This Business newsletter series will give you insights and techniques to help you build a better business no matter how large or small yours is. I always say that success comes from working on your business as opposed to in your business. I want to share with you the systems and philosophies that have been successful for me over the years.

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In order to project the potential amount of profit or loss that results from each job, you must prepare a job-costing analysis by reviewing the historical data from the job. Job costing acts as a measure of the accuracy of your estimating abilities, and indicates how well you managed the project. Collecting this information over time gives you a basis for more accurate estimating of similar jobs in the future. When reviewing actual job cost, compare the historical figures with the estimate you originally developed and make adjustments as necessary to your material assemblies and labor units. You will often discover that a few little changes will make a significant difference in you’re ability to accurately predict the cost to perform a certain type of work.

Labor: A skilled estimator can usually come close on the actual cost of materials, but estimating labor is where care must be taken to ensure the estimate reflects the actual ability of your company to complete the job. The labor number in your cost accounting includes your shop-charge, labor-burden, and overhead percentages. Improper estimates of labor will also affect the amount to be allocated to overhead expense, since overhead is calculated as a percentage of labor. The greater the error you make in estimating labor, the greater the overhead will be off as compared to your actual costs. This will cause you to make less money, or worse yet—you’ll lose money!

If you were to use the same employees for all jobs, and the type of work remained the same, you could arrive at a close comparison between estimated and actual hours. However, an estimate on a changing labor force with different types of work will not be consistent. Since this is the usual pattern of business in contracting companies, you can significantly improve the accuracy of your estimates by basing your labor estimates on labor-units. A labor unit represents the approximate amount of time required to install a product, component, or piece of equipment.

Once you’ve established the labor-unit for each item, it will remain constant on all estimates. You can make adjustments through percentage changes to compensate for changes in productivity, weather factors, etc. Keep accurate records for labor hours (actual) per phase (slab, rough, trim, final, etc.) as you go along. It’s too late to do this at the end of a job.

Job Expenses: Basically, job expenses are the costs of doing a contracting job that are not directly related to the labor to install the material on the project.
Some examples of expenses include permits, financing costs, and special job insurance cost. Using an approximate or average figure in your estimate for permits may be costly for a job in an area you are not familiar with. Each municipality uses its own formula for determining the cost of the permit—by the job, or by amperage, by the square footage, or other factors, making it easy to overrun your budget. Check with the permit office for the job prior to submitting the bid instead of guessing.

Some project proposal requests may limit the percentage of overhead and profit that may be applied to an estimate. In such circumstances, most job-related overhead expenses, such as the cost of tools, supervisory labor, and equipment rentals become a job expense instead of overhead. To help determine if a specific cost should be overhead or job cost, ask yourself if this job is causing your company to have the expense. If the answer is yes, then it is a job specific expense.

Profit: Determining how much profit to add to an estimate is influenced by various factors and is in some sense an art as much as a science. Facts such as, how many contractors are bidding, how much work you need, and the type of work your company is skilled at can influence this decision. Studies show that if four contractors bid on a job, a median profit is established. When only one contractor submits a bid, the cost average is 135 percent above the same project with multiple bids. As the quantity of contractor bids increase, be aware that the average bid price decreases. At ten competitors, the profit will be approximately 90 percent of the median profit. Don’t feel guilty about earning higher than average profit on a job because you are skilled or there are fewer bidders. Some day you may have to settle for minimum profit to meet the market demand.

Some of the common variations in profit are cyclical, depending on season, business conditions, availability of money and other factors. If you need the job to keep your work force intact, or to meet a sales goal, management may elect to quote at a reduced profit. At all times (but particularly when business is slow), try to upsell a job. How about recommending LED lighting, paddle fans, 3-way switches, recess cans, fire and burglar alarms, or other improvements that will allow you to build in additional profit? This allows you the opportunity to do more work with the same basic overheads increasing the amount of profit for the project.

Change Orders: Additions and change orders are negotiated, typically at a better profit margin. When changes are ordered on a job, prepare a separate estimate, and bill for it separately. Your productivity decreases on change orders, so estimate it more along the lines of service work as opposed to new construction. Consider stating in your contract that a minimum flat fee will be charged for all change orders that includes office labor for billing. Remember, it's never a good idea to proceed on a change order unless it is authorized in writing by the contractor or owner!

Inflation: Like everything in the business world, inflation may cause a serious erosion of your profits if it's not accounted for. If you’re bidding on a job that will not be completed or paid for several months, consider adding a percentage to your total price that will account for the eroded value of your dollars. The average annual inflation over the last twenty years has been between two and three percent. If you anticipate inflation to rise three percent this year (or one-quarter percent per month), and you don’t expect payment to be made for five months, add one and one-quarter percent to the bid price. Don’t allow your customers to pay you in dollars that are worth less than the money you used to pay for the job.

Overhead: Overhead is the cost of doing business that is not chargeable directly to any particular job. Each contracted job must pay a share of your overhead, and the most equitable way is for you to know what the percentage of overhead cost is attributable to the labor cost, then add this percentage to each hour of labor. A small part of the overhead percentage is variable and increases with each hour of labor that is performed but the larger part is fixed and remains constant regardless of how much labor is done. The manager should try to increase the amount of billable labor without radical change in the company that will increase fixed overhead. The end result is a lower percentage of overhead per hour of labor, and more competitive billing rate.

Retention Cost: Some jobs require that a portion of each payment (typically 10 percent) be held for a specific period of time (typically 90 to 180 days) after the final electrical inspection; and some require a portion be held for the duration of your warrantee period.

The purpose of the owner holding back the money (Retainage) is to guarantee that the electrical system has been installed correctly and according to the contract before all final payments have been released. You might want to add the cost of money you do not have access to using the current average interest rate for a short-term loan.

Example: Retainage cost (10%) for 180 days for a $250k project will be $1,500 at an interest rate of 12%.
Cost = ($250,000 x 10%) x (12% x 0.50)
Cost = ($25,000) x (6%)
Cost = $1,500 or 0.6% of the selling price

Expansion: Expansion due to growth in business sometimes requires more employees. Each time you add an employee, your variable overhead increases but with proper management and planning, your fixed overhead remains relatively constant. The result is that companies with more employees can have a smaller overhead percentage per employee than smaller ones.

Reconcile your job-costing analysis on a monthly basis. Use proper forms for clarity, consistency, and accuracy. You’ll have the records needed to review the performance of your employees, suppliers, and estimates. If the actual costs versus estimated costs are out-of-line, determine the root causes and immediately take steps to correct these same potential discrepancies on future estimates. Improve your personal estimating and project management skills and give clear direction to your employees. Work toward reaching your profit goals through the production of accurate job-cost estimates. An estimate is the foundation for the management of the project but the success of a project relies on careful and proactive project management. It takes both accurate estimates and good project management to make money.

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This content is extracted from Mike Holt's Business Management Skills book. If you have enjoyed this newsletter, you can get the full content here.