Overhead Costs – The Difference Between Direct and Indirect

Every construction or renovation estimate includes overhead costs — and they’re not a small line item. Overhead is typically added as a percentage on top of the combined total of labor, materials, and equipment. It can represent a significant portion of your overall project cost.

For a contractor, accurately projecting overhead is the difference between a profitable project and a money-losing one. For an owner, understanding what overhead actually covers helps you evaluate bids intelligently and ask the right questions.

Overhead costs break down into two categories: general overhead (indirect costs) and job overhead (direct costs). Here’s what each one includes.

General Overhead — Indirect Costs

General overhead covers the contractor’s cost of doing business. These are expenses that aren’t tied to any single project but are necessary to keep the lights on. These costs are shared proportionally across all active projects based on project size.

A contractor calculates this by averaging annual operating expenses and converting that figure to a percentage of total annual revenue. Common indirect overhead items include:

• Office Expense — Rent or lease costs for office space (or a return on investment if the building is owned), plus utilities, insurance, phones, office supplies, equipment, furniture, and taxes.
• Staff Salaries — Wages for executives, estimators, purchasing staff, bookkeepers, and administrative personnel — anyone working in the office and not assigned to a specific project.
• Miscellaneous Indirect Costs — Travel expenses, legal fees, marketing and advertising, professional services like auditors, association dues, and charitable donations.
• Depreciation — A percentage written off annually on office equipment and company-owned construction equipment as part of the ongoing cost of doing business.

Overhead Costs – A Simple Example

Say a contractor does $1,000,000 in annual revenue and calculates $50,000 in annual operating expenses. That’s a 5% general overhead rate. For example, suppose that contractor works on a $150,000 project. Consequently, the allocated general overhead is $150,000 ÷ $1,000,000 × $50,000 = $7,500.

It follows that smaller contractors carry less general overhead. In contrast, larger ones carry more. On larger, more competitive projects, a contractor may trim their indirect overhead percentage to sharpen their bid. Alternatively, some contractors absorb a portion of indirect overhead into their fee. As a result, they do this rather than breaking it out as a separate line.

Job Overhead — Direct Costs

Job overhead is also called General Conditions. Therefore, it covers costs tied directly to a specific project. Specifically, these are the things required to actually build that job. Furthermore, they exist in addition to the indirect overhead discussed above.

Direct overhead items typically include:

• Project-Specific Salaries — Wages, payroll taxes, and benefits for superintendents, foremen, field engineers, project schedulers. This includes any other on-site staff assigned to the project. These are estimated based on a burdened hourly, weekly, or monthly rate multiplied by the expected duration on site. Reimbursable expenses like travel and per diem are included here as well.
• Temporary Office Facilities — This includes a construction trailer, field office space, utilities, and equipment. On-site staff use these to conduct business and hold meetings. Additionally, these costs cover temporary office space for an architect or owner’s representative. Even an owned trailer carries a depreciation charge. Consequently, it requires a modest return on investment against the project.
• Other Temporary Enclosures — For example, this category includes tool sheds and on-site container storage. It also covers temporary barricades, railings, ramps, and protective walls. Essentially, it includes any other temporary structures required during construction.
• Temporary Utilities — This involves hydrant meters, temporary water, heat, electricity, generators, and fuel. In particular, the contractor may provide all light and power. This applies to both direct employees and subcontractors. Furthermore, it includes temporary power poles, transformers, and energy usage. Finally, winter work adds extra costs for portable heat generation.
• Sanitation Facilities — Portable toilet rentals for on-site workers. Required by code on every project and a direct project cost.
• Drinking Water — Potable water, cups, and maintenance for on-site staff and workers.

Other Miscellaneous Direct Costs

Additional direct overhead items that are easy to overlook include:

• Project photography and signage
• Surveying and project staking
• Daily and final cleanup
• Cold weather costs — heating concrete, tenting and heating enclosures, snow removal, and pumping
• Soils testing, materials testing, and inspection
• Building permits and local authority fees such as after-hours inspections or fence permits

Contingency Within Direct Overhead

Contractors may include a contingency allowance within their direct overhead to cover incidental damage that occurs during construction. A damaged sidewalk, a scraped adjacent structure, or finished work that gets damaged with no one stepping up to claim responsibility. It happens on virtually every project.

On a lump sum contract, any contingency that goes unused at the end of the job becomes additional profit for the contractor. Because contingency can impact your bottom line, it’s an important line item to understand when reviewing a bid.