Pricing Your Work (Overhead Recovery Review)

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2 Pricing Your Work (Overhead Recovery Review) To accurately price your work, you need to be aware of three main factors: 1. The Estimate these costs are the direct costs of labor, equipment, materials, and subcontractors for the project. You need to calculate these costs on your estimate/bid. 2. Overhead Recovery this is the amount of overhead (company operating expenses) that you will recover on this project. We discussed three different methods of recovering overhead earlier in this course. 3. Net Profit you need to price your jobs so that your business earns a profit. Build profit into your pricing plan so that you are planning for profit, not hoping for it. Let s begin by examining the first factor in pricing a job the estimate 1. The Estimate Your estimates should clearly define all the costs of doing a job. This course will not cover the estimating process entirely LMN offers a course dedicated to the best practices of estimating work. We recommend you think about all your estimates in terms of the four main components of work:, ment, s, and Subcontracting. You may also add a component called General Conditions these are costs on a job that aren t directly related to production, but they are related to the job. Permits and temporary washroom facilities are good examples of general conditions costs. Your estimate needs to allow you to calculate the costs of each one of your components, and they are typically broken down by individual work areas on the job. A sample bid worksheet might look like the following: Work Area Front Plantings 30 $ $ $ $0.00 $ Front Irrigation System 0 $0.00 $0.00 $0.00 $ $ TOTAL COSTS $ $ $ $ $13,500.00

3 Once you have built a proper estimate, where you have estimated all your production costs for the job, you can move on to step two, overhead recovery. 2. Overhead Recovery Once you ve calculating how much it s going to cost your company do to the work, you need to calculate how much of your company s overhead costs this job needs to recover. By actually calculating how much overhead each job needs to recover, your company will stand a much stronger chance of being a profitable company. Using the three methods we covered earlier, single overhead recovery, field labor hours, and multiple overhead recovery, let s review how each method would add an overhead markup to our sample estimate.

4 METHOD #1: Single Overhead Recovery The single overhead recovery method is the most simple overhead recovery markup. One markup percentage is calculated (using your operating budget) and then added to all your costs. Let s demonstrate how to apply the single overhead recovery markup to our sample estimate. 1. Using your operating budget, calculate your single overhead recovery markup %. Using the Danscaping example earlier in this course, we calculated this markup to be 32%. Reminder: Formula for Single Overhead Recovery % Forecast Overhead Forecast Cost of Goods Sold = Overhead markup % 2. Add your overhead markup percentage to your job costs. The formula to do this is simple. Simply multiply your cost by 1 + (your overhead markup percentage). Remember percentages are expressed in the form of a decimal. 15% is calculated as.15. If your costs were $10,000 and your overhead markup was 36%, the formula to markup your costs would be: $10,000 x 1.36 = $13,600 You job costs, plus your overhead markup equals $13,600. Let s review our sample estimate we used earlier in the course and apply our markup percentages: Work Area Front Plantings 30 $ $ $ $0.00 $ Front Irrigation System 0 $0.00 $0.00 $0.00 $ $ TOTAL COSTS $ $ $ $ $13,500.00

5 Add Overhead Markup 32% 32% 32% 32% TOTAL COSTS + $ $ $10, $ $17, OVERHEAD Work Area After adding overhead costs to our sample estimate, the total for the bid equals $17,820. This means that, using the single overhead recovery method, the breakeven price of this bid is $17,820. This total covers the direct job costs, plus a percentage of the company s overhead costs. No profit has been added. If you wanted to calculate the total of just one of the work areas, you could do so, simply by using the same formulas, but on just one of the areas. We can calculate the break-even price for the Front Walkway using the method below: Add Overhead Markup 32% 32% 32% 32% TOTAL COSTS + OVERHEAD $ $ $ $0.00 $ Using our example bid, and the single overhead recovery method, the breakeven price of the front walkway is $ This amount covers the direct costs of building the walkway, plus a portion of our company s overhead costs. Finally, we will have to add profit to our bid. This will be covered in step three of pricing adding net profit.

6 METHOD #2: Field Hours The field labor hours method recovers all overhead costs based on the number of hours of labor worked on a job. To calculate your overhead recovery costs on an estimate using the field labor hour method, follow these steps: 1. Using your operating budget, calculate your field labor hour markup. Your field labor markup is not a percentage like the single and multiple overhead recovery methods. Your field labor markup is expressed in dollars per hour. Using the Danscaping example earlier in this course, we calculated Dan s overhead cost per hour to be $ Reminder: Formula for Field Hour Overhead Recovery Forecast Overhead Number of Forecast Field Hours = Overhead Cost Per Hour ($) 2. Add your overhead markup percentage to your job costs. The formula to do this is simple. Simply multiply the overhead cost per hour by the number of labor hours on the estimate. This number is your overhead markup cost for your estimate. For instance, if you bid 100 hours on a job, and your overhead cost per hour was $20 per hour, your overhead recovery markup on that job would be $2,000. Let s review the sample estimate we ve been using to see how the Field Hour method would calculate our overhead recovery costs. Remember, Danscaping s overhead cost per hour was calculated to be $18.18 per hour. Work Area Front Plantings 30 $ $ $ $0.00 $ Front Irrigation System 0 $0.00 $0.00 $0.00 $ $ TOTAL COSTS $ $ $ $ $13, Add Overhead Markup 135 total man hrs x $18.18 per hour = $ $ TOTAL COSTS + OVERHEAD $15,954.30

7 Work Area After adding overhead costs to our sample estimate, the total for the bid equals $15, This means that, using the field labor hour overhead recovery method, the break-even price of this bid is $15, This total covers the direct job costs, plus a percentage of the company s overhead costs. No profit has been added. If you wanted to calculate the total of just one of the work areas, you could do so, simply by using the same formulas, but on just one of the areas. We can calculate the break-even price for the Front Walkway using the method below: Add Overhead Markup 105 total man hrs x $18.18 per hour = $ $ TOTAL COSTS + OVERHEAD $ Using our example bid, and the field labor hour overhead recovery method, the break-even price of the front walkway is $ This amount covers the direct costs of building the walkway, plus a portion of our company s overhead costs. Finally, we will have to add profit to our bid. This will be covered in step three of pricing adding net profit.

8 METHOD #3: Multiple Overhead Recovery The multiple overhead recovery method is more accurate method of calculating your overhead recovery costs, but requires a few more calculations. Let s examine how we would calculate our overhead costs on a sample estimate using the multiple overhead recovery method. 1. Using your operating budget, calculate your multiple overhead recovery markup percentages. Remember, eac h cost type (labor, equipment, materials, and subcontracting) will have its own markup percentage. Reminder: Formula for Multiple Overhead Recovery % ment 25% (industry standard can be adjusted to suit) s 10% (industry standard can be adjusted to suit) Subcontracting 5% (industry standard can be adjusted to suit) -?% - is calculated by taking the overhead expenses remaining (after subtracting the recovery amounts from the other three cost types) and dividing it by your forecast labor costs. Using the multiple overhead recovery formula, we calculated the multiple overhead recovery factors for Danscaping to be the following: Expense Type Markup % ment 25% (include tax) 10% Subcontracting 5% 53% 2. Add your overhead markup percentages to your job costs. The formula to do this is simple. Simply multiply each individual cost type by 1 + (the cost type s overhead markup percentage). Remember percentages are expressed in the form of a decimal. 15% is calculated as.15. If your labor costs were $10,000 and your overhead markup was 53%, the formula to markup your costs would be:

9 $10,000 x 1.53 = $15,300. You labor costs, plus your overhead markup equals $15,300. You then repeat the same calculation for your equipment, material and subcontracting costs using their unique markup percentages. Let s review our sample estimate we used earlier in the course and apply our multiple overhead recovery markup percentages: Work Area Front Plantings 30 $ $ $ $0.00 $ Front Irrigation System 0 $0.00 $0.00 $0.00 $ $ TOTAL COSTS $ $ $ $ $13, Add Overhead Markup 53% 25% 10% 5% TOTAL COSTS + OVERHEAD $ $ $ $ $15, Work Area After adding overhead costs to our sample estimate, the total for the bid equals $15,945. This means that, using the multiple overhead recovery method, the break-even price of this bid is $15,945. This total covers the direct job costs, plus a percentage of the company s overhead costs. No profit has been added. If you wanted to calculate the total of just one of the work areas, you could do so, simply by using the same formulas, but on just one of the areas. We can calculate the break-even price for the Front Walkway using the method below: Add Overhead Markup 53% 25% 10% 5% TOTAL COSTS + OVERHEAD $ $ $ $0.00 $ Using our example bid, and the single overhead recovery method, the breakeven price of the front walkway is $ This amount covers the direct costs of building the walkway, plus a portion of our company s overhead costs. Finally, we will have to add profit to our bid. This will be covered in step three of pricing adding net profit.

10 Net Profit Margin vs. Net Profit Markup The final component to your prices is a profit margin. You need to price your work using an expected profit margin. If you ve built an operating budget, your Net Profit Margin, as shown on your forecast profit and loss statement is a good start, but your margin doesn t have to match that number. Your margin can be lower or higher, depending on the situation. When you are thinking about profit, remember that every job needs careful attention to this factor. Competitive jobs with many bidders typically have lower profit margins than custom design-build work. You will often find yourself pricing some work at one profit margin, and other work at a different profit margin. Remember: When you are lowering your prices, you are lowering your profit. You need to be firm on the costs as defined in your estimate. Don t be tempted to mentally beat your estimates while at the negotiating table. 9 times out of 10, your job will finish as estimated (or worse!), and the profit you thought you d earn by beating the estimate will remain in your customer s pocket, not yours! There are two easy steps to add a net profit margin. 1. Select a net profit margin 2. Add this net profit margin to your job costs + overhead cost recovery The formula to add a net profit margin to a bid looks like this: Cost ($) (1 Desired net profit margin (%)) = Price to customer ($) Let s look at a simple example. We have a job where the total costs of the job, including all job costs and our overhead cost recovery markups, totals $18,000. We want to make a 10% net profit margin. The formula to calculate the price we need to charge our customer looks like this: Start by filling in the information you know. The total costs go on the top of the equation. The profit margin you desire goes on the bottom of the equation (don t forget to express profit margin in the form of a decimal) $18,000 (1 -.10) Before you divide your numbers, calculate the bottom of your equation. 1 minus.1 =.9. Now you re ready to divide. $18,000.9 = $20,000 And it s that simple. To earn 10% profit on $18,000, you need to charge your customer $20,000 for the work. 1

11 Why do I need to calculate my margin differently than my markup? When we calculated markups, we simply multiplied the cost by 1 + the markup percentage. So then why are we dividing to calculate a profit margin? The answer is because there is a difference between a markup and a margin. A markup is specific to the cost of the item. A margin is specific to the price of the item. Let s look at what would happen to our example above if we tried to use the multiplication formula: Our costs were $18,000 and we wanted a 10% profit margin. $18,000 x 1.1 = $19,800. Notice the difference? When we calculated the profit margin using the margin formula (divide by 1 desired profit margin) our price was $20,000. The formula to calculate a profit margin is: (Selling Price Cost) Selling Price ($20,000 - $18,000) $20,000 =.1 or 10% We can see by this equation that our formula for profit margin (using division) and our formula for a markup (using multiplication) came up a bit short. Why did this happen? Because the markup formula calculates 10% of the cost and adds it to the total costs. To calculate a profit margin, you want to add 10% of the eventual selling price to the cost. The margin formula enables you to do this. 2

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