Should We Allocate Overhead Before Reaching $6M in Revenue?

A Contractor University Member recently utilized the Ask-The-Expert Q&A feature within the member dashboard by submitting the following question and received the response below.

Contractor Question:

“In videos and materials, i see Contractor University recommends that we departmentalize our income statements down to net profit, but I read something today in searching the web site that recommended we not allocate overhead until we reach at least $6M in revenue. Is that something we shouldn’t bother with under reaching a certain size?”

Contractor University Expert Response:

“This is a good question and can create a little confusion. The answer is a bit more complex than a simple yes or no. I know as a business coach there can be multiple answers and no specific answer is necessarily right or wrong depending you and your situation which is the key.

So, let’s start by asking this question. Do you want your business to grow from where it is now to $6 million? Because I’ve had a coaching call with you, I know the answer to that question is “Yes”, you do eventually want to get to $6 million even in your smaller market.

If you are going to intentionally stay under $2 million in revenue and only run residential demand service and replacement, then departmentalizing your revenue and allocating overhead to those departments is a step that may not be needed. What is needed is the ability to accurately job cost each install job so that you know you are consistently producing desired gross margins. As you start to grow past $2 million and add say a dedicated commercial group, and more people associate with a new group, it becomes more necessary to departmentalize and even more important, allocating overhead expenses correctly to each department. One common practice is to allocate overhead expenses like rent and utilities based on percentage of labor between departments. This is a rough way to do it but does work. You can also allocate overhead expenses based on the square footage of your location the departments use. For most contractors, residential departments will have more allocated overhead than a commercial group, especially those who do a lot of residential new constriction vs. commercial work as most of the time big equipment purchases are delivered directly to a job site vs. stored at the contractor’s site.

As you start to add more people, obviously those folks will wear more specific hats, for example, a residential sales lead coordinator position would be fully allocated to residential replacement. This is usually the type of position you will want to add after you’ve added 2 commissioned residential salespeople and realized 3 to 4 million in replacement revenue.

In summary, there is no right or wrong revenue band to start departmentalizing your revenue streams if you have 4 or more revenue streams. It does make more P&L sense to do it after you’ve reached over $2 million in sales and added revenue profit centers past just residential demand service and replacement. “

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