Budgeting your costs
Now that you’re determined an activity rate to allocate each overhead cost, you need to budget for both direct cost and overhead costs.
This step is important, in order to generate job estimates that are as close to your actual costs as possible.
Sure, your actual costs may be different than what you budget. A labour shortage, for example, may require you to pay more for labour costs than you planned. But thinking carefully about budgeted costs minimises the differences between budgeted and actual costs.
As a business owner, that’s the best you can do.
Plan your overhead costs
To create a budget, start by reviewing your income statement for the prior year. Scan the expense categories and note each overhead cost, and the amount you spent in the prior year.
Some overhead costs, such as insurance premiums or a building lease, are fixed costs, and those can be used to allocate overhead in the current year.
Other overhead costs must be estimated for budgeting purposes. Travel costs, for example, will vary, depending on the number of projects Susie completes, and the distance between each job and the office.
To budget for variable overhead costs, consider the prior year expense, and your expected change in sales for the year. If, for example, travel costs totaled $5,000 in the prior year, and Susie expects a 10% increase in sales, she can budget for a 10% increase in travel, or $5,500.
Your goal is to decide on a budgeted dollar amount of annual overhead cost for each cost category.
Budget for direct costs
The two big direct costs for a contractor are direct labour and direct materials. As explained above, direct costs can be traced to a product or service.
The Johnson kitchen addition, mentioned above, requires 50 labour hours, and Susie needs to decide on a labour rate per hour. She also needs to budget for all materials, including a cost per square foot for lumber.
To create a budget for direct costs, Susie should review prior year jobs and note the labour rates paid and the costs she incurred for specific materials. Direct costs are budgeted based on rates, such as a labour rate, or a rate paid per square feet of material.
Once you have budgeted costs for both direct costs and overhead, you can create useful job estimates.