Log in to view the full article
In last issue's column, we discussed methods for determining your overhead and break-even points.
But where's the fun in that? We want to make a profit, right? The profit you want to earn is just that—it is the amount of money you want to make at the end of the year based on the risk you take and the return you want for being a business owner.
Some contractors shoot for a minimum net profit target return on overhead (ROOH) of 20 percent. To calculate this, determine your annual overhead expenses and then multiply by 20 percent to determine your annual minimum net profit goal (pre-tax). Next, the hard part: Try your best to estimate annual sales you'll generate over the next year, as shown in example 1.
Minimum Profit (Example 1)
- Estimated Annual Sales: $1,000,000, $2,000,000, or $3,000,000, respectively
- Annual Overhead (in all examples): $500,000
- Annual Profit Target of 20% ROOH (in all examples): $100,000
- Overhead + ROOH = $600,000
- Overhead & Profit Margin: 60%, 30%, 20%
- Margin Conversion Rate: (MCR = 1.0 - Margin %) = .40, .70, .80
- Estimated Annual Job Costs: $400,000, $1,400,000, or $2,400,000
In example 1, to calculate your final selling price on jobs to earn a minimum of $100,000 for the year, divide your estimated job costs by the MCR to determine your final selling prices. Example 2 shows what a job bid might look like using this model.
Job Bid - Overhead Plus Minimum Profit (Example 2)
- Direct Job Cost: $1,000
- Margin Conversion Rate: (MCR = 1.0 - Margin %) = .40, .70, .80
- Job Sales Price (Cost / MCR) = $2,500, $1,428, $1,250
Set Higher Profit Goals
However, an annual net profit return on overhead goal (ROOH) of 20 percent is too low for the risk most contractors take. I recommend you consider a higher profit target of at least a 40 percent return on your annual overhead. Again, first determine your annual overhead expenses and then estimate your projected annual sales. Next, multiply your annual overhead by 40 percent to determine a higher net profit goal for the year, as shown in example 3.
Higher Profit (Example 3)
- Annual Overhead (in all examples): $500,000
- Annual Profit Target 40% ROOH (in all examples): $200,000
- Total Overhead & Profit: $700,000
- Overhead & Profit Margin: 70%, 35%, 23%
- Margin Conversion Rate: (MCR = 1.0 - Margin %) = .30, .65, .77
- Estimated Annual Job Costs: $300,000, $1,400,000, $2,400,000
- Estimated Annual Sales: $1,000,000, $2,000,000, or $3,000,000, respectively
In the example above, to calculate your final selling price so you will earn a minimum of $200,000 overhead and profit for the year, divide your total estimated job costs by the MCR, as shown in example 4 below.
Job Bid: Overhead Plus Higher Profit (Example 4)
- Direct Job Cost: $1,000
- Margin Conversion Rate: (MCR = 1.0 - Margin %) = .30, .65, .77
- Sales Price (Cost / MCR) = $3,333, $1,538, or $1,298
Estimating Jobs To Make A Profit
To determine you final selling price on jobs you bid, use a job estimating template to determine your breakeven sales price, your minimum profit sales price, and your higher sales price. In last issue's column we determined a break-even MCR is .75; to make a minimum profit, .70; and for a higher profit, .65.
Job Estimating Template (Example 5)
-
Projected Annual Budget
- Annual Estimated Sales: $2,000,000
- Annual Overhead: $500,000
- Break-Even MCR: .75
- Minimum Profit MCR: .70
- Higher Profit MCR: .65
-
Bid recap for 1,000-square-foot (SF) project
- Labor: $2,000
- Equipment: $400
- Materials: $2,000
- Subcontractors: $200
- General Conditions: $400
- Total Job Cost: $5,000
-
Final Sales Price = Cost / MCR / SF
- Break-Even: MCR .75 = $6,666 ($6.66 per SF)
- Minimum Profit: MCR .70 = $7,142 ($7.14 per SF)
- Higher Profit: MCR .65 = $7,692 ($7.69 per SF)
Converting Annual Targets To Weekly Goals
Next, it would be great to know how much work you need to perform every week to hit your annual goals. Using example 5 above, you need to cover at least $500,000 of annual overhead to break even. If you can work productively for 50 weeks per year, you need to make at least $10,000 more than your job costs a week to pay for your annual overhead. In most parts of the country, an average of only 40 productive weeks per year is the norm. If you only can work for 40 weeks a year, you need to make at least $12,500 more than your job costs a week to pay for your annual overhead.
Convert Targets To Weekly & Daily Goals (Example 6)
-
Break-Even Overhead = $500,000 / Year
- Productive Weeks: 40
- Overhead Recovery Needed = $ 12,500 / Week
- Break-Even Point = $ 2,500 / Day
-
Minimum Profit Goal = $100,000 / Year
- Annual Overhead & Profit = $600,000 / Year
- Productive Weeks: 40
- Overhead & Profit Needed = $ 15,000 / Week
- Overhead & Minimum Profit = $ 3,000 / Day
-
Higher Profit Goal = $200,000 / Year
- Annual Overhead & Profit = $700,000 / Year
- Productive Weeks: 40
- Overhead & Profit Needed = $ 17,500 / Week
- Higher Overhead & Profit = $ 3,500 / Day
Taking Overhead and Profit to the Crew Level
Let's say your company has three regular crews, each comprised of five men with trucks. Your crew cost might look like this:
Typical Crew Cost (40 Weeks / Year) (Example 7)
- Labor: 5 Men @ $30/Hour = $150 / Hour
- Down Time @ 10% = $15 / Hour
- Truck = $15 / Hour
- Small Tools & Equipment = $10 / Hour
- Miscellaneous Supplies = $10 / Hour
- Total Crew Cost = $200 / Hour
- 3 Crews = $200 x 3
- Total 3 Crews = $600 / Hour
- Total 3 Crews = $4,800 / Day
To determine how much you need to bill each day, forty weeks per year, add the following costs to your crew daily rates shown above in example 7:
- Break-Even: Overhead $2,500 / Day ($104 / Hour / Crew)
- Overhead & Minimum Profit: $3,000 / Day ($125 / Hour / Crew)
- Higher Overhead & Profit: $3,500 / Day ($145 / Hour / Crew)
To break even in the example above, each of the three crews will have to be billed out $200 per hour to cover their cost, plus $104 per hour to cover your company overhead = $304 / hour, plus what you want to earn for profit. If you want to make the higher profit, your crew billing rate is $200 + $145 = $345 / hour.
Understanding what it takes to make the money you want is not a simple task. It takes time and concentration to figure out your numbers. And then it takes discipline to actually ask and get the proper amounts you need to make a profit at the end of the year. Take the time to get to know how to make a profit and then work to make it reality!