Time and time again I meet great contractors struggling to make good money.
Fantastic tradesmen who know their stuff but can’t put their finger on why they’re only scraping by when they should be smashing it. The reason: they haven’t paid enough attention to their overheads.
This article looks at how to calculate overheads and how to ensure they’re covered with every quote you send out.
Step 1 – Know Your Overheads
Overheads are the costs you incur every day just to keep your business running, otherwise known as ‘indirect costs’. They’re not the costs to do the project, those are called direct costs. Overheads are the additional costs you’re going to pay come rain, hail or shine.
The best way to know your overheads is to make an extensive list of them. Ensure you include all the indirect costs you pay over the year, including director wages (we all need to feed the family). Right is an example of a list of typical overheads. This list is by no means exhaustive, your business is likely to have many more items on it.
Step 2 – Covering Overhead With Every Quote
There are two ways to make sure you’ve covered the cost of running your business in your quotes. Both are perfectly valid options, just be sure to pick one:
1. Add overhead to your labour rate
2. Add overheads to all direct costs as a percentage
Adding Overheads to Labour
This option is fool-proof and favoured by many contractors. For a more detailed explanation of this option revisit the article I wrote in the Jan-Feb 2017 LCM titled ‘The Costs of Labour’.
1. Calculate the total billable hours you and your staff will work in the year.
- Billable hours are those hours that your staff are on the tools working for a client. Hours you can bill directly to a job/client.
- Billable hours are usually calculated in Australia using this formula:
- ZAn efficient team will only manage to work a maximum of 80 per cent of the time, there will always be downtime in the day.
- Make the calculation for every employee on the tools but be sure to adjust the days/hours down for part-time staff.
2. Divide the total cost of overheads by the total team billable hours.
3. Add the ‘Overheads per billable hour’ sum to your labour cost.
Example: If your labour costs $34.50/ hour then your labour costs including and covering overheads is $49.81/hour 4. Make sure you add profit!
Adding overheads to direct costs
This option is also fool-proof as long as you know what your overheads are as a percentage of your turnover. Here is how we work that out:
- Calculate your overheads, as we did in Step 1.
- Estimate your turnover for the year. The best way to do this is to look at your exact turnover for the previous year and add a percentage for growth, if you think you will grow.
- Divide your overheads by your turnover. Example:
4. The tricky part: Mark up the direct costs enough to cover your overheads AND give you some profit. Mark-upand Margin are different, so adding 24 per cent mark-up would only get you a margin of around 19.5 per cent. If your overheads are 14 per cent then your nett profit would only be 5.5 per cent, which is way too low! To ensure your overheads and profit are covered calculate the difference between your sell price and your direct costs and make sure the margin is there.
Example: If overheads are 14% the profit margin in this case would be 11%
THE MARGIN CALCULATION = 1- (DIRECT COSTS/ SELL PRICE) X 100 = GROSS PROFIT MARGIN CALCULATE THE NETT PROFIT BY = GROSS PROFIT – OVERHEAD % = NETT PROFIT
Overheads are often neglected or under charged, leading to contractors selling themselves short. It’s impossible to predict your exact overheads for the year but filling out the table above you’ll get very close.
Be sure to add your overheads to your quotes by adding them to your labour rate OR adding them to all direct costs as a percentage of turnover. It doesn’t matter which one you choose, but pick one and stick with it!