capital expenditures Ofce utilities and communication Ofce supplies Ofce equipment (rented, if owned depreciated) Ofce maintenance Advertising/jobs procurement/public relations Associations and clubs dues Licenses and fees Donations/sponsored research Trade journals subscriptions and books Travel Entertainment Company sponsored training programs Accounting services Legal services Estimating and project management (not salaries) Consulting fees (legal, CPA, etc.) Home ofce vehicles, depreciation Home ofce vehicles, operation expenses Insurance expenses Total anticipated home ofce expense

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Annual expenses

Percentage of total

Industry average (%)

60

4 4 2 0.50 0.50 1 1 1 2 1 2 1 2 3 2 2 5 6 100

100

Copyright 2003 Marcel Dekker, Inc.

General Overhead, Contingencies, and Prot

653

19.1

GENERAL OVERHEAD (HOME OFFICE EXPENSES)

The company home ofce expenses cannot be chargeable most of the time to a single project. These expenses are usually neglected by small contractorsa bad practice because it minimizes the net prot or generates a real loss. General overhead represents contractor xed expenses. A general contractors or subcontractors main ofce expense consists of many items. A summary of the major categories is presented in Table 19.1, Home Ofce (General Overhead) Estimate Summary, which can be used for budgeting expenses for the future calendar year. Exempt and nonexempt employees are designations from the Fair Labor Standards Act. The major difference between them is that employers are exempt from paying overtime to exempt employees. For these employees, referred to as salaried employees, the workweek is not limited to 40 hours. The expense list presented in Table 19.1 is not appropriate for all contractors. For smaller contractors who operate from a truck, the list would contain considerably fewer items and for a large US top 40 contractor as listed by ENR (nationally and internationally), the list could ll pages, but the concept is the same. The expenses should be estimated, and all efforts must be made to stay in the budget and to generate the planned business volume. In general, main ofce expense ranges from 2.5 to 10% of annual construction billings. Table 19.2 provides average percentages from total construction business volume based on the contractor site. If the planned future construction operation calls for growth and diversication in other areas, attention should be paid to which ofce expenses need to be increased, and how much and when additional staff should be added. As shown in Figure 19.1, main ofce expenses (allocated), estimated contingencies, and prot must be added by the estimator to gure the bid price, before the envelope is sealed. The contract provisions for additional work as a result of an anticipated change order may require the contractor/subcontractor to state the percentage to be added as an allowance for overhead (jobsite overhead main ofce overhead prot).

TABLE 19.2 Home Ofce Expenses as Percentage of Annual Business Volumea


Business ($ Millions)
Home Ofce Expenses (%)
a

1
10

15
7

510
5

20
4.5

50
3.5

100
3.25

500
2.5

US Average.

Copyright 2003 Marcel Dekker, Inc.

654

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FIGURE 19.1 Total components of cost within a bid (the bid selection).

Copyright 2003 Marcel Dekker, Inc.

General Overhead, Contingencies, and Prot

655

19.2

GENERAL OVERHEAD ALLOCATION

Once the business volume for the next year has been planned and the home ofce expenses to support the planned production have been budgeted, a planned percentage can be developed. This percentage will be applied with minor variations to all future bids as a portion of markup (see Figure 19.1). For example, suppose there is an estimated business volume (billings) of $7.5 million for the next year. To support this production the budgeted home ofce overhead would be $750,000/year. The percentage of home ofce budget allocation to new projects should be $750,000/$7,500,000 10% applied to the total direct and jobsite overhead estimated bid cost. If a new estimated job (direct cost jobsite overhead cost) is $2,000,000, the portion of home ofce expense to be allocated would be $2,000,000 10% $200,000. This amount regarding market opportunities may be adjusted positive or negative based upon encountered home ofce expenses and realization of planned business volume, being the successful bidder on targeted projects.

19.3

CONSTRUCTION CONTINGENCIES

Contingency is that amount of money added to an estimate to cover the unforeseen needs of the project, construction difculties, or estimating accuracy. Many chief estimators or contractor executives add a contingency to the estimate to cover one or possibly more of the following: Unpredictable price escalation for materials, labor, and installed equipment for projects with an estimated duration greater than 12 months; Project complexity; Incomplete working drawings at the time detail estimate is performed; Incomplete design in the fast-track or design-build contracting approach; Soft spots in the detail estimate due to possible estimating errors, to balance an estimate that is biased low; Abnormal construction methods and startup requirements; Estimator personal concerns regarding project, unusual construction risk, and difculties to build; Unforeseen safety and environmental requirements; To provide a form of insurance that the contractor will stay within bid price. Most often, if for any reason an accurate estimate is not made (95 to 100% accuracy), an estimator never knows how much money to allow for these forgotten items. Many times added contingencies are an excuse for using poor estimating practices such as not enough time, subcontractors not reporting, no time to visit
Copyright 2003 Marcel Dekker, Inc.

656 TABLE 19.3 General Construction Project Contingency Averages


Project phase
Planning Budget (engineering) Detail (bid)

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Contingency Range (%)


25 to 35 10 to 20 5 to 10

the jobsite, and so on. Contingency for these reasons is difcult to sell to management and can hurt the credibility of the estimating team. On the other hand compounding building projects bidding complexity justies the need to add contingency as part of the markup (see Figure 19.1). This construction risk compensation is added to the nal direct and jobsite overhead cost. The magnitude depends on the type of contract agreement, type of construction, and certainly project location. Contingency is not potential prot. It includes risk and uncertainty but explicitly excludes changes in the project scope (change orders). The contingency should absolutely not be treated as an allowance. Allowances are costs that are foreseen to be spent, and need to be included in the detail estimate in the proper construction category of work and not as a total for the project. There are many factors that affect the amount of contingency to be included in the estimate. Averages for general construction projects at various stages of design are listed as a percentage of direct and jobsite overhead in Table 19.3. General contingency guidelines also apply to different types of construction. For underground work the contingencies should be increased by 2 to 5% for each design phase.For buildings it is recommended to decrease the contingencies by 1 to 3% for each phase. In general, contingency reects the contracting organizations judgment decision to avoid bid cost overrun. On the other hand, too much contingency will create a fat estimate if management is not willing to accept some construction risks. To management, contingency is money it hopes will not be expended, but instead returned as prot at project completion. If the amount of contingency added to the bid is too large the contractor risks not getting the project and recording an additional expense for doing the estimate and bidding. This is the reason that a cost line item is usually not included in the bid.

19.4

CONTRACTOR/SUBCONTRACTOR PROFIT

The last item to be included in the bid and representing contractors return on investment is the prot. The magnitude of desired prot must be decided by the
Copyright 2003 Marcel Dekker, Inc.

General Overhead, Contingencies, and Prot

657

owner for each individual bid, depending on local market conditions, competition, and the contractors need for new work. In the construction industry, markup is dened as the amount added to the estimated direct cost and estimated job into overhead cost to recover the rms main ofce allocated overhead (general overhead) and desired prot. The less prot added to a bid, the greater the chance is of being the successful bidder. Bidding a job with a high prot added does not mean the contactor will get the job. Bidding a job below cost with no planned prot or a minimum prot only to get the work is also no guarantee of being a successful contractor. A contractor can go broke by not obtaining enough protable work. There are more than 3600 contractor bankruptcies each year in the US. To be competitive, a construction companys general overhead and prot should be close to industry norms, as reported annually by Dun & Bradstreet (New York). The concept of percentage of return on indirect cost investment must also be considered. The return on indirect cost is calculated by dividing the corporations annual net prot before taxes by the general overhead cost. For example, a general contractor with $1 million pretax prot and $5 million general overhead has a return on indirect cost of $1Mil/$5Mil 0.20 or 20%. General overhead and prot recovery factors are developed from the annual general overhead budget. After bid opening, contractors occasionally ask close competitors what percent they added for prot. Surprisingly, competitors are refreshingly candid in revealing the amount added for prot. This natural curiosity is related to the many kinds of prot. Contractors are intuitively trying to ascertain why competitor A, who lost the job, marked up 2%, and competitor B, who marked up 4%, was awarded the bid. Different kinds of prots are related to several considerations, including the following. The rm must recoup sufcient prot for return on equity. The prot must be commensurate with industry averages. The prot must consider competitive bidding strategies. The prot must be as high as possible or what the competitive market will bear, while commensurate with the contractors risk. The four general kinds of prot are return on equity, planned, optimum, and competitive bid. These are briey described below.

19.4.1 Return on Equity


Return on investment is the prot necessary to meet a percent return in equity commensurate with the contractors risk. A return of 20 to 40% is normal for construction risk.
Copyright 2003 Marcel Dekker, Inc.

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19.4.2 Planned Prot Margin


Planned prot is the prot that must be achieved over a certain period to meet the rms business goals. Again, nancial surveys reveal what competitors are achieving. An organization must meet or exceed this prot percentage to remain in business.

19.4.3 Optimum Prot


The optimum markup for prot is the one that yields the greatest total prot the greatest expected prot. The expected prot is the total possible prot multiplied by the likelihood of being the low bidder. Lowering the prot provides a greater chance of being the successful bidder. However, if the prots are too low, a contractor can go broke because he does not perform enough highly protable work and/or does too much cheap work. A markup that is too low will not carry a contractor through dry bidding spells. In the US, optimum prot ranges average 8.0%.

19.4.4 Competitive Prot


Competitive prot is the amount chosen that represents the intangibles of past bidding history and competitors need for work. For example, in lean times, contractors might average a 0.5 to 1.5% prot to remain competitive in the bidding game.

19.5

REVIEW QUESTIONS

1. What is the home ofce or general overhead? 2. What is the average percentage from total home ofce expenses of wages and benets paid to home ofce employees? 3. What is the difference between exempt and nonexempt employees? 4. What competitive advantage is there for a contractor to keep the general overhead budget low? 5. What procedure is used to recover the home ofce expenses? 6. What is the base to allocate the general overhead among contractors projects? 7. Develop a list of estimated home ofce overhead for a small ($500,000/year business volume) partner subcontractor. 8. Which are the components of the markup amount added to an estimate to nalize the bid? 9. What is the contingency amount to be included in the bid? 10. What are the reasons for a prudent contractor to add contingency in the bid?
Copyright 2003 Marcel Dekker, Inc.

General Overhead, Contingencies, and Prot

659

11. What is the contingency range as a percentage of direct and jobsite overhead (direct during the detail estimating phase, drawings and specications 100% completed). 12. To be competitive in building construction what is the recommended percentage range for contingency? 13. What does the prot amount added to the bid represent? 14. What is the competitive prot range in building construction, competitive bidding, as a percentage of total cost (direct) plus jobsite overhead as used in the US? 15. Who makes the nal decision regarding the prot amount to be added to a bid?

Copyright 2003 Marcel Dekker, Inc.

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