CSLB Contractor's Law & Business Practice Exam

What is the correct calculation for determining selling price in a construction contract?

1. Add overhead and profit to direct costs

2. Subtract overhead and profit from direct costs

3. Multiply direct costs by overhead and profit percentage

4. Average the direct costs with the overhead and profit

The correct answer is: Add overhead and profit to direct costs

To determine the selling price in a construction contract, the correct approach is to add overhead and profit to direct costs. Direct costs refer to the expenses directly tied to the construction project such as labor, materials, and equipment. Overhead costs include indirect expenses necessary for running the business like utilities, administrative salaries, and tools, while profit represents the desired return on the project. By adding these elements together, you ensure that all expenses are covered, and you achieve a profit margin that sustains your business. This method reflects a comprehensive approach to pricing where both the operational costs and the desired profit are factored into the final selling price, ensuring the contractor’s financial viability. Other calculations, such as subtracting overhead and profit or averaging costs, do not align with how pricing strategies are structured in the construction industry. The practice of multiplying direct costs by overhead and profit percentages also does not accurately capture the total costs involved when setting a selling price. Understanding this comprehensive calculation is vital for maintaining a profitable contracting business.