One of the reasons I guess I am so opposed to the antique idea of breaking out and displaying your Overhead and Profit for a project is that if you are doing that you can’t really be running a departmentalize operation because different departments would have different Overhead Cost and Allocations. e.g. the Overhead for the Design Division would be different from the Installation Division (the field carpenters) and their Overhead would be different than the Shop Fabrication Division or The Handyman Small Projects Division etc.
The markups for the work done in or by those separate divisions are different so they should really be applied at the Estimate Line Items level or maybe the phase level but not lumped together as one average markup rate applied to the sum of all the projects Direct Job Costs.
While it fine for a small company to operate with just one Overhead/Markup rate as at some point in a company’s operational growth departmentalization starts to become important if not essential.
How to Allocate Overhead Expenses into Departments
- Assign a percentage of direct labor for each employee that works with tools to service or replace equipment in each department.
For example: the Installation Carpenter may spend 65 percent of his or her time in the field doing installation, 17.5 percent doing Shop Work Fabrication, and 17.5 percent installing on Handyman Small Projects. You must repeat this process (assigning a percentage to departments) with all direct labor employees making sure the hours they work in each division add up to the total hours you expect them to work in a year.
- Add up all the annual direct labor dollars for each specific department or division.
- Add up the total of all departments direct labor dollars for work doen by that department or division.
- Divide total labor dollars in each department or division by the total of all direct labor dollars to get a department percentage figure.
- Multiply each overhead expense (rent, insurance, utilities, etc.) by the department percentages.
What Kinds of Departments Should You Have?
Departmentalization is grouping by functions performed, or placing employees with shared skills and knowledge into departments. It works best with 10 or more employees. It can also be used in grouping products, customers, geographic locations, etc.
Departmentalization also allows you to be aware of your business mix in terms of Gross Profit as well as Revenue. This is valuable information for management to evaluate and improve a company’s financial performance. Revenue by business segment without the corresponding Cost of Sales is NOT departmentalization!
Getting Departmentalized Above The Line
Decide what departments are important enough to be tracked in measured:
- Meet with your management team and explain why it’s important to be departmentalized, otherwise they may resist the change
- Set up your Chart of Accounts to define the Revenue accounts (department) and Cost of Sales (within QuickBooks this is done via a “class” function and “item lists”)
- Create source documents to support departmental information flow
- Train office personnel on departmentalized bookkeeping entries, if applicable
- Train Technicians on what departmentalization is, why they need to fill out timesheets correctly, and why paperwork must be completed in a timely manner.
- If you employ mobile apps, first of all make sure you time tracking application is setup to record work done by different divisions and then train the Techs on how to correctly enter information onto the system
- Begin entering data at the beginning of a new month
- Managers should collect all timesheets and service tickets during this transition so they can check for accuracy and provide immediate feedback and coaching as needed
Other Considerations Once You Get Departmentalized:
- Use the Income Statement to decide if you need to change your business mix
- Use the Income Statement to Benchmark the industry financial Key Performance Indicators
- Use the Income Statement to help analyze pricing
- Make sure your managers understand the income statement and can relate to the operational issues that drive the numbers
- Hold Managers accountable for their department Income Statement performance
- Process paperwork daily – when you do this, the month to date numbers are much more accurate; (all the information has to be entered anyway, so why not get it done daily instead of waiting until month end?)
- Get the Income Statement in a timely manner after months end – it should be available within ten business days after month end (five is better)
- Make sure Technicians and installers are diligent at recording time and materials (this includes identifying the correct department)
- Make sure administrative people are diligent in entering departmental information
- Utilize departmental information when you budget or in the forecasting proces