Look! Up in the Sky!

...It’s a bird! It’s a plane! No — it’s your overhead!

I met an actual bean counter a few weeks ago. A former bean counter, truth be told.

Now vice president of sales for a company in another industry, this guy began as a cost accountant at – wait for it – a soybean processing company. Like I said, an ACTUAL bean counter.

I share this anecdote to point out where my new acquaintance started and what he has become. If more people on the sales side had a first-hand understanding of what it costs to do business, a whole lot more companies would be a whole lot more profitable. That is what our spreadsheet-building efforts of the last three months are about, and this month the rubber really meets the road.

So far, our cost accounting template has covered job-specific expenses for materials, labor and taxes on that labor. But operating a business costs us in other ways – ways that can’t be directly tied to any particular project. This month, we are going to identify those indirect costs, and make room for them on our spreadsheet.

Also known as “overhead,” indirect costs are the services you buy, the space you rent (or own) and the cost of debt you pay just to enable your company to do the work it does. Totaling them up and accounting for them fractionally on each job is nowhere near as daunting as it sounds. The spreadsheet makes it easy.

Take a look at the Overhead Calculation Form (OCF) on the right. It’s as easy as filling in the blanks. Later, we will do a little division, and you will have a solid number, tied to actual shop production, to cover overhead on the costing sheet.

Most items on the OCF are self-explanatory, but a few need further discussion.

“Unemployment Compensation Taxes” are generally charged as a percentage of each employee’s wage. But – unless you have laid someone off for lack of work and they have collected unemployment – these taxes (depending on your state) are either miniscule or nonexistent. We include them as overhead so we are sure that, big or small, they are captured and that their cost is distributed across all the jobs we do.

The same is true of “Employee Benefits.” Total your costs for all the benefits you offer to people on the floor, administrators and managers. Similarly, “Admin/Mgmt Salaries (including SS/Medicare taxes)” should be considered overhead, because these folks are not directly contributing to a specific job; they are working on all of them, but in an indirect manner.

The simplest way to differentiate between direct and indirect costs is by answering this question: “Does the expense arise from the job itself, or is it a price I pay for being in business?”

You will notice several spots on the OCF under “Other Expenses.” Each business is unique, so don’t assume the items I have listed include all your overhead costs. Refer to your checkbook and other records to make sure you are capturing everything, and be sure to label them and enter their amounts.

I provide room for both the cost per month and cost per year because different expenses are billed in different ways, and because there is no better test of a particular item’s value than seeing what it’s costing you annually.

A ‘Far-Sighted’ View

Cost accounting has the reputation of being a highly myopic practice. In truth, there is no better way to both understand the nuts and bolts of your business and to apply that knowledge to the bigger picture, so it can become a profitable machine.

When you are confident that you have listed all your overhead items and their costs, sleep on it. Taking an additional day or two will often save reworking the numbers to include that forgotten annual spray booth maintenance or something else you have overlooked.

Divide the total of your projected annual overhead expenses by the number of hours you realistically expect to be worked ON SPECIFIC JOBS in the coming year. Note that BOTH of these are PROJECTIONS. It’s okay to use your current rent figure. But if you are in the middle of an annual lease and know your rent will go up sometime in the next 12 months, make your best estimate of your total for the year with that in mind.

Likewise, you are PROJECTING total shop hours to be worked in a typical month and across the next year. Base your projection on reality, not hope. If your shop is on a 40-hour week, use 36 weekly hours for each full-time worker. It’s better for your profitability to divide your overhead by fewer hours than will actually be worked than by more. The lower number helps ensure your costs are covered. One that is too high risks not covering them (and pretends that you have a shop full of workaholics).

(Note: I have entered “1” as “Projected Shop Hours” on the blank OCF to avoid an error message about dividing by zero, which appears in the “Overhead Rate” boxes when “Projected Hours” is left blank.)

Creating the OCF is easy, and it’s a spreadsheet you will need to keep current as you do cost accounting on every job. Rather than give you step-by-step guidance for preparing it, I’d like you to try it yourself. If you have been working along with me on the costing spreadsheet to this point, the OCF should be a piece of cake. (Shoot me an e-mail if you have any trouble, but at least give it a shot.) For the added experience it provides in creating spreadsheets, I think you will be glad you did.

In the meantime, let’s return for a moment to the costing template on page 23. Last month, we completed it through “Labor Total,” cell N3. In the accompanying graphic, that column is now shaded, along with the rest of our previous work. This month, label the final seven columns as shown. When done, go to cell O3 (below “M + L Subtotal”) and enter this formula: =D15+N3.

Enter the quotient of the OCF, “Overhead Rate” in the next cell, P3. Then, in Q3, insert this formula: =H15+J15. It gives “Total Hours” by combining regular and overtime hours worked.

I said earlier that it is always better to project too few hours worked over a month or year than too many. Overtime is a big reason why. To get “Cost of Overhead” in the next column, we are going to include overtime hours in the calculation.

Overtime is difficult to project. By including it in our cost analysis, we better determine what we can and should be charging for our work, based on what it really costs to run our business. “Projected Shop Hours” on the OCF should be estimated based only on “regular” hours, because when doing a quote, your labor estimate is based on the “regular” shop rate. But, estimating and analyzing are two different things. Including OT hours to get the cost of overhead at the analysis stage helps: (1) account for some of the cost of overtime, and (2) develop a record of the total hours your shop is really working, making future “Projected Shop Hours” estimates more accurate.

So, enter the formula =P3*Q3 in cell R3. Now we are really close. Here is your homework:

1) Prepare an OCF template.
2) When it is finished, save it as the blank template, then save it as “OCF 08.”
3) Fill in “OCF 08” and meet me here next month to put everything together — and to take our costing sheet out for a test drive. e

Anthony Noel has written for CWB since 1994. Send comments to him at [email protected]. A full archive of Management Strategies columns can be found here.


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