Generating Profit from Overhead

Generating Profit from Overhead

Frank Blue
Contributing Writer

Some people say that the “numbers crunching” I teach is overly complicated. “Frank, why bother to go through all that arithmetic, when all we need to do is apply a few simple multipliers to achieve decent profits?”

My reply is that, first, I use my method in my seminars as a teaching tool to get across some principles of business math. I think it is just as important for a businessman to know why he is doing something as what to do. It’s the same reason why we teach principles of hydraulics to apprentices as well as how to use the tools. It’s what separates thinking men and women from robots.

Furthermore, the biggest problem with multipliers is that they still don’t guarantee a profit. So you “tweak” your materials one and a half, or two, or three, or four times. You can still lose money if you are pricing your labor and overhead under cost. Also, the amount of material varies with each job. You don’t want to put yourself in a position where the only way you can make money on a job is to load it up with materials that may not be needed.

Another drawback for those contractors still wedded to time and material billing is that multiplier markups draw attention to the stark difference in your material prices and what’s being charged by the discount home centers.

Profit Dollars Everywhere: Instead, the concept I prefer to use is one of generating profit dollars not only on material, but on each and every component of a selling price – materials, labor, overhead, fees, etc.

Some people react with shock when I talk about this concept. Make money on overhead? Make a profit on the permit you pull! Why that’s ridiculous! That’s cheating!

Don’t hyperventilate. It’s simple a matter of bookkeeping more than anything else. Profit dollars can get assigned any way you like, but I think my method is the best because it tends to guarantee a profit on every job you do, big or small, using lots of material or just a little. Also, it blends in nicely with the flat rate pricing system that I favor.

The example shown here is taken from my seminar workbook, showing how to create a hypothetical flat rate price for a kitchen sink faucet installation. Assumptions include one hour of installation time at a direct labor cost of $30. This includes fringe benefits. Also, we pay our service techs a commission of 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of our company’s net cost on all materials they sell, which I’ve included as an added cost component. There are no permit fees or subcontractors that apply here, but I include them as line items in the example just as a reminder that they could come into play on other jobs.

Columns 1-3 show the different cost components and their percent of the final selling price, $229.87. Note that on this particular example I targeted a net profit margin of 25{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. This can be any figure you wish. If you were to figure a net margin of 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, the selling price would be $191.56.

Column 4 shows the selling price derived from each component. When totaled they add up to a selling price of $229.87. Since net profit goal is 25{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, I get the selling prices by dividing the cost of the components in Column 2 by .75. (Flat rate contractors often get pressured by customers to provide a breakdown of their costs. I recommend against it, but if you absolutely had to do it, Column 4 would be a suitable format.)

Column 5 shows the profit, 25{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of selling price, provided by each component. This is what I mean when I say that profit dollars are generated from each component of every job, including overhead.

Yes, there are easier ways to come up with selling prices. The value of this technique is that it helps to dramatize how important it is for you to understand the overhead and other cost factors that go into each productive, billable hour you have to sell. If you get your butts in gear to find out what those costs are, you can put those costs to work earning profit dollars.