Cost of goods sold (COGS) makes up a substantial portion of construction contractors’ expenses. Most purchases are related to projects, either for labor or materials. Tracking these costs and keeping them separate from regular business expenses is key when it comes to measuring job profitability.
What is cost of goods sold in construction?
In construction, any costs that are associated with the performance and completion of a project for a contractor or subcontractor are considered to be cost of goods sold. For most companies, this includes a wide range of cost types, which we’ll discuss more below.
COGS is used to calculate the gross profit margin on specific projects and for the company overall. Gross profit margin is calculated by subtracting the cost of goods sold from total sales, then dividing that result by total sales. This percentage can be computed for a specific project to analyze its profitability, or it can be based on a company’s overall sales and costs to show profitability during a specific period.
What types of costs are included in COGS?
Two types of costs are included when calculating COGS in construction: direct costs and indirect costs.
Direct costs are costs that are related to performing work and completing a project. They include materials, subcontractors, wages for labor, and other expenses.
For example, a concrete contractor’s direct expenses include costs for concrete (materials), a rebar subcontractor, wages for their employees, and miscellaneous tools (other costs). All of these are considered direct job costs and are included in the cost of goods sold.
The other type of cost that can be included is indirect costs. As the name suggests, these costs are indirectly related to a project. They are necessary for the completion of a project but aren’t incurred for a specific project.
Examples include vehicle expenses including gas and maintenance, phones, business insurance, and payroll burden (the employer-paid portion of payroll taxes and benefits). These expenses are also included in the COGS calculation, even though they aren’t directly going into projects.
How to calculate COGS in construction
Calculating cost of goods sold in construction is pretty easy. Once you’ve decided which indirect costs to include, add up all the project related direct costs and the indirect costs you have identified. That’s it. Don’t include overhead costs or business taxes.
Contractors usually break out their COGS by job so they can track job profitability and compare costs to their estimate for a specific project. Most accounting software for construction will do this for you quite easily.
Tips for calculating cost of goods sold for contractors
- Set up your accounting software and the chart of accounts to track cost of goods sold. You may want to set up multiple general ledger accounts for these costs to keep things organized.
- Set up your accounting software to track job costs. This helps with project profitability reporting and comparing project costs to original estimates.
- Break down your COGS general ledger accounts by cost type. This means you’ll have separate COGS accounts in your chart of accounts for material, labor, labor burden, subcontractors, and other costs. Doing this helps you reconcile your accounts at month-end and makes insurance audits easier, as you can quickly pull up how much you’ve spent on labor, burden, and subcontractors.
- Code as many indirect expenses to jobs as possible. If an employee is on a job for several months, the cost of their phone and vehicle expenses can be costed to that project. This lowers your overhead by reclassifying it as the cost of goods sold.
- Make sure both direct and indirect costs are included in project estimates. This ensures you get paid for them. Tracking cost of goods sold will give you more information about job profitability, but it won’t make a difference if you aren’t getting paid. You should always communicate with your client about additional project costs and always protect your lien rights with the proper notices.
Calculating COGS isn’t hard
The most difficult part of calculating COGS in construction is deciding which indirect costs to apply to projects. Once you’ve figured that out, the math is easy. Tracking your costs by job will help keep costs organized, allowing you to quickly see how profitable a project is.
Including all project costs in your estimates and proposals is the only way to ensure that you’re paid for them. Bottom line: Getting paid is vital to the success of your business. Make sure you know what your rights are and protect them on every project.