Cutting Yourself Short?

Determining job cost is the first step to intelligent bidding and estimating. Mastering the skills of estimating is your best defense to help ensure that you do not overbid or underbid your work. Plenty of jobs are lost because the contractor was not aware that he could have done the job for a lower price tag. By the same token, plenty of jobs are completed for a low payout or, at times, even a loss. If the contractor would have just done the up-front work and determined his cost for the work, he could have saved himself a lot of time and aggravation while, at the same time, giving himself the opportunity to take a more profitable job. Priced “just right” is where you want to be; but, of course, this doesn't guarantee you the work — just that if you do get it, there's a chance for larger profits and the opportunity to only work jobs that make you the most money.

Don't even think about going the route of hit-or-miss bidding. This method of bidding is out of the question because virtually every customer looks for, and usually takes, the absolute lowest price. It is important to set a price that not only covers costs, but also provides an adequate profit. Time is money and the less time that you spend on jobs that make you little money, the more time you have for jobs that will maximize your profits.

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Of course, the lazy way out is to totally ignore the cost of doing business, and focus, instead, on price. This is a sophomoric mistake that is easy to make. The problem is that if you bid the job too low to make money on it and your competitor has done his homework and knows this, you have not won anything by getting the job. In fact, your competitor has won by allowing you to take the time to do a job that is decreasing your time to take on a more profitable job within the community. To maintain profitability in the green industry, the price of labor cannot be determined in the marketplace. You have to determine it based on your own labor cost. Losing a job because you determine it to be unprofitable for you is not a loss at all. The guy who took the job is the one who is going to lose and as long as you are the one making educated decisions, you can count on that competitor low-bidding himself right out of a career. If you don't know your costs, you have no reference point of control. Without cost knowledge you actually give up control and can't determine for certain your profit on any completed project. In some cases, it may be uncertain if even your costs were covered.

With job-cost knowledge, you can calculate whether you have efficient costs, (can't be done cheaper or faster) and that's about as good as it gets. Using your efficient costs as a starting point, you can then develop prices. When you're bidding jobs, it's a good idea to come up with three price levels for the same job: base price, realistic price and premium price.* For any one job bid, do the mental “gymnastics” of trying them on for size. In this industry, contractors know all too well the extremes of too much work or not enough. At any given time a contractor may find himself “hungry” for work or booked so far in advance that it gets embarrassing to talk to customers about start dates. It is in the busy times that you can benefit from cost intelligence the most. Nevertheless, bidding and pricing is the single most important thing you'll do because it is the future of where your business is going. Today's bids are tomorrow's customers and the real determining factor of your company. Your company is composed of your customers, you, your employees and the assets necessary to deliver your services.

START HERE

All businesses incur three kinds of cost: direct costs, indirect costs and overhead costs.

The direct costs are those expenses that happen because labor was applied, equipment and vehicles were put into action, materials were used and work was done. Direct costs are usually easy to predict when you know how much time a project will take and what equipment and materials you'll need.

Indirect costs follow or tag-along with direct labor and include payroll taxes, employee benefits, insurance, fuel consumption, depreciation, repairs and other on-the-job costs. Although you can easily estimate payroll taxes, benefits and insurance, the indirect costs related to equipment are tougher to predict. Depreciation of equipment is a given, but fuel consumption can vary greatly and repairs are often unexpected.

Overhead costs include any expenses that support the operation of a business. Good examples of these expenses are rent for facilities, utilities, advertising, property taxes, storage, insurance on buildings, office expenses and other “behind-the-scenes” costs that, in some cases, take place simply because time went by. The overhead expenses, for the most part, take place even when no work was done. Rent and insurance are the most common examples. As with some indirect costs, certain overhead costs are easily estimated (rent, utilities, taxes and insurance) while others (advertising and office expenses) are more difficult to estimate.

You can learn to differentiate between direct costs, indirect costs and overhead expenses by visualizing what happens in your business on any given workday. Direct costs are incurred when work is done and labor is applied. The workers come into work and as soon as they turn the key in the ignition, direct costs and indirect costs follow them and stay with them all day. Overhead or “back-at-the-shop expenses” are just that. These costs are “left-behind” items of expenses that support your operation.

SYSTEM ANALYSIS

Labor and indirect costs represent the bulk of expenses for most contractors and dwarf true overhead costs, by comparison. The questions to answer about these costs can be reduced to what I call “time costs.”

  • How much does time cost my company?
  • How much time will the job take?
  • What are my hourly or time profit goals?
  • What are my hourly direct costs?
  • What are my hourly indirect costs?
  • What is my overhead rate per hour?

To answer these questions is to formulate a bidding system.

You can easily relate to a financial statement and assign time costs to each expense category by simply dividing each cost category by the total number of production hours your company applied over the course of your season. Doing so gives you a capsule of actual costs that you can use to compare to your estimated costs used at the job bidding stage. You can then use the variations between estimated job costs and actual costs to find cost variations. In other words, job costs were supposed to be, or bid at, a certain price, and the actual costs were different.

BID BASED ON COST

A good understanding of how much work will be required along with realistic labor time hour standards are the two measurements you'll need to bid based on cost. This is the crucial step to the entire job estimating process. If you don't know within approximately 10 percent how much labor time is required, your job bids are destined to be inaccurate. Labor is a big factor — the biggest single expense you have — and costs are highly dependent on job-time knowledge. If you thought a job would take 1,000 hours and it took 1,200, you're going to lose money.

A working knowledge of job specifications and job time standards (at least how much times similar jobs have taken in the past) is another important element of bidding based on cost, as is an hourly cost factor for the three areas of cost, including direct costs, indirect costs and overhead costs.

Keep a realistic attitude about profit per hour that you can add to costs to arrive at a total price that the customer can afford. How much you add in for profit should stand the test of competitiveness while still turning a profit. Keep in mind that if your company does not operate efficiently, this is not the customer's problem and the competition may not allow adding profits on top of inefficient costs just because you happen to need to earn a living. Your production time and methods needs to be as good as you can get them before adding in a realistic profit. This will also indicate your “walk-away” price, as well.

MAKING it HAPPEN

Once you have a handle on hourly job costs and can assign these costs to job functions that will take place at the job site, you need to make them happen by adhering to labor time budgets. This is where the labor hours and costs on paper are proven at the job site with control over expected, or anticipated, costs and actual costs.

Can you get the job done within the estimated time? Profits go up and costs go down when the job is done faster; profits go down and costs go up when the job takes longer than expected. Having said that, job costs are truly estimated costs because many variables are at play in the process of actually doing the work. Because labor is the single biggest expense, controlling labor and making employees aware of job time goals are important parts of cost control and profit achievement.

ELEMENTS OF COST

Direct costs, such as payroll expenses, are an easily calculable figure: payroll hourly rates multiplied by realistic labor times required to do the work.

Indirect costs follow direct costs and are closely related to hourly payroll rates. Payroll taxes, benefits, depreciation on vehicles and equipment — in fact the entire cost lineup that supports labor activity in the field — can be lumped together to develop an hourly rate based on the time, by the hour, of actually using the support equipment or “expense group.” The only shortcoming you may have is that to assign an indirect cost per hour, you'll have to estimate the total production hours predicted in the current season.

Overhead costs have less impact and represent a far lower total expense group than direct or indirect expenses. The best you can hope for in terms of developing an hourly overhead rate to apply to total labor hours projected for any given job is to lump the entire year's overhead expense and estimate the total number of labor hours expected for the year. Then divide that overhead total by the total hours to arrive at the overhead per hour rate. As the backlog of work increases, hourly overhead rates go down; and as the backlog drops, hourly overhead rates rise. This doesn't mean, however, that increases in overhead can be passed on to the customer if you don't have enough work to carry overhead at a conservative rate. Unreasonably high lucrative overhead expense schedules make a company far less competitive from a cost point of view.

Last is the addition of profit to the cost group to arrive at a price to assign to the work. Sometimes a final price can be higher; sometimes it needs to be lower in view of current market and economic conditions. But here, too, you should arrive at an hourly profit add-on that justifies a reasonable profit.

ADD-ONS

Of course, the higher the profit expectation, the lower the chance you'll be awarded the work. Profit after and beyond cost is the true mystery number that's locked up and somewhat a secret in virtually every job bid submitted. Some contractors will use industry averages for profits. Others will charge what they think the traffic will bear, while still others will test their price levels, including profits, by going with a higher and higher price for the same work until they find the price ceiling. Another route is to ask yourself what amount of money is being the boss worth? Is it $50,000 or $100,000 or $200,000 a year? If you were to replace yourself with a hired manager, what would it cost? What's it worth being you?

* Base Price is the lowest price you must charge to cover your business costs, salary and profit. Realistic Price is higher than Base Price. Top of the quality range in your field but still competitive. Premium Price is even higher where you price for the client who wants and can afford the best.

Phil Nilsson is a green industry consultant who resides in Connecticut. He is the author of numerous books about succeeding in the landscaping business.

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