How Much Should I Charge?
Originally published: 1/1/10 by Ruth King
There is a better way to accurately price jobs—you determine your profit.
This seemingly simple question stumps many contractors, because they don't understand true costs. They look at their income statement which shows great gross margins and losses on the bottom line. They think, "I'm already the highest prices in the area ... what is wrong?" Or, they see terrible margins and great profits on the bottom line. They think, "There must be some mistake."
We have progressed as an industry. We've gone from the early seventies pricing, using markup where we thought that markup is the profit we're making (totally wrong), to using margin to calculate prices (which is OK if you have equal costs between labor and materials). But, there is an even better way to accurately price jobs. This method also gives you some decisions as to how much profit you want on a job. This pricing methodology uses gross profit per hour, overhead cost per hour and net profit per hour decisions.
Why is overhead cost per hour important? Because if your company's overhead cost per hour is $50 per hour and your competitor's cost is $30, he can charge $160 less than you for the same eight-hour job and make the same profit as you. Or, if it is a slower time of the year, he can charge less than you do, win the job, and break even. You're scratching your head saying, "How can he sell it for that?" He understands his true cost of the job. Here is how to calculate how much you should charge:
1. Calculate your overhead cost per hour. To do this:
a. Determine the total number of revenue producing hours you had in 2005. This is your field labor total payroll hours less their non-billable hours. Or, think of it as how many hours did you bill for?
b. Get your total overhead cost for 2005.
c. Divide: Overhead/total revenue producing hours.
2. Get an accurate labor estimate for the job. Here's where you can go wrong. You must be accurate with respect to the number of hours that the job will take. Make sure that you include travel time, running to the parts house and all of the other miscellaneous hours that should be billed to that job. Once you know this number, you can then calculate any price you want.
3. Calculate the total direct cost for the job. This includes the cost of labor, materials, subcontractors, warranty, service agreement, freight and tax (if any).
4. To calculate the overhead that should be applied to the job, take the total labor hours (NOT COST) and multiply it by the overhead cost per hour.
5. Add this sum to the direct cost for the job.
6. Add the commission you will pay. This is your break even for the job.
You now have a choice. You must decide how much profit you want to earn for the job. During slower times of the year, you might want less profit than busier. This is where you earn your pay as the business owner or sales manager.
Using gross profit per hour and overhead costs per hour can help you with accurate pricing for high labor or high material jobs. This methodology is also the best way to handle pricing during slower times of the year when you want to lower prices, but may not necessarily know by how much.
This method also tells you how productive your field labor is. If a job should come in at 16 hours and instead it comes in at 12 hours, you've earned more profit. Find out why this happened and repeat it again and again. Likewise, if you estimate 16 hours and it comes in at 20 hours, find out what is wrong and don't repeat it again.
By using this pricing methodology, you'll never have to ask the question, "How much should I charge?" again. The decision, based on accurate numbers, is yours.
Articles by Ruth King
Your Accounts Receivable to Accounts Payable Ratio: Do You Have a Collection Problem?
Use the accounts receivable to accounts payable ratio to determine if you have enough money to pay your bills.
Your Acid Test - Do You Have Too Much Inventory?
Your Acid Test - Do You Have Too Much Inventory? Track This Indicator to Get a Clearer Financial Picture
Do You Have Enough Cash to Pay Your Bills on a Long-Term Basis?
Check Your Liquidity Ratios
Why I Hate KPIs
Comparing KPI ratios to industry standards alone can be a risky move.
Finishing and Implementing Your 2014 Three Page Business Plan
In the past two months you’ve created your 2014 goals with your employees and your 2014 marketing plan. This month you’ll complete your three page business plan by estimating your 2014 budget. I’ll end this series with some implementation suggestions so that you make 2014 your best year ever.