Predicting Profit Accurately
All design firms have to factor in overhead when calculating project profitability. There are two main approaches for doing this: the Job Cost Rate approach and the Overhead Allocation approach. Most software packages offer one approach or the other. Sema4, for example, uses Job Cost Rate, while Advantage and Vision use Overhead Allocation. InFocus is unique: it offers both approaches. Let’s review how each approach works.
The Job Cost Rate Approach
Job Cost Rate is often referred to as burdened payrate because it’s an hourly payrate plus an hourly overhead rate. Job Cost Rate is usually an employee’s pay rate times a standard multiplier. Typically that multiplier is based on a firm’s direct labor and overhead costs at the financial statement level. For example, a firm has the following on their books:
Annual overhead: $1,000,000
Annual direct labor: $500,000
Total: $1,500,000
You’ll notice that the total ($1.5m) is 3 times the direct labor amount ($500k). That means a good Job Cost Rate multiplier is 3.0. This multiplier can be set up in a Job Cost Rate schedule and applied to each direct hour charged in a timesheet.
Say John’s payrate is $100 per hour and he enters 5 hours on his timesheet. In this case here is how the Job Cost Rate is calculated:
$100 * 5 hours * 3.0 Jobcost multiplier = $1500
InFocus automatically stores the Job Cost Rate on John’s timesheet.
Summing up, having a Job Cost Rate makes estimating a project’s profit much more accurate since it accounts for both direct and indirect expenses. InFocus has a global setting that allows a Job Cost Rate to be used instead of Pay Cost in reports.
The Overhead Allocation Approach
This approach uses Pay Cost within the project reports. Overhead is calculated separately based either on a multiplier or a proportional allocation of actual periodic overhead.
Let’s use the amounts from the previous example. This time we will calculate an overhead multiplier not a Job Cost Rate multiplier. We do that by dividing the annual overhead ($1m) by the annual direct labor amount ($500k), which results in an overhead multiplier of 2.0. This multiplier can then be applied to periodic direct labor amounts to represent the allocated overhead for the job.
The InFocus overhead allocation utility provides the user with the ability to enter an overhead multiplier. InFocus then stores the resulting project overhead amounts.
Alternatively, the user can design overhead allocation scripts that will distribute actual overhead for a period across projects proportionally. For example, a project that is consuming 10% of the firm’s direct labor for a period will receive 10% of the overhead allocation.
Conclusion
Overhead has to be accounted for in order to estimate profit properly. Fortunately, InFocus makes this as easy as possible by providing two distinct approaches, the Job Cost Rate approach and the Overhead Allocation approach. There isn’t a right way and a wrong way. The approach you choose depends on your business and accounting practices.