Your Overhead Isn't Someone Else's Problem!
Understanding the cost of running a landscape business—and how to recover it through your work.
Let's say you've just completed a $20,000 landscape installation. The project went well. Your crew worked efficiently, the materials arrived on time, and the customer is delighted.
You sit down and review your numbers. Labor cost $5,000. Equipment cost $3,000. Materials cost $6,000. That's $14,000 in expenses.
You collected $20,000, which means you made $6,000 in profit.
Right?
Well, not necessarily.
Because while your crew was installing that landscape, your business was still operating. Someone answered the telephone. Someone prepared the estimate. Someone scheduled the work. Someone ordered the materials. Your insurance premiums still had to be paid, your software subscriptions kept renewing, and your office expenses didn't disappear. And somebody had to manage the whole operation.
Those expenses are part of the cost of doing business. They're called overhead.
And if you haven't accounted for them in your pricing, that $6,000 you thought was profit may be considerably less. It might even disappear altogether.
What Exactly Is Overhead?
Every landscape company has expenses associated with performing its work. Some are directly related to a particular project. Others are necessary to operate the business, whether you're installing a patio, maintaining a commercial property, or simply preparing estimates for future work.
We generally divide these expenses into two categories.
Direct costs are expenses that can be assigned to a particular project or service. These typically include field labor, equipment used on the project, materials, subcontractors, and other identifiable project expenses.
Overhead, sometimes called indirect costs, includes the expenses of operating the company that aren't assigned directly to a particular project. Examples might include:
Office rent, utilities, and supplies
General business insurance
Accounting, bookkeeping, and legal services
Administrative employees and management compensation
Estimating, scheduling, and customer service
Advertising, marketing, and website expenses
Software subscriptions and communications
General shop expenses and other indirect operating costs
Not every company has the same overhead. A one-person landscape maintenance business operating from a home office may have relatively modest overhead. A company with multiple crews, a large equipment yard, administrative employees, and dedicated management personnel will probably have considerably more.
Neither arrangement is necessarily better. They're simply different business models, and each must recover the expenses associated with operating that business.
The Owner Is Part of the Equation
Here's something I believe is particularly important.
If you're spending time managing your company, preparing estimates, meeting customers, scheduling work, handling payroll, or performing other administrative responsibilities, that time has value. You should be compensated for it, and that compensation is a business expense.
If you're working in the field, your compensation for that work may be treated as a direct labor cost. But when you're performing management and administrative duties, that compensation generally belongs in overhead.
Your compensation isn't automatically profit simply because you own the business. Profit is what remains after the company has paid its operating expenses, including appropriate compensation for the work you perform.
Of course, the accounting and tax treatment of owner compensation depends on how the business is organized. But from a pricing standpoint, the principle remains the same.
The business must generate enough revenue to compensate the people doing the work—including you.
Let's Look at a Million-Dollar Landscape Company
Imagine a landscape company that generates $1 million in annual revenue. It operates several field crews and performs residential landscape installations, drainage improvements, and hardscape projects.
Over the course of the year, its direct costs — field labor, equipment, materials, and subcontractors — total $700,000. That leaves $300,000 after direct expenses.
Sounds pretty good, doesn't it?
But now let's look at the company's overhead.
Annual Overhead Expense | Amount |
Owner's management and administrative compensation | $100,000 |
Office and administrative expenses | $40,000 |
General business insurance | $30,000 |
Accounting, software, and professional services | $20,000 |
Sales, estimating, and other indirect expenses | $50,000 |
Total Annual Overhead | $240,000 |
The company has $300,000 remaining after direct costs, but it must pay $240,000 in overhead. That leaves:
$300,000 − $240,000 = $60,000 in operating profit
On $1 million in revenue, that's a 6% operating profit margin — not the 30% someone might mistakenly believe they earned by looking only at direct costs.
And if the company had another $70,000 in overlooked overhead expenses? It would have lost $10,000.
Despite completing a million dollars in work.
Being busy doesn't necessarily mean you're profitable.
These figures are illustrative. Actual overhead and direct-cost percentages vary considerably depending on the company's services, location, equipment, staffing, and operating structure.
Your Customers Have to Pay for Overhead
Now here's the important part. Who pays for all those expenses?
Your customers do. Or at least, they should.
Think about it. Every dollar your business spends must ultimately come from the revenue it generates, unless you're financing the expense through debt or contributing money from somewhere else.
Your employees don't pay your office rent. Your suppliers don't pay your business insurance. Your accountant doesn't pay your administrative expenses. And your customers aren't going to send you an extra check at the end of the year because you underestimated your overhead. (I've been waiting on a few of those for thirty years.)
You have to include those expenses in the prices you charge.
Overhead isn't an expense you absorb after the job. It's a cost you plan to recover when you price the job.
That doesn't mean adding arbitrary charges to every estimate. It means understanding your company's operating expenses and developing a consistent method for recovering them through your work.
First, Know Your Annual Overhead
Before you can recover overhead, you need to know how much you have. Start by developing an annual overhead budget.
Review your actual expenses from the previous year, identify which expenses are indirect, and estimate what you'll need to operate the company during the coming year. Include reasonable compensation for management and administrative work. Account for expenses that may increase, such as insurance, rent, software, and professional services. And don't forget the expenses that come around only once or twice a year.
For our million-dollar company, we've established an annual overhead budget of $240,000. That's the amount the company needs to recover through its work before it can accurately determine operating profit.
Now the question becomes: How do we recover it?
Recovering Overhead Through Labor and Materials
One practical approach is to recover overhead through the labor and materials included in your projects.
Why labor and materials? Because they're two of the primary components of most landscape contracting work, and they provide a relatively straightforward basis for distributing overhead recovery across the projects you sell.
But here's something important.
Not every landscape company should recover overhead in the same proportions.
A maintenance company relies heavily on labor. A landscape installation or hardscape company may have substantial material purchases. A full-service landscape contractor may fall somewhere in between. That means the proportions of overhead recovered through labor and materials may be different.
Let's look at how that works.
Understanding the Split
Suppose our million-dollar landscape company has the following annual direct costs:
Direct Cost Category | Annual Amount |
Labor, including labor burden | $300,000 |
Materials | $250,000 |
Equipment and subcontractors | $150,000 |
Total Direct Costs | $700,000 |
Its annual overhead budget is $240,000. Now suppose the company decides to recover 60% of its overhead through labor and 40% through materials. That means:
60% of $240,000 = $144,000 recovered through labor
40% of $240,000 = $96,000 recovered through materials
Together, those two amounts recover the entire $240,000 overhead budget.
But how do we translate those allocations into estimating percentages?
Calculating the Labor Recovery Rate
Our company projects $300,000 in annual direct labor costs, and we've decided that labor will recover $144,000 of overhead. Divide the labor overhead allocation by annual direct labor costs:
$144,000 ÷ $300,000 = 48%
That means the company needs to add a 48% overhead markup to its direct labor costs to recover the labor portion of its overhead budget, assuming it achieves its projected annual labor volume.
Remember, those direct labor costs should already include wages, payroll taxes, workers' compensation, benefits, and other appropriate labor burden. We're not adding those expenses again. We're recovering the company's indirect operating expenses.
Calculating the Materials Recovery Rate
Now let's look at materials. Our company projects $250,000 in annual material costs, and we've allocated $96,000 of overhead recovery to materials. Divide the materials overhead allocation by annual material costs:
$96,000 ÷ $250,000 = 38.4%
That means the company needs to add a 38.4% overhead markup to its material costs to recover the material portion of its overhead budget.
Now we have two overhead recovery rates:
Labor: 48%
Materials: 38.4%
These percentages aren't arbitrary. They're based on the company's annual overhead budget, projected labor and material costs, and the proportion of overhead the company intends to recover through each.
And here's an important distinction:
The 60/40 split determines where overhead will be recovered. The 48% and 38.4% figures are the actual markups applied to labor and materials.
Those are not the same percentages.
What Might Different Companies Do?
Let's look at three possible approaches using the same $240,000 overhead budget and the same projected labor and material costs.
Business Approach | Overhead Through Labor | Overhead Through Materials |
Maintenance-oriented | 80% | 20% |
Balanced installation | 50% | 50% |
Construction-oriented | 40% | 60% |
These are examples, not prescribed industry standards.
A maintenance-oriented company might place a greater share of overhead recovery on labor, because labor is its primary source of production. A company performing substantial landscape construction might recover more overhead through materials. A company offering a mixture of services might prefer a more balanced approach. Whatever the approach, the percentages should reflect the company's actual operations and projected costs.
For our example, here's how those different allocations would affect the recovery markups:
Overhead Allocation | Labor Markup | Materials Markup |
80% labor / 20% materials | 64% | 19.2% |
60% labor / 40% materials | 48% | 38.4% |
50% labor / 50% materials | 40% | 48% |
40% labor / 60% materials | 32% | 57.6% |
Notice how significantly the markup percentages change, even though the annual overhead budget stays the same. That's because we're changing how the overhead is distributed, not how much overhead exists.
And that's why simply copying another contractor's estimating percentages can be a mistake.
Your estimating system should reflect the kind of landscape company you operate, not somebody else's business model.
Let's Apply It to a Project
Now let's take our 60/40 overhead allocation and apply it to an actual landscape installation. Suppose the project has the following direct costs:
Direct Project Cost | Amount |
Labor, including burden | $4,000 |
Materials | $4,000 |
Equipment and subcontractors | $2,000 |
Total Direct Costs | $10,000 |
Using our overhead recovery rates:
Labor overhead recovery: $4,000 × 48% = $1,920
Materials overhead recovery: $4,000 × 38.4% = $1,536
Total overhead recovery: $1,920 + $1,536 = $3,456
Our project now looks like this:
Project Expense | Amount |
Direct labor | $4,000 |
Direct materials | $4,000 |
Equipment and subcontractors | $2,000 |
Labor overhead recovery | $1,920 |
Materials overhead recovery | $1,536 |
Total Cost Before Profit | $13,456 |
That's the amount the project needs to recover to cover its direct costs and its allocated share of overhead.
And we haven't added profit yet.
Recovering overhead is not making a profit. It's paying the expenses necessary to operate the business.
Now Let's Add Profit
Suppose the company wants to achieve a 15% operating profit margin. We take the total cost, including allocated overhead, and divide it by 0.85:
$13,456 ÷ 0.85 = approximately $15,831
Here's the complete picture, using rounded figures:
Project Expense | Amount |
Direct project costs | $10,000 |
Allocated overhead | $3,456 |
Total cost before profit | $13,456 |
Operating profit | $2,375 |
Selling Price | $15,831 |
Now the company has established a selling price intended to recover direct expenses, contribute its allocated share of overhead, and produce a 15% operating profit margin.
Compare that to a contractor who simply adds 20% to the original $10,000 in direct costs. That contractor charges $12,000. But based on our example, the company's allocated full cost is $13,456, which means the $12,000 selling price falls $1,456 short of recovering its full allocated cost.
The contractor might believe the project made $2,000. In reality, under this allocation method, the project failed to cover its allocated share of company expenses.
That's a very different financial picture.
But What About Equipment?
You may have noticed that we didn't apply an overhead markup directly to equipment or subcontractor costs. That's intentional in this example. We've chosen to recover the entire overhead budget through labor and materials.
That doesn't mean equipment and subcontractor expenses aren't important. They still have to be accurately included as direct project costs. And some companies may find it appropriate to recover a portion of overhead through equipment charges or subcontractor markups as well.
The important thing is understanding how your system works. If your equipment rates already include certain indirect expenses, you shouldn't recover those same expenses again through another markup. Likewise, if you decide to recover all your overhead through labor and materials, you need to make sure those categories generate enough work to recover the annual budget.
Recover your costs, but don't count the same expense twice.
What Happens When Business Slows Down?
Here's another important consideration. Our million-dollar company established its overhead recovery rates based on projected annual direct costs of $300,000 in labor and $250,000 in materials.
But suppose business slows down. Maybe the weather is unusually bad. Maybe several projects are delayed. Maybe sales simply don't meet expectations. Instead of the projected amounts, the company finishes the year with $240,000 in direct labor costs and $200,000 in material costs.
Using the same overhead recovery rates:
Labor recovery: $240,000 × 48% = $115,200
Materials recovery: $200,000 × 38.4% = $76,800
Total overhead recovered: $192,000
But the annual overhead budget was $240,000. That leaves a $48,000 shortfall.
Of course, some overhead expenses may decrease when business slows down. But many continue regardless of how much work the company performs. Insurance premiums still come due. The office still needs to operate. Management responsibilities don't disappear. (Neither does the insurance agent.)
This is why overhead recovery isn't something you calculate once and forget about. You need to monitor your actual expenses, labor and material volume, and recovery rates throughout the year, and adjust your pricing or operations when necessary.
More Overhead Isn't Always a Bad Thing
Some contractors become so concerned about overhead that they try to eliminate every expense that doesn't directly produce work in the field. That can be a mistake.
Consider hiring an office administrator. At first glance, that's an additional overhead expense. But what if that employee answers customer calls promptly, organizes scheduling, handles routine paperwork, and frees the owner to spend more time selling profitable projects or managing production?
That additional overhead may actually improve the company's performance. The same can be true of estimating software, employee training, professional accounting, or a better management system.
Sometimes spending more money on overhead allows a company to make more money overall.
Imagine a company that spends $30,000 a year on administrative support and, as a result, improves scheduling, reduces missed opportunities, and allows the owner to focus on higher-value work. If those improvements generate substantially more than $30,000 in additional contribution after direct costs, that overhead expense may be a very worthwhile investment.
The objective isn't to operate with the lowest possible overhead. It's to operate with the overhead necessary to support an efficient, productive, profitable company.
Good overhead supports the business. Unnecessary overhead burdens it.
And both still have to be paid for.
As Your Company Grows, Your Overhead Changes
Let's say you started your business with one truck, a small crew, and a home office. You handled the estimates, scheduling, bookkeeping, customer communication, and most of the management responsibilities yourself. Your overhead was relatively modest.
Now imagine you've grown to three crews. You may need an office administrator, a production manager, additional software, more insurance coverage, and a larger facility. Your overhead increases.
But here's the interesting part: your overhead doesn't necessarily increase at the same rate as your revenue. You might be able to manage two crews with nearly the same office expenses as one. Or you might reach a point where adding another crew requires an entirely new level of management and administrative support.
These are important considerations when deciding whether to expand. Growth should be evaluated based on what it contributes to the business, not simply how much additional revenue it produces.
A bigger company isn't automatically a more profitable company.
Know Your Numbers
I believe every landscape contractor should be able to answer a few basic questions:
How much does it cost to operate your company each year, apart from direct project expenses?
How are you recovering those costs through your pricing?
How much overhead are you recovering through labor? How much through materials?
Are those recovery rates appropriate for the kind of work your company performs?
And after paying those expenses, how much profit is the business really earning?
You don't need a complicated accounting system to begin understanding these numbers. But you do need accurate records and a willingness to examine them. And as your company grows, the importance of that understanding only increases.
The Bottom Line
Let's return to that $20,000 landscape installation we started with.
You collected $20,000. Your direct costs were $14,000. That left $6,000.
But that $6,000 wasn't necessarily profit. Some of it still had to pay the expenses of operating your business.
How much? That depends on your overhead and how you recover it. The important thing is recognizing that those expenses exist and that your pricing must account for them.
Your overhead isn't someone else's problem.
It's your responsibility to understand it, manage it, and account for it when you price your work. But your customers are ultimately the source of the revenue that pays for it.
And that's exactly as it should be.
Because your customers aren't simply paying for the plants, pavers, labor, and equipment they see on their project. They're paying for the professional business capable of delivering that project.
And that business has a cost.
Know that cost. Recover it. Then earn your profit.
~ Eric
Comments