Last month I wrote about net profit per hour, one of the four metrics (key performance indicators) I track every month. This metric answers the question, “For every billable hour, how many dollars of profit are you generating?” It’s not a percentage. It’s a dollar amount.

Unfortunately when establishing pricing, most contractors look at their gross margin to calculate their prices. Percentages don’t matter. Real dollars do.

Another mistake most contractors make is to look at their net profit percentage. This doesn’t tell the real story either. The percentage doesn’t matter as much as the number of dollars you take to the bank.

Take a look at the example to the right. Even though Contractor A and Contractor B have the same net profit percentage, Contractor B is actually more profitable than Contractor A since his company’s net profit per hour is $12.50 whereas Contractor A’s net profit is $10 per hour.

You can earn almost as much working for a fast food company.

Here’s how to establish your pricing using net profit per hour.

1. Determine your billable hours last year. These are revenue producing hours. Do not include vacation, holiday, training, meeting, sick, personal time off, or unapplied hours.

2. Determine what profit you want to earn. Don’t have a clue? Here are some industry averages:

• Service: $75 net profit per hour

• Low efficiency residential equipment: $100 net profit per hour

• High efficiency residential equipment: $200 net profit per hour

Commercial is totally dependent on high material or high labor jobs. High material jobs can have huge net profits per hour (over $1,000). High labor jobs can be as low as $20 per hour.

3. Determine your overhead cost per hour. Overhead cost per hour is your year end overhead cost divided by the billable hours. Overhead cost per hour can be departmentalized.

4. Add overhead cost per hour and net profit per hour. This is the gross profit per hour you need.

5. Multiply the gross profit per hour by the number of hours for the job. If you are calculating service rates, the multiplier is 1 since you are calculating the hourly rate for one technician. Make sure you use your highest paid technician when calculating your service rates.

6. Add the direct cost of labor, materials, sales tax, permits, subcontractors, financing, commission, maintenance agreement, etc.

7. This is your job cost.

When calculating service rates, there are two more steps:

8. Determine the percentage of billable hours per day. This is one of the only times I will use a percentage when calculating pricing. Assuming that your technicians bill 6 out of 8 hours divide the number you derived in Step 7 by 75%. This is your hourly rate for maintenance clients.

9. To get your hourly rate for non-maintenance clients, divide the number you derived in the last step by your discount. For example, if you give maintenance customers a 15% discount on repairs, divide by 0.85 to arrive at your non-maintenance service rate.

The key to pricing using net profit per hour is that you must estimate labor hours correctly. I have found over the years that once contractors start using this method of pricing, their field labor becomes much more efficient and they usually get the jobs done in the estimated hours.

Those who can’t complete the jobs in the required number of hours usually don’t stay. And, sales people who underestimate hours to get the jobs don’t stay either.