There are generally three cost categories in construction: direct costs, indirect costs and general and administrative expenses (G&A). The word overhead is sometimes used interchangeably to describe indirect costs and G&A expenses. However, indirect costs should be thought of as field overhead while G&A expenses should be thought of as company overhead. G&A expenses are costs for managing a business and are not directly tied to how much work is performed. Examples include administrative salaries, marketing, office supplies and rent. This blog focuses on managing G&A expenses.
G&A expenses are often challenging to manage because they do not increase or decrease in correlation with revenue. Management decisions are the main factor that influence these expenses. G&A will remain at a constant level to effectively support a range of revenue. For example, an electrical subcontractor can perform $5 to $10 million in work with just two people in the office to handle all the administrative work. However, at $10 million and above the sub is stretching the administrative staff and new staff needs to be hired to handle the workload. This new staff will support an increase in revenue up to another range of revenue and the cycle continues. There is not a specific ratio of revenue to G&A that a company should strive for because this can vary even between companies in the same trade. This is because business structures can be significantly different from one to another. For example, two mechanical subcontractors that perform the same type of work have different rent expense because one owns a building and the other one does not.
Consider the electrical subcontractor in the example above. At $5 million the administrative staff can handle their workload with no problem; however, profit is low. At $10 million profits are up, but the administrative staff can barely handle the workload and the company begins to have breakdowns in the system. Therefore, the current administrative staff can operate effectively with volume somewhere around the middle of $5 to $10 million.
Understanding the relation between revenue and G&A can help leaders make better management decisions at the different business cycles (see previous blog A Basic Understanding of the Three Market Cycles – Construction Companies).
- In a down cycle, companies should focus their efforts on the best work and people. This is a good time to drop bad clients and type of work that is not profitable. This is also when companies let go of low performing people.
- In an up cycle, companies can find out how much they can stretch their G&A, making the early stages of this cycle the most profitable.
- In the static cycle, companies improve systems and staff. Companies also train, fix equipment, make major changes to systems and project management needs. Companies do not typically do this during the other cycles because they are hesitant to invest or too busy to improve.
A well-managed company can find value in each stage. It is important to recognize your company’s cycles and knowing how much work your current G&A can handle. The next challenge is to react in time to the changing cycles.
Our professionals have many years of experience working with the construction industry. If you have accounting questions about your business, don’t hesitate to contact a Henry+Horne professional adviser.
Abel Coronel, CPA