Business Tips: Back to Basics – Overhead Cost

Frank Blau
Contributing Writer
ShuBee®

I realize that I am a controversial figure around the industry. That doesn’t bother me. What does get my goat just a little is that people who level criticisms at me tend to say that I encourage people to charge too much. This is a gross distortion of my central message.

I have never once advised a contractor how much to charge for his or her services. I firmly believe this is a personal business decision that must be made in light of individual needs and market conditions.

What I do say to every contractor who will listen is that they ought to make a profit, and I encourage them to strive for more than the pitiful industry average of 2-3% net before taxes. I am not about to apologize for that.

What gets lost in all the back biting and finger pointing is my central message – which is, before you can calculate a profitable selling price for any of your services, you must have a good handle on what it costs you to provide those services. The most important business principle is to know exactly what it costs for every billable hour you sell. The difference between that cost and your selling price is profit.

There aren’t many contractors who would take a guess at how much a one-piece toilet costs when bidding a job that calls for them. You wouldn’t say, “Let’s see, I think I paid around $190 for one six months ago, so that’s what I’ll bas my estimate on!” No, all of you would do the intelligent thing and call the supply house to get an exact price quote.

Yet the vast majority of you do exactly the kind of wild guessing when it comes to factoring overhead into your prices. “Let’s see, I think I’ll allow 25%!” I say you need to figure your overhead to about the same degree of accuracy that you price a toilet.

If you know your cost, you have some control over your profit picture. If you don’t, you are flying as blind as a bat in a cave, but without that creature’s excellent echo-location abilities.

Hogwashing Hermans: I know from my seminars and travels around the country that there is not one PHC contractor out of 10 who can tell me how much it costs him to open his doors for business each hour and each day. Most can’t even give me a decent “guesstimate” within 10%. Instead they base their prices on annual phone survey in which they have someone pretend to be a customer and call competitors around town to ask how much they charge.

What hogwash! Herman’s Plumbing Co. charges $45 an hour, so you’ll be real smart and chart $40! Never mind that it might cost you $50 to make a service call.

“Oh well, I’ll make it up on materials,” goes the thinking. But as we all know, that’s getting harder and harder to do as more and more people buy their PHC goods at the home center. Pretty soon you’ll get to the point where you have to mark up your pipe dope and elbows 10,000%, and sooner or later people will catch on.

Cost accounting is a fundamental business concept relevant to every type of business endeavor. For instance, it is a poor restaurant owner who doesn’t know to the penny how much it costs to provide each mean on the menu (on average, of course). In reality many don’t, which may be one of the biggest reasons why restaurants suffer one of the highest failure rates of any type of business.

Overhead Neglect: There are two different types of costs to any business: direct, sometimes called “fixed” costs, and indirect costs, also known as overhead.

A contractor’s fixed costs are his labor and materials, plus permit fees, subcontracts and commissions if you pay any. These are easy to figure and most of you do okay here – though I would remind everyone that when calculating labor costs you must include not only wages but benefits, insurances and everything else related to employee compensation.

PHC contractors typically fail to keep close track of overhead. By keeping “close track” I mean more than adding it all up at the end of the year in preparing to file income taxes. It’s not enough to await that big surprise once a year. You must create an ongoing profit and loss statement and monitor it at least once a month. Only then will you be able to flag runaway expenses before you get hurt too badly.

Different types of businesses will have different overhead. Here I will suggest some possible overhead categories. In parentheses are some possible individual line items to include under each category.

Overhead Categories:

Salaries (Proprietor, supervisors, administrative/office help, etc.)

Salary Burden (Social security, insurances, taxes.)

Nonproductive Labor (General supervision, cleanup, maintenance, training.)

Office Expense (License fees, stationery, printing, postage, telephone, etc.)

Utilities (Electricity, heat, water.)

Mortgage or Rent (Also property tax, maintenance, repairs.)

Travel & Entertainment:

Credit & Collection (Credit reports, collection agency, etc.)

Bad Debt Allowance (Count on getting burned for at least 2-3% of your revenues each year.)

Vehicle Expenses (Depreciation, insurance, licenses, taxes, repairs, maintenance, fuel, parking fees, etc.)

Advertising & Promotion (Yellow Pages, direct mail, newspaper, radio, TV, home, shows, signs, gifts to customers, cash awards, sponsorships, etc.)

Training (Materials, registration fees, etc.)

Dues & Subscriptions (Trade associations, business & civic organizations.)

Donations (Charitable, PAC, etc.)

Professional Services (Accounting, legal, consultants.)

Insurance (General liability, fire, fidelity, theft & vandalism, etc.)

Depreciation (Office equipment, large tools & equipment, etc.)

Interest (Borrowed money, equipment & vehicle loans, etc.)

Miscellaneous (Janitorial, redecorating, store & shop supplies, etc.)

Applying Overhead: Once you add up all these costs at the end of the year, divide the total  by the number of billable hours of work you performed in the same time period. This will give you your dollar-per-hour overhead burden. To convert this to a percentage figure, divide your total overhead dollars by your total revenues.

Note that I said you must divide by billable hours of work. Don’t use 40 hours a week or 2,000 hours a year per service tech unless you reasonably expect to get paid for that many hours. Your billable overhead must also pay for all those nonproductive hours spent idle, cleaning up, in training, etc. If you divide your total overhead dollars instead by the total number of hours you put in each year, the dollar-per-hour overhead applied to your selling prices will be too low to reflect the real cost burden.

Dollar-per-hour overhead is something every person in business needs to know. Sadly, at least in our industry, it is a mystery to most. This number tells you how much money is flying away every hour that you open for business. The only way to recoup this money is to tack it on to every bill you present to your customers.

 

 

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