What Are Indirect Expenses and Why Should I Care?

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Understanding indirect expenses will greatly benefit your remodeling business. By pretending they don’t matter, you’re jeopardizing your remodeling company’s fiscal health.

Last week one of my very favorite people (yes you, that’s right YOU!) and I agreed to ‘argue’ about Indirect Expenses.  This is so important to me (and to you!) that I dropped everything including decorating my tiny Christmas tree to write this very important PowerTips Article.

First things first – some definitions:

FIELD LABOR BURDEN: all costs related to employees who work on jobs, including

  • Field employer paid payroll taxes – FICA/Medicare/FUTA/SUTA
  • Field insurances – workers comp and general liability
  • Field benefits – medical/dental/life insurances, paid time off, retirement contributions, among others
  • Field indirect expense allocation – an allocation intended to move indirect expense from overhead to COGS and therefore to the jobs

INDIRECT EXPENSES: all expenses related to keeping a field employee productive on the job but that can’t be easily tied to a specific job.  Field cell phones are a perfect example – if you provide cell phones to your field employees, it makes them more efficient.  However you can’t easily tie that cell phone bill to the jobs he/she worked on.

So we ‘bundle’ all these indirect costs into an expense range – called INDIRECT EXPENSES.  Here’s a good list from my QuickBooks Manual showing all the costs I think should be included. Comment below if you’d like the chart of accounts and I’ll send it to you.

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Now you know all the costs that should be included in Indirect Expenses – next we need to get these expenses into COGS AND equally important ONTO THE JOBS.

The BEST way to do this is through payroll – this makes the process automatic!  And it makes your average hourly field labor cost complete.

This is the payroll setup in QuickBooks:

  • Company contribution
  • Name – Field indirect allocation
  • Track expense by job
  • Liability Account: overhead expense account Indirect Allocation
  • Expense Account: COGS/Field Labor Burden/Indirect Allocation
  • Skip through the remaining data entry screens to Default Rate & Limit

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The % rate to be allocated is the TOTAL of the Indirect Expense range (from your 2016 budget, you have completed your budget haven’t you?) DIVIDED by the TOTAL of the Field Gross Wages (from your 2016 budget).

SO – here’s the test: what would the Default Rate be if

The TOTAL budget for INDIRECT EXPENSES for 2016= $150,000 and

The TOTAL budget for COGS/FIELD LABOR/GROSS WAGES for 2016 =$450,000

If you said 33% – PAT YOURSELF ON THE BACK.  You get an A+ – $150,000 (the Indirect Expense total) is 33% of $450,000 (Gross Field Wages).

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The PROOF of the accuracy of this rate shows in the Actual vs. Budget for the INDIRECT EXPENSE range over the year ….  If you actually spend $150,000 in Indirect Expenses AND your field gross wages are $450,000 then the balance in the Indirect Expense range at year end will be ZERO.  And you’ll earn another A++.

 EXAMPLE of ZERO BALANCE BELOW

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And NOW you’ll have all indirect costs applied to COGS AND to the JOBS – you can now calculate your estimated labor costs so your estimates will capture all labor for the New Year! 

Think this was good? Well it’s just the beginning!

I do a session titled “Measure What Matters” at the Mastering Your Remodeling Business Workshop next month! (Yes, January 2016). Register right now so we can meet and discuss your financials! And there will be some other experts there, too. 🙂

GO FORTH AND PROSPER and HAPPY NEW YEAR!

Don’t Be A Hater: Accounting is Good for You!

Have you ever said “I know I should understand my financials but they just don’t interest me?”  Have you even thought it?  Admit it, probably!  Owners of most remodeling companies came from design or production backgrounds, few from accounting.

In fact the simple term “job cost accounting” recently caused looks of disdain and disgust among the TSA team where I was briefly detained on my way to Dallas.  They asked what made my suitcase so heavy:  job cost accounting books, I said.  Then they laughed at me and said “ick!”  True story!

Regardless of whether you’re a member of the Remodelers Advantage Roundtables or simply receive Power Tips in your inbox weekly, it’s time to take the 2016 Challenge:  get your finances and job costs in order and reap the rewards!

Here’s what “in order” means:

Balance Sheet clean and pretty:

  • No unexplained negative balances;
  • Cash accounts reconciled with no outstanding checks or deposits prior to 30 days;
  • Credit card accounts reconciled to last statement dates with no outstanding charges or payments prior to statement date;
  • All Shareholder loans moved out of Current Assets into Other Assets;
  • Accounts Receivable and Accounts Payable aging reviewing for balances older than 60 days;
  • Payroll liabilities reconciled
  • Long-term notes payable reconciled to year end statement for principal and interest charges
  • Equity balances reflecting only current year transactions.

Profit/Loss (aka Income Statement) clean and pretty

Gross Profit line:

  • All income from client contracts: no insurance dividends, rent income or “miscellaneous” income not related to client contracts
  • Over/Under Billings for all jobs open at year end (over $15,000 and/or 6 weeks in duration)
  • All job costs in COGS, none in overhead: all materials/trade contract/equipment used on jobs and labor including burden included in COGS and associated with jobs

Overhead:

  • All expenses related to running the company, as opposed to running jobs
  • All owner salary and distributions included in overhead – journalize out the distributions at year end for tax purposes

Other income/expense

  • Any income/receipts or expenses NOT related to client contracts or running the company in the current year

That’s the first part of the challenge: you can do this, probably by the middle of February. Now you’ll have a very good baseline from which to begin 2016.

Here’s the next part of the challenge and the most important part: learn to understand what they mean.  Start with job costs:  review estimated to actual with every payroll or at least twice a month.  Monthly review and question the balance sheet and the profit/loss – they go hand in hand.  One can’t be correct without the other’s accuracy.

If you don’t’ understand something – ASK!  Ask your bookkeeper, who should definitely know the answer, ask your CPA, ask members of your local NARI or NHBA, ask me, ask the Googleweb.

The point is – in 3 months you have accomplished the following:

  • Got 2015 books – including job costs – accurate;
  • Know how to keep 2016 books in the same state;
  • Begun to understand the reports;
  • Be able to manage the company based on what you see in them; and finally
  • FEEL GOOD ABOUT YOURSELF!