Estimate labor costs

A system for accurately determining labor costs is important for every company to develop sooner or later. Needless to say, the earlier the better. A "graveyard" of companies that never really addressed the problem attests to this need.

Like many companies at the time, Grass-Roots Inc. was riding the wave of an economic boom when we first founded it. Thus, we had no need-or so we thought-of going to the trouble of being exact. We believed we did not have the time to waste. Our attitude was simply to keep getting the accounts signed on and everything would work out. The first hint that something was wrong came when the bank told me that my gross profit margin was too low and my net was zero! I thought we were doing fine. "Not so," said the bank.

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A visit by George Morrell, of the Morrell Group in Atlanta, turned our strategy around. The giveaway for Morrell that our firm needed help was when he saw we were using big crew cabs to transport four or five people to a job. "You might want to try using smaller crews and see what happens," he suggested. My immediate-and ultimately incorrect-reaction was, "That will never work here."

Several days later, my mow manager came in and told me his crew would be finishing late because on one of the five-man crews, three of them didn't show. I recalled my conversation with Morrell and decided to test his theory. I drove immediately to the site and recorded the time it took the two men to mow a 3-acre account. The next day I asked the manager, "How long does it take to mow the account with five men?" He didn't know. So I asked him to start keeping track.

When the manager was finally able to tell me how long it took five men to cut the account, I could hardly believe it. Over the next few weeks, I started checking times on more jobs. When someone did not show up for work, I sent out smaller crews and compared times. It was not long before I understood that we were losing money because the larger crews were not getting the work done faster but slower than the smaller crews. So I finally made the change that Morrell suggested.

1) Measure how long jobs really take Obviously, it's important to realize that smaller crews usually work out better than larger crews, and many operators already know that. More basic, this story illustrates clearly that you cannot measure the efficiency of your operation if you don't know how long your jobs take to complete (in worker-hours). As obvious as this sounds, many managers don't bother to do this.

When you are determining the time that jobs take, remember that determining these figures is a lot like statistics: the bigger the sample the more accurate the estimate. In other words, keep track of a job's time not just once but several times. Ideally, you should track a job every week for several seasons to come up with an accurate average. The first season may be wet, the second may be dry, the quality of your labor may change, you may have different equipment-all these variables-and more-affect working time. Therefore, take a while to determine an average in which you can be confident. You also cannot perform this task with just one account. (I tracked all of our accounts over several years.) In addition, you must track all facets of your business, not just cutting grass. All aspects of your operation ultimately contribute to your cost of doing business.

Today, charts cover the walls of my office. Though it's easy to use a computer or let your office personnel compile the data in books, I believe wall charts are better because everybody can see the numbers. With job times so clearly displayed, you may see some improvement before you even begin.

At Grass-Roots, we employ a "cipher"-an accountant who can take the numbers and help determine, with some degree of accuracy, how long it really takes people to perform certain jobs. Whether it is mowing, planting a tree, watering flowers or installing edging, unless your time estimates are accurate, all subsequent numbers you derive from them will be wrong. The examples I use in this article are simplified for the sake of illustration; a real business situation can be very complicated. You may need an accountant to help deal with your numbers.

For example, let's say you just figured out how much you pay an individual (more on that later), and someone calls you and wants a bid. If you do not know how long it is going to take to do the job, you're just guessing with your bid. I know this happens a lot. One time I sat in a meeting with two of my competitors, and they were arguing with one another as to how long it was going to take to mow a property. Their estimates were hours apart, so at least one of them had to be guessing. That is why bids in our industry vary so much and why a cipher is well worth the expense.

2) Determine how much your labor really costs If you know how long a job is going to take, the only other things you need to determine are how much your labor actually costs you and how much money you want to make. That part is pretty simple...Or is it? It is easy to find out who knows how much his or her labor costs. For example, if someone says his or her labor costs are somewhere between $20 and $25, they probably do not actually know.

Let's say an operator has a laborer that he pays $9 per hour. He tacks on another $3 for taxes and figures he would like an extra $1 just for putting him to work. So he charges a total of $13 per hour for his laborer, thinking he is making a dollar for every hour he works. This seems logical, but he finds that he's not making any money. What's wrong?

When you start monitoring time, you will notice that you can never account for all of it in terms of billable hours. Cleaning equipment, convenience-store stops, restroom breaks, meetings, flat tires, a laborer with a hangover, delays in getting the crews out...the list goes on. If you operate in the Snow Belt, how about those employees you bring in just to give them some clock time (charitable contributions!).

That's why your cost of labor may not reconcile with the hours for which you actually bill. For example, say you charge $25 per hour for your help and after 3 months of tracking, your accountant tells you that according to your billings, you're only charging $19. What happened to the other $6? Somewhere you lost 24 percent of your labor cost. At this point, you have to understand two things: As an owner or a manager, it's your job to reduce wasted time. However, you must realize that despite your best efforts, you will always have some lost time.

When trying to reduce wasted time, you easily can go to extremes-surveillance cameras, positioning devices that let you pinpoint a truck's location at all times, binoculars, etc. Regardless, unproductive time is inherent in any operation. Fortunately, using a combination of incentives and management techniques can usually reduce it to acceptable levels.

You should include unproductive time in your labor-cost estimates for jobs. If you pay a crew member $10 per hour and your accountant tells you that he spends 25 percent of his time being unproductive, how much are you really paying him to do a job? You need to find out.

Here's a more detailed example: * An employee works 8 hours, which costs the company $80 in wages. * His productive time is 80 percent of his total time, or 6.4 hours. (In other words, it took him 8 hours "on the clock" to do 6.4 hours of billable work-the rest is unproductive time.) * His productive-hour cost is $80 per 6.4 hours, or $12.50 per hour-25 percent more than his base wage. In effect, this is the rate you are paying for the employee for his production.

For simplicity, this example addresses only the base-wage portion of his cost of employment. In actuality, to get a true figure you must include other factors such as payroll taxes, worker's compensation, fringe benefits and the cost of people in supervisory roles, not just base wages.

3) Determine your production-efficiency percentage and break-even point The procedure I use for arriving at employment costs is still evolving. With so many variables, trying to pinpoint the cost to the penny for every individual is almost impossible. Therefore, I like to look at whole departments. Begin by tracking the clock time within the department-the total hours for which you are paying-regardless of whether it is for managers, supervisors, crew chiefs or laborers. Next, associate all identifiable employment costs by the total clock time (payroll taxes, worker's compensation, etc.). You now have arrived at your average cost per man-hour of employing a person in that department.

Remember, because you are tracking all hours, this figure includes non-productive as well as billable time. Now go back to the wall charts you have been using to track the time spent on your accounts and find the total number of production-hours. That total divided by the total clock hours gives you the production-efficiency percentage. If you then divide your average hourly employment cost by the product-efficiency percentage, you will arrive at the hourly cost you must recoup on jobs just to break even on the cost of employing your workers.

Let's look at a more comprehensive example for a fixed period (see table, below). In this example, the length of time and number of employees does not matter. We are dealing only with total hours and total costs.

To arrive at the proper amount to charge the customer, you must then add an hourly amount for equipment cost, overhead and desired profit to our labor break-even point of $15.84. (You can figure overhead and equipment costs in a manner similar to how you figure labor costs.) Assuming hourly production costs of $4 for equipment, $3.50 for overhead and $3 for desired profit, you must charge the customer $26.34 per hour to achieve your profit goal.

4) Hire an accountant As you may guess, my cipher wrote the last few paragraphs. This brings me to my concluding point. As owners, we often feel that we know everything about running a business. That is a mistake! Many owners want to grow their business but know that something is missing. That "something" usually is the desired level of profit. You want to make a certain amount of money and, for some reason, you never reach that goal. So you go to all kinds of meetings to learn how to run your business better (which is good). However, if you're like most contractors, you just nod your head as you listen because you don't want anyone to know that you don't understand what you're hearing (which is not good).

Conference meetings are a great way to find consultants that have the background to address your particular problems. And regardless of how you choose a cipher, you definitely should have one at your disposal-either an accountant that works with your business regularly or a consultant that can help you get a handle on your situation.

Lance Schellhammer is owner of Grass-Roots Inc. (Lenexa, Kan.).

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