Last month I addressed the general issue of overhead. That is, too many people in our industry don't take into account the overhead costs they entail in the course of business. As a result, their selling prices tend to be less than the cost of doing business.
Once you learn how much overhead costs, you need to break it down to a dollar-per-hour basis. This month, let's take a closer look at exactly how that's done.
The chart on page 32 shows an actual firm's dollar-per-hour overhead (DPHO) over the course of 1991. Note the references to "allocations." The allocations referred to were a profit-sharing plan for employees and management bonuses. This firm, like most companies that offer profit-sharing or bonus plans, only pays out if profits reach certain levels.
To apply overhead, obviously you must keep track of it. The key is to have good bookkeeping and accounting systems that enable you to keep close watch of your business expenditures. Every business owner ought to see a financial statement at least monthly.
Notice, in column E, that this firm's monthly DPHO fluctuated rather substantially from a low of $53.17 to a high of $71.26. However, Column
F, showing the year to date numbers, is much more consistent.
It's impractical to keep changing prices each month to reflect different overhead. Updating once or twice a year is sufficient. The final YTD number ($62.70) is the one this firm applied to its selling prices going into 1992.
Keep in mind that this $62.70 figure is just overhead. It doesn't include the direct labor, materials and profit components of this firm's selling prices. Yet this overhead figure is greater than most PHC firms charge for an hour's billing. Is it any wonder why so many people in our industry are going down the tubes?
The other key component of DPHO is the number of productive - i.e., billable - hours of labor your firm sells. This, too, will fluctuate month by month, and even year by year. The final figure of $62.70 was derived by dividing the year's total billable hours (Column D) into the overall YTD overhead dollars (Column B).
Shrinking Dollars
The numbers shown here are adapted from the workbook I pass out as part of my "Business of Contracting" seminar series. Let's do some number crunching based on data not shown here.Let's say this firm's total truck maintenance expenses for the year totaled $175,000, which would not be far off the mark. This would include all parts, labor and fueling charges. Dividing that by 37,764 billable hours comes to $4.63 in DPHO from truck maintenance alone.
What's your DPHO for truck maintenance? Do you even charge any? I fear in too many cases the answer would be no. Yet every PHC firm in existence has truck maintenance costs, and most would be more or less in line with this company's costs on a dollar-per-hour basis. Think of it this way, if you don't factor in truck maintenance on a DPHO basis, it comes out of your hourly billings. So if you charge a labor rate of $50 an hour, you are, in actuality, only making $45.37, because you must pay for truck maintenance out of that.
What about advertising dollars? Thanks to an aggressive program in the Yellow Pages, this firm spends over $250,000 a year in advertising. Divided by 37,764, that comes out to about $6.62 per billable hour. If you fail to factor that into your prices, guess what? The
$45.37 left over becomes the equivalent of $38.75.
But wait. Ever hear of depreciation? This is a measure of the diminishing value of various equipment that is bound to break and wear out over time - including your vehicle, power tools, office equipment such as faxes and copiers, etc. Charging for this in overhead enables you to build up a reserve of cash that will enable you to replace these items. This company calculates around $75,000 a year in depreciation expense, or $1.99 per billable hour. Oops, that $38.75 selling price just dropped to $36.76 if you failed to build something into it for depreciation.
Then there's this firm's rent and utilities, which cost some $80,000 a year, or $2.12 per billable hour. Down to $34.64.
Office supplies and telephones cost over $100,000, or $2.65 per billable hour. They have a broad miscellaneous category that includes everything from medical and dental premiums to dues and subscriptions, from hiring expenses to charitable donations. Total cost is around
$190,000 a year, or $5.03 an hour.
Look out below! This firm's $50 an hour labor rate has been whittled down to $26.96, and we haven't even begun to apply some other heavy overhead factors, such as administrative salaries and pension contributions.
The firm contributes about $186,000 a year to an employee profit-sharing and money-matching pension plan, about $4.93 per billable hour. Ask around the industry and you won't find one out of 10 that does so. Then people wonder why it's so hard attracting good people to work for them.
Small Firm Comparisons
Granted, the company in question is very large, and the gross expenditures are way out of line with what most of you spend. However, the DPHO figures aren't.For instance, if you run a small company shop with one or two trucks, you certainly don't spend $250,000 a year in advertising. But $10,000 is not out of the question for even one-man operations, especially if you have a Yellow Pages display ad.
Instead of 37,764 billable hours annually, a one-man shop more likely bills around 1,500. So your DPHO for advertising would be $6.67, pretty close to the big firm's DPHO.
Same with various other expenditures. Annual truck maintenance won't cost $175,000, but for one truck it could very well run $7,500 counting fuel. So add another $5 in hourly overhead.
That truck depreciates just as much as it does for the bigger firm. Rent, electricity, heat, telephones and many other expenses cost just as much proportionally for the small operator as for the big guy. In fact, in some areas economics of scale enable the big guys to operate with less DPHO than the little guys.
We can speculate about these numbers, but in the real world it is imperative that you find out exactly how much your DPHO amounts to.
Some people operate with less overhead then others, and those firms will have pricing advantages in the marketplace.
But don't automatically assume you have low overhead. Take the time to crunch all the numbers and find out for sure. Find out before you set your selling prices, not after. Or else you'll end up like the businessman who shrugged his shoulders after finding out he lost $10 on every sale he made.
"That's OK," he said. "I'll make it up in volume."
