However, the actual term “profit” is often thrown around quite haphazardly in most business settings. If asked, most people would define Profit as “making money.” As we will learn, however, profit is much more nuanced than this. Moreover, this causes profit to be conflated and used interchangeably with revenue. There is a big difference between the two:

• Revenue – The total amount of income generated by a company’s goods or services during a given period of time.
• Profit – Total revenue less total expenses.

Revenue is all money earned by performing services and completing jobs. As you’ll notice, it has nothing to do with expenses. This is money that is exchanging hands from your customer’s wallet to your bank account for a job well done.

Profit, on the other hand, is defined as the difference between a company’s total revenue and its total costs over a specific period of time; it’s any money left over after covering all costs—“after covering costs” is the key phrase here. How a contractor defines costs and tracks costs is what makes all the difference.

Where does profit margin fit into all of this? While profit measures a specific dollar amount, profit margin is a percentage used to measure how much money a company actually keeps from every dollar of revenue it brings in; it will display how many cents of profit is made per each dollar of revenue.

Profit and profit margin are significant indicators of the overall success of a business. When Contractors can better afford expenses, they open up the opportunity to put profits back into their business to grow and scale operations.

Maintaining a healthy profit margin is essential for long-term sustainability. Understanding profitability and profit margins helps contractors better assess the performance of their projects and make more informed decisions regarding pricing and prioritizing work.

Every business owner will claim to have the determination and focus that is required to become successful. You wouldn’t have taken on the risk of starting your own business if you didn’t. Time and time again, we have seen the hard work of contractors pay off in extraordinary ways.

Why, then, do 66% of all contracting businesses fail within ten years? This is an impossible question to fully answer, but unequivocally, one of the leading causes is the inability to identify and account for cost centers that drain profits without the business owner even knowing that it’s happening.

What is a cost center? How does a cost center contribute to profitability? What are the hidden expenses that are costing my business money? We’ll answer these questions and more so that contractors can gain a better understanding of their cost centers.

What is a cost center?

Think of someone who decides to purchase a new car. They find a car they like, check the price and save up just enough money to buy the car they want. Then, with the paperwork signed, they drive off the lot knowing the exact price they just paid; but what they might not have factored into their decision is the cost of taxes, insurance, registration fees, or service plans. These additional costs are unavoidable. New car owners quickly realize that the actual cost of buying a car is much more than just the sticker price.

While this is a lesson many first-time car owners learn, failure to account for indirect costs is also a common pitfall amongst first-time business owners. In construction accounting, these indirect costs are called cost centers. Cost centers are business activities that don’t directly contribute to revenue but incur costs all the same. If not handled properly, these activities can drain profits, but if understood and approached intentionally, they can be significant forces of profitability.

Cost centers can be straightforward, such as the cost of employing a single accountant; the accountant does not directly contribute to the profitability of jobs as they are not physically in the field swinging a hammer. They do, however, provide invaluable financial services that indirectly result in improved financial performance.

In construction, like many industries, time is money. Any inefficient process, like manual data entry, can be thought of as a cost center. It’s taking you away from revenue-generating work, preventing you from taking on new projects, or cutting into the profitability of your current ones.

With that said, cost centers are not always a bad thing.

Most of the time, they’re essential to keeping your business operating smoothly. Identifying, observing, and tracking cost centers is integral for contractors to understand their financial standing and maintain profitability.

Cost centers in construction

To better understand cost centers in construction, let’s start with an example.

Take, for instance, a roofing contractor that works as the sole proprietor of their business. They bid on jobs, do the work, and bill for their services all by themselves—working as a one-person show. In this case, the roofing services function as the primary profit center. As this contractor starts to get more and more work, however, they find the need to scale their operations.

To do so, they bring on two additional laborers to help on larger jobs, hire an accountant to help with finances and rent out facilities for performing administrative tasks and storing equipment. Of course, this means that salaries and rent must be paid to keep the operation running smoothly.

The new workers and facilities are now considered cost centers. This is money that must be paid but does indirectly contribute to the success of the business. While this example provides a high-level overview, as we will see, cost centers become much more nuanced as we look at individual jobs and the scenarios that are unique to the construction industry.

With increasing material costs and a continuing labor shortage, cost centers play an interesting role for those in the specialty trades. They support the business in some way, but they don’t generate revenue and yet they cost the company money. This affects both cash flow and bottom line.

So what’s to be done? How should these activities be handled? To answer these questions, let’s examine some of the major cost centers in the construction industry.

Labor burden

Labor burden is a substantial cost center in the construction industry. It is defined as the total cost that an employee incurs on a business beyond their wage. This mostly entails employer-paid costs such as payroll taxes, benefits, bonuses, overtime, and any additional costs.

Paying for benefits and bonuses does not directly contribute to profit. However, these costs must be paid to comply with tax laws and are obviously needed to adequately support employees. If you’re not taking care of your employees, you soon won’t have any employees.

For this reason, they must be appropriately recognized and calculated into labor costing. Failure to do so can result in numbers that are off by as much as 50%. Luckily, properly accounting for labor burden is just a matter of knowing where to access the needed information. Once factored into your financial assessments, the labor burden will help contractors accurately cost jobs and assess the true profitability of each job.

Labor burden in construction typically includes the following:

• FICA (payroll taxes)
• State unemployment tax
• Health/Dental/Vision or other benefits
• Retirement contribution
• Workers’ comp

To access most of this information, contractors can reference payroll reports, workers comp documents, and health insurance papers. Once labor burden is identified, contractors must be aware of the various factors that affect labor burden.

These factors include:

• Type of labor performed
• Hours worked
• Rate of pay
• Benefits offered
• Location

For a more in-depth breakdown of labor burden and how it fits into a well-rounded job costing system, reference our essential guide to construction job costing.

Materials

Material costs constitute any money spent on items used to complete the job: paint, lumber, bricks, concrete, metal, etc. While materials directly apply to revenue, several factors go into securing materials that incur costs outside of the direct purchase of the material itself (think back to the first-time car owner–the cost is always more than sticker price).

This includes any costs for procuring, importing, and transporting materials. Transportation stands out as an often overlooked cost for many projects. Transporting materials from a warehouse or from one job site to another can significantly impact the overall cost. If not accounted for during the budgeting phase of a project, these costs can severely impact a job’s profitability. Transportation costs will fluctuate depending on distance, mode of transportation, and the materials themselves (e.g., heavy materials typically cost more to transport).

Visibility plays a key role here. Failure to track and account for material purchases can lead to repeat orders, excess materials, and a cluttered job site. If you aren’t paying attention, things can quickly get out of hand.

You might not think it’s a big deal to buy another ladder, but when you have five new ones sitting around unused, those costs add up quickly. And since they’re sitting around unused, they aren’t helping you get the job done any faster or more efficiently. Additionally, repeat orders can lead to billing mistakes and slow POs that stack unnecessary fees and expenses. Not to mention that this could cause tension with your suppliers.

Unfortunately, you also need to account for material theft. There were over 11,000 burglaries from job sites reported in 2021 alone. While valuable equipment is an obvious target, many of the reported burglaries were for common building materials such as metal wiring, bricks, lumbar, and more.

As material costs continue to rise, common building materials have become more vulnerable to thieves. When factoring in production delays, it goes without saying that theft can have a major impact on projects. The cost to secure a job site will be minuscule compared to stolen materials or equipment that completely derail a project.

To mitigate theft impacts, create a security plan:

• Ensure your job site is always secured.
• Consider installing CCTV cameras. 
• Install a security fence.
• Assess security risks ahead of time:
  • Is this a high crime area? 
  • Are you working with valuable materials? 
  • Who is responsible for securing different aspects of the job? 

Equipment

Equipment costs will include any cost associated with renting, owning, loading, transporting, unloading, or maintaining a piece of equipment. This includes the cost to fuel and regularly maintain equipment. Contractors must factor these costs into their equipment estimates. 

This cost can be averaged over the equipment’s expected lifespan to determine a standard hourly rate. This rate can then be used to help create more accurate estimates for jobs using the particular piece of equipment.

Like a new car, heavy equipment depreciates as soon as it’s bought. Therefore, depreciation is a critical detail of equipment that must be factored into billable rates. Contractors must include an allowance in their estimate or billable rate for depreciation. Failure to do so may leave contractors strapped for cash when equipment eventually requires significant repairs or fails altogether.

Manual vs. Digital processes

One cost center that isn’t often accounted for is the amount of time spent on administrative tasks, especially if you’re relying on pen and paper instead of software/apps. When you’re a young business with a small team, it’s easy to overlook the amount of time you spend on admin work. But as you grow your team and take on more or larger projects, the hours start to add up.

As contractors scale their business, they inevitably transform from an army of one to a fully-fledged business that brings new employees, bigger facilities, better equipment and tools, and company vehicles. But making the transition from manual to digital doesn’t always happen organically. In fact, nearly half of all construction managers rely on manual data entry to capture critical pieces of information; and while it may be the way you’ve always done things, manual processes will leave bags of money on the table.

Manual purchase orders, by-hand invoice processing, and scattered job costing can waste hundreds of hours per year. In addition, manual data entry often results in constant back-and-forth communication to validate data, only for all data to be reentered or changed after the fact.

Digital tools allow for automated procedures that bring real performance improvements almost immediately. This fosters the ability to better track costs, review financial reports, and organize data to create a historical database. A lack of historical data makes analyzing or searching for information across jobs nearly impossible. In addition, this disorganization makes it challenging to hold vendors, workers, and general contractors accountable. As a result, contractors can set themselves up for a better financial future by ditching antiquated or by-hand accounting methods.

Manual processes can lead to the following:

• Excessive time spent on administrative tasks
• Siloed information
• Inaccurate data
• Data re-entry
• Lack of transparency
• Reduced bottom-line

This isn’t to say that all manual processes are detrimental to running a successful business. On the contrary, many contractors have relied on paper-based business processes and created functional, profitable businesses. However, this can only lead a business so far. Eventually, there is a point of diminishing returns that can only be solved through digital solutions.

Information is the lifeblood of the modern construction industry. Construction management software enables contractors to collect, organize, analyze, and use information to direct their business wherever they see fit. The best part is that you don’t have to be a software developer to use these tools. Many tools, such as Knowify, are built specifically for specialty contractors, with ease of use in mind. With the right know-how and practice, contractors can take advantage of digital tools to take their business to new heights.

Compliance

Safety and legal violations are classic examples of an easily preventable cost center. You may think you have all your bases covered or that you won’t be the one subject to inspection, but any lapse in due diligence here can result in a hefty fine. The cost you will have to pay if found in violation will greatly outnumber the cost of ensuring compliance.

Despite OSHA’s prominent presence in the industry, 5,260 fall protection violations were handed out in 2022 alone. Along with general fall protection, ladders and scaffolding are among the most cited violations. With 30,000 inspections annually and fines ranging from $14,502 to $145,027 per violation, contractors cannot afford to ignore these regulations. To avoid these devastating costs, contractors must take an active role. Learn the rules and put in the safeguards needed to stay compliant.

Additionally, the buck stops with you as the business owner. Workers are only human and will inevitably forget or ignore certain standards. The owner’s job is to ensure these rules are understood and enforced. They are non-negotiable. Staying compliant is something within the direct control of contractors that is just a matter of diligence.

To better protect yourself, document all processes and procedures. Have physical proof that you are training and implementing appropriate procedures. In addition, any incidents should be duly and honestly documented and reported in good faith. OSAH provides many resources available for contractors to help them play by the rules.

Top construction site safety regulations:

• Building codes
• Lien requirements
• Safety regulations
• Contractual agreements
• Insurance and bonding requirements
• Wage and union payroll agreements

Final thoughts

Cost centers are meant to show business owners that there is more to financial management than just revenue and expenses and that expenses are more than just job costs. While job costs are a massive contributor to financial success, several indirect costs will impact your bottom line. Cost centers permeate every aspect of a business. By identifying them and creating plans to work around, or better yet, use these cost centers to help generate more profit, contractors can take hold of their business in ways they never thought possible.

Financial success begins and ends with a strong job costing system. As we discussed, manual processes and lack of visibility can cost a business thousands of dollars. This is why Knowify set out to provide contractors with a system that allows for real-time visibility into finances. Quickly identify and address unexpected expenses and evaluate past jobs to better plan for the future.

Additionally, Knowify provides contractors with tools to track and manage their cash flow, allowing them to make more informed decisions about their financial health. Schedule a 30-minute demo and start taking control of your finances today!