Understanding Direct Cost vs. Indirect Cost for Construction Projects

Understanding Direct Cost vs. Indirect Cost for Construction Projects

July 31, 2023
Understanding Direct Cost vs. Indirect Cost for Construction Projects

Construction projects are highly complex with several moving pieces. Developers need to manage land acquisition, permitting, site preparation, and materials costs — all before they ever start building. There are large expenses along with smaller costs that all need to be accounted for in the budget. A company that lacks attention to detail when setting a budget could cause a project to lose money as forgotten expenses add up.

As you work to improve your budgeting, make sure you consider the direct and indirect costs in your plans. By learning more about these two costs, you can set a more effective budget for your projects.

What Are Direct Costs?

Direct costs are any expenses that you can directly correlate to a project. For example, if you’re laying down a concrete foundation, the materials used for that specific project and the labor costs of hiring workers are two of your direct costs.

How To Estimate Direct Costs

Because direct costs are easy to identify, they’re also fairly easy to calculate. You can do so by evaluating the size of the project and determining the kinds of materials you will need to complete it. For example, you can calculate labor costs by estimating the number of people needed, multiplying by the project duration in days, and multiplying that estimate by the hourly wage rate.

This process gets even easier if you use construction takeoff software that helps you budget ahead of a job. Construction estimator tools can also help you provide project quotes to clients before you move forward with the work. You can also build out estimates based on similar previous project expenses.

What Are Indirect Costs in Construction?

While not directly associated with a single project, indirect costs are still essential for running your company. For example, the salary of your human resources professional who hires contractors and secures labor for a job is an indirect cost. Without this person, your team wouldn’t have skilled employees ready to do the work.

Other indirect costs in the construction world include equipment and tools — which have repair, maintenance, and depreciation costs — along with office supplies, taxes, employee benefits, and workers’ compensation. Oftentimes, you can find many indirect costs listed on your construction submittals, which go into greater detail on equipment and processes.

When your company completes a balance sheet at the end of the year, it can’t ignore indirect costs. Each cost contributes to the profitability of the organization.

How To Estimate Indirect Costs

The process to estimate and calculate indirect costs will vary depending on your goals. If you simply need to record an expense for your annual bookkeeping, you can add line items for these indirect costs within various expense categories. However, some construction teams track indirect costs on a project-by-project basis.

For labor, consider the total number of hours that a person would spend working on a specific project. Using HR once again as an example, it will take more labor hours to hire 30 workers for a job than to hire five. The U.S. Department of Labor also has guidelines for calculating indirect labor costs.

When tracking equipment, assign a value for using specific tools or machines as if you had to rent them from your organization. Essentially, you are. You’re checking out a truck or tractor to be used for a project that would otherwise be used elsewhere.

Finally, you can take a flat cost and divide it across your projects to estimate its per-project value. For example, you can take the CEO’s salary and divide it across all 20 projects you completed in 2022 to see what their value is on a per-project basis.

Key Differences Between Direct and Indirect Costs in Construction

The main thing you need to know about direct and indirect costs is that a direct cost will be used for a specific project, and usually nothing else. For example, materials used in one project cannot be used for another. While the same contractor might work on multiple projects, you won’t get the hours you allocate to a specific project back.

Think of indirect costs as expenses related to running a business as a whole. If you have a work truck that drives to the office in the morning and then to four job sites throughout the day, the truck is an indirect cost. It’s essential to the company’s operations but isn’t tied to a specific task or project.

The Importance of Accurately Classifying Costs

Improper calculation and classification of funds can have a significant impact on your short and long-term finances. In the short term, you might discover that your bids are much less lucrative than you expect. This usually occurs when companies focus on direct costs without thinking about the costs associated with equipment repairs and office maintenance.

In the long run, your company could struggle to turn a profit without carefully managed bookkeeping. Every expense, from the cleaning service that visits your office to the oil changes on your fleet, needs to be categorized and recorded. Even if you don’t have a strong financial background, you don’t want to ignore your company's finances. Tracking indirect costs is a great learning opportunity to understand how a business functions.

Once you have a clear picture of your direct and indirect costs, you can take steps to change them. You can work to reduce your costs while increasing your revenue, which can lead to greater profitability. You can also accurately record your tax deductions to receive a larger rebate.

Impact of Direct and Indirect Costs on Construction Bidding

Knowing your direct and indirect costs is essential when you are bidding on construction jobs. First, you’ll know if a bid will be profitable for your company. There’s less stress around breaking even with the jobs you earn. Next, you can create a better experience for your clients. There’s less of a risk of your project going over budget because you have already clearly mapped out your expenses.

Good budgeting and accurate estimates are two ways to win over clients and make them recommend your business in the future.

Picking up coffee and donuts for your crew in the morning might not seem like a critical expense, but every line item counts with bookkeeping. Know the differences between direct and indirect construction costs so you can accurately budget each job and keep organized books.

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