An indirect cost in construction is an expense that doesn’t relate directly to the functions, products or operations of a construction project. For instance, expenses that cover the costs of administrative processes and salaries for staff are indirect costs that construction companies are typically responsible for.
Why are indirect costs important?
Indirect costs are essential to business functions. Indirect costs are required to create, bid on, and establish contracts for client projects even though they aren’t directly connected to finishing a construction project. Additionally, indirect costs are crucial for carrying out a number of crucial business processes, such as:
Cost allocation
Companies need to understand where they should invest business funds in their operations. A business can learn important information about its expected recurring costs from indirect costs each accounting period. Determine where to distribute income to support business growth and profitability by understanding how indirect costs affect the business’ processes.
Financial reporting
Indirect costs are important for financial reporting purposes. For instance, when filing state and federal taxes, businesses must disclose additional financial information along with their expenses, income, profits, and losses. Because these costs reflect ongoing business operations that businesses must deduct from revenues to understand profitability, indirect costs are crucial for financial reports.
Budget planning
Having a better understanding of indirect costs can aid businesses in creating budgets for organizing and beginning construction projects. Building contractors must keep a budget in order to understand their financial situation in order to submit bids for construction contracts and acquire the tools or personnel they require. Deducting indirect costs from revenues can help businesses with budget planning because they are frequently recurring obligations, like utility bills and employee salaries.
What is an indirect cost in construction?
An expense in the construction industry that isn’t directly related to the operations, functions, or products of a construction project is known as an indirect cost. For instance, indirect costs that construction companies typically bear include those that cover the costs of administrative procedures and employee salaries. Contrary to direct construction costs, which cover costs incurred to complete construction projects, a business must pay indirect costs to maintain vital operations and foster business expansion. Several indirect costs construction companies often have include:
How can you analyze indirect costs?
Despite the fact that an indirect cost in construction isn’t related to a single project specifically, businesses typically divide indirect costs equally among all projects and overhead. Indirect costs can also impact a company’s gross profits from completed projects, so it’s crucial for the company’s success to analyze indirect costs and allocate them wisely among construction projects. More information on how to evaluate indirect costs to allocate funds to construction projects can be found in the steps that follow:
1. Find your general and administrative costs
It’s important to comprehend how general and administrative costs impact fund allocation in order to classify your indirect costs more accurately. Regardless of project volume, general and administrative costs typically include fixed costs like overhead. Additionally, these expenses can cover any indirect expenses that affect project revenue indirectly.
2. Determine variable indirect costs
Some of the indirect costs a business incurs are variable costs that can impact project completion and can change depending on the project. The various aspects of indirect costs for assisting business processes can also include a variety of costs that can have an impact on revenue because each project a business launches requires different considerations. Subcontractors, safety gear, and insurance are a few examples of variable indirect costs that vary from project to project. This could imply that certain personnel are needed for one project while different personnel may not be required for another project to be completed.
3. Classify your indirect costs
Understanding your administrative costs and other indirect costs will help you categorize each expense into a specific accounting category. Your overhead is included in the general and administrative expense account, or G&A costs as it is known in the business world. Your variable indirect costs can also include the costs your business incurs when submitting bids for projects, starting contracts, and overseeing the completion of each construction project. Typically, businesses classify and analyze their indirect costs to determine how best to allocate financial resources.
4. Establish an allocation method
After examining your indirect costs, you can devise a system for allocating financial resources for your company. For instance, many businesses in the construction industry may divide costs according to labor hour rates, total direct costs, or direct labor costs. Additionally, you can develop an allocation strategy based on historical or projected cost data from your business, which can reveal how your business budgets for crucial operations like project materials, personnel, and other indirect costs.
5. Develop a plan for adjustments
Businesses can better plan for changes in the rates they charge per project or labor hour by creating a plan for allocating funds that pay for indirect costs. For instance, a business can better prepare for rate adjustments based on labor costs if the number of employees needed on a job site varies from one project to the next. For businesses to achieve business objectives, generate revenue, and maintain profitability, the capacity to change rates between projects is crucial.
Tips to streamline your indirect costs
Companies may need to pay for specific indirect costs depending on the project in order to successfully complete project tasks. You can, however, simplify your indirect costs by only including those outlays required to support project contracts and business outcomes. The following advice outlines several methods to reduce construction’s indirect costs:
Cost Control in Construction: Direct, Indirect, Variable, Fixed Cost, how they impact your project
FAQ
What is indirect cost example?
Overhead costs, such as rent and utilities, as well as general and administrative costs, such as officer salaries, accounting department costs, and personnel department costs, are examples of indirect costs.
What is the difference between direct and indirect costs in construction?
For a particular project, direct cost items include labor, materials, subcontractors, equipment rental, and other costs. Project-related expenses known as “indirect costs” may not always be directly related to a specific contract.
What are indirect costs?
Indirect costs are business expenses that are not immediately associated with a specific grant, contract, project function, or activity but are necessary for the organization’s general operations and the performance of its activities.
What are the 5 types of indirect cost?
Accounting and legal fees, administrative salaries, office costs, rent, security costs, telephone costs, and utility costs are a few examples of indirect costs.
