Overhead allocation distributes your indirect costs across jobs so you know what each project actually costs to complete. Without it, your job cost reports only show direct expenses like labor and materials. That gives you an incomplete picture of profitability because it ignores all the money you spend just to keep the business running.

Start by identifying what counts as overhead. These are costs you incur that don’t tie directly to any single job. Rent or shop lease, insurance premiums, office staff salaries, vehicle costs not charged to specific projects, accounting software, equipment maintenance, utilities, and general supplies all qualify. If you can’t point to a specific job that caused the expense, it’s overhead.

Next, choose an allocation base. This is the metric you’ll use to spread overhead across jobs. The most common options for contractors are labor hours, labor cost, and direct cost percentage.

Labor hours works well when your jobs vary in size but use similar labor rates. You divide total overhead by total labor hours to get a per-hour overhead rate. If your annual overhead is $120,000 and your crews log 6,000 billable hours, your overhead rate is $20 per labor hour.

Labor cost makes more sense when you have significant wage differences between workers or job types. You calculate overhead as a percentage of direct labor dollars. $120,000 in overhead divided by $300,000 in labor cost gives you a 40% burden rate. A job with $5,000 in labor gets $2,000 in allocated overhead.

Direct cost percentage is simpler but less precise. You add overhead as a percentage of all direct costs including labor and materials. This works for businesses where the ratio of labor to materials stays fairly consistent across jobs.

Once you’ve chosen your method, calculate the rate using your prior year’s actuals or your budget for the current year. Apply that rate to each job as you track costs throughout the year. A contractor bookkeeper in American Fork can help you pick the right approach for your business and build it into your regular reporting.

Here’s a practical example. Your overhead last year was $96,000. Your crews worked 4,800 hours on billable jobs. Your overhead rate is $20 per hour. When Job #142 logs 120 labor hours, you allocate $2,400 in overhead to that job. Now your job cost report shows direct labor, materials, subcontractors, and a realistic share of overhead. You can see whether that job actually made money.

Review your overhead rate at least quarterly. If your actual overhead is running higher than expected, your rate is too low and your job profitability reports are overstating margins. Adjust the rate so your numbers reflect reality.

Most contractors don’t allocate overhead at all. They think they’re making money on jobs that are actually losing money once you account for the cost of keeping the lights on. Proper construction job costing includes overhead allocation because that’s the only way to know your true margins and bid future work accurately.