What does it cost you to install a job from start to finish? A typical formula calculates materials (windows, shingles, caulk, fasteners, etc.) and the labor per piece (opening or square foot). Why is it important? Because to calculate gross profit you need to start from what it costs to actually build or install the job. Miscalculate and it can end up costing you because what you've budgeted for overhead won't cover the expenses incurred, whether fixed or variable.
Knowing direct costs — defined by construction accounting expert Leslie Shiner, of The Shiner-Group, in Mill Valley, Calif., as “anything that fluctuates with volume” — is where a profitable pricing strategy begins.
PITFALL OF ERROR Shiner points out that contractors often confuse fixed costs with direct costs. The danger, she says, is “the guy's volume goes up, and he thinks he should be making a lot more money and he ends up making less.” With sales down for many contracting companies and most compelled to reduce overhead (fixed) costs any way they can, those companies “that really understand [their direct costs] do better than those that are flailing around trying to guess as what they need to do to attain profitability,” Shiner says.
Charles Gindele, owner of Dial One Windows, in Santa Ana, Calif., defines direct costs as “all the costs you've incurred because you sold that job.” Or, put another way, costs — permits, Dumpsters, subcontracted labor, etc. — that wouldn't have existed without that job. Gindele, who conducts a financial boot camp for contractors twice a year, agrees that the biggest problem is when contractors mix direct costs and overhead in their record keeping.
He believes that a replacement contracting business needs to generate a gross profit in the 55% to 60% range, given direct costs, marketing costs of 8% to 12%, and unintended and unforeseen expenses, usually 5% to 6%, that “add cost or reduce revenue.”
CAUSE OF CONFUSION Failing to get an accurate direct cost can cost your company its profit or cause a loss.
“The confusion comes with labor,” Shiner says. “If you're installing with your own employees, you may calculate the labor by multiplying the number of hours it takes to do the job by the amount paid per hour. And in doing so you'd omit FICA, Medicare, workers' comp, and other costs — sick pay and vacation — incurred as a result of putting someone in the field to install that job.” (See the labor burden calculator available at www.shinergroup.com.)
Gindele says that opportunities for greater profitability lie in reducing unforeseen expenses. “If you can build processes and systems to manage those things out of the business,” he says, “you can pick up 2%, 3%, or 4% that drops to your gross profit.”