ConstructIQ

What are indirect costs? 

When we think of construction costs, we think  of things like the costs of buying concrete,  structural steel, cranes and an electirician’s  wages. While these costs form a large  proportion of the total project costs, they are  not the only costs we incur on the project.  Indirect, also known as preliminary costs, form  a large proportion of the project’s total budget.  

Indirect costs are site running costs. They are  costs that are necessary for running the project,  but not directly attributable to a specific  construction activity. Indirect costs cover a  broad range of project costs, They are the  opposite of direct costs, which are the costs  directly applicable to a specific construction  scope.  

Examples of indirect costs include the costs of  setting up and hiring lunchrooms and toilets,  paying for security guards overnight and on  weekends, sueprvision and management staff, temporary fencing, insurances and permits. The  specific indirect costs applicable to a project  will vary significantly. For example, a solar farm  in the middle of nowhere would need little or no  money for communtity engagement, as  opposed to a disruptive rail project where  community engagement is a key risk and need  to be properly managed, 

Furthermore whether costs are classified as  direct or indirect will also vary from project to  project. For example, on a major road project  where traffic management is needed for each  and every task, then traffic management costs  would be classified as a direct cost, applicable  to that construction activity. Whereas on a  building job, where a traffic controller is needed  at the site gates everyday for the project  duration and not used specifically for a  construction task, then this would be classified  as an indirect cost. 

Categories of Indirect Costs 

Since indirect costs are loosely defined as “not directly applicable to a specific construction  activity” or basically not a direct cost, we need  some other ways of categorising these different  types of costs. Having categories of indirect  costs will help us to understand, estimate and  control them. 

There are two main ways we can categorise  indirect costs; by type and by time-base. 

There are several different types of key indirect  costs. These groups are: 

• Supervision and management staff 

• Site facilities 

• Shared costs 

• Permit and approval costs 

• Insurances and bank guarantees 

And Corporate overheads 

Supervision and management staff costs are  the costs of hiring and paying for the  management staff who will run the project.  These consist of the salaries of project staff like  superintendents, project engineers, quality  advisors and project managers.

Site facilities consist of the costs of the hire and  set-up of the temporary facilities needed for the  project. These are things like site offices,  lunchrooms, toilets, bins, waste disposal and  concrete washout bays. 

Shared costs are a broad category costs for  shared resources used to facilitate works.  Survey costs are an example of this. Surveyors  are needed for lots of different construction  activities and generally captured as a project  wide cost rather than tracked per activity. Other  examples include traffic management, site  craneage, forklifts and telehandlers and  storemen. Sometimes these are referred to as  gray labour.  

Permit and approval costs are the costs for  developing lodging and applying for permits.  Permits are a necessary part of any construction project and include council  permits, building permits and utility permits.  Permit costs and fees can be substantial.

Insurances and bank guarantees, or sometimes  referred to as finance costs, cover the costs  assosciated with obtaining insurances like  public indemnity, workers compensation or  works insurance. Bank guarantees are  mandated in construction contracts and also  come with a significant cost. 

Finally, corporate overheads cover the project’s  contribution to the on-going running and  management of the contracting business. In  addition to contributing profit, project’s need to  contribute to business costs like tendering for  new work, paying non-project management  staff and other shared resources like software  licenses. Typically, corporate overheads are  paid as a fixed percentage of total project cost. 

The other way we can categorise indirect costs  is on their time-base. Indirect costs can be  either recurring on non-recurring. Meaning they  can either be one-off payments or regular on going payments. 

Recurring indirect costs are incurred at multiple points in time throughout the project lifecycle.  They are incurred on an on-going basis whether  that be weekly, monty, quarterly or yearly. For  example, staff salaries are paid monthly on an  on-going basis. Other examples of recurring  costs include temporary facility hire, waste  disposal or security guards. Importantly,  recurring costs are driven by the overall project  duration. 

Non-recurring costs, as their name suggests,  are one-off expenses. They will only be paid  once during the project lifecycle. For example,  the costs of setting up the new site facilities  only needs to be paid once. Other examples of  non-recurring indirect costs include permit  applications, staff hiring costs and site  investigations. 

Calculating Indirect Costs 

Estimating indirect costs poses unique  challenges. Unlike estimating direct costs,  where the scope is based on drawings and  specifications, indirect costs vary from project to project and are based on the project team’s  discretion and assumptions as to what will be  required. There will be no detailed drawing or list telling us exactly what indirect costs to  price.  

Recurring indirect costs are also driven by the  project schedule. The project schedule is simply  an estimate as to how long the project will take.  If the project takes 1 month longer than what  we originally planned, then we will still need to  pay for another month of indirect costs.  

Together with the fact that indirect costs make  up a large percentage of the total overall project  costs, these factors make estimating indirect  costs an important and challenging part of  construction cost estimating. 

There is a simple process we can follow to  calculate indirect costs. 

1. Define the indirect costs applicable to the project 

The first step is to define all of the applicable indirect costs. We need to list out all of the  indirect costs that will apply to our project. This  is a difficult but important step. If we miss an indirect cost, we will not have budgeted for it, 

There are three main ways to do this.  

• First, we can look at similar historical projects  and look at what indirect costs were applicable.  This should give us a comprehensive list but will  miss any unique project specific costs, 

• Second we can brainstorm with subject matter  experts. This involves setting up a meeting with  knowledge delivery personnel to review the  project scope and develop a comprehensive list  of applicable costs. 

• Finally, we can use a comprehensive, holistic  checksheet that lists out all possible indirect  costs and tick-off which ones apply to our  project. 

I recommend using all three methods to make sure you do not miss any costs. 

2. Categorise the project indirect costs into  either recurring or non-recurring 

Now you have developped a comprehensive list  of indirect costs, the next step is to cateogirse  these costs as either recurring or non-recurring.  Basically, ask yourself the question, will these  costs be incurred once or at regular intervals? 

3. For recurring costs, determine the on-going  cost, frequency of payment and payment  duration. 

For any recurring costs, we need to know three  things to calculate them accurately; the  payment amount, frequency of payment and  payment duration. When we multiply these  three factors together we get the total indirect  cost amount. 

Most indirect costs will be incurred consistently  over the project lifecycle. Therefore, the payment duration will equal the project  duration. It is important to accurately estimate  the project duration by creating an accurate  project schedule. 

4. For non-recurring costs, price them as a  stand-alone activity like any direct cost 

For our non-recurring costs, we simply price  these like any direct cost activity. We look at the  task scope and estimate the individual labour,  plant, materials and sub-contract costs. 

Using this method, we can accurately estimate  the cost of our indirect project costs.