June 18, 2012
All you need is a calculator
By J. Paul Lamarche

Years of hands-on experience have shown me there are some jobs not worth doing if I want to make money.

Through the creation of a proven pricing system, I now bid confidently and competitively. While it requires consistent record keeping, my system is simple and will show you what you need to charge to be profitable.

"What can I charge for my services?" is the number one question among entrepreneurs. Some entrepreneurs believe that estimating is pricing according to what the market will bear. For others it may be a matter of pulling out the Yellow Pages, calling half a dozen competitors, averaging out their prices and using that price.

Many industries simply take a markup percentage on top of their goods or material costs. This can work well for retailers, but is not good for service industries like landscape contractors. Service contractors may know the exact amount of material and labour hours required to do a job, however, many do not understand how to price to cover their overheads -- their cost of doing business. No two companies will have the same overhead. A proper strategy for pricing requires you find your cost of doing business, so you can establish your breakeven point per person hour, per service and per job. My step-by-step plan allows you to go beyond breakeven points and price for profits, determines which jobs to bid and even how to use equipment profitably.

Essential first step: Determine overheads

I cannot stress enough that you must have an accurate picture of your true overhead costs. Sure, it means some discipline. But it will give you confidence in your bidding, and long-term success.

Determining the costs of doing business requires the commitment to maintain a 12-month budget. In fact, nine out of 10 service companies don't do any budgeting at all. Some don't even reconcile their bank statements at the end of the month. For others, records are kept in their heads -- or their pockets. I know one individual who kept revenues in one pocket and expenses in the other.

Overheads are all your costs that cannot be allocated to specific jobs. Be sure to include your own salary. And your spouse's! If you physcially work on the jobs and are charged hourly to the job, then you only need to put in an incremental amount under salary to cover your time for estimating, selling, designing, etc. Use your accounting software. Once you get set up, you can calculate the cost of your overhead more accurately. Note that accounting software enters only cash or cheques paid out for invoices. One of the most important items in your overhead is ROI, or return on investment. After your equipment is paid off you should continue to charge your overhead the monthly fee you were paying on your equipment. This allows you to collect the funds to pay cash for your next piece of equipment. It takes a little patience, but the results are worth the effort.

Next: Forecast your sales

Now you must forecast a number to represent your forecasted net sales, meaning sales, less GST and sub-contractors. In determining this figure, be absolutely realistic about using a number pegged as closely to your real sales as possible. DO NOT use this as an opportunity to set yourself a sales goal -- the system gives you plenty of chances to boost your profit margins later on.

Know your overhead percentage

Now you have two important numbers: your annual overhead cost and your annual sales forecast number. Divide your overhead cost in dollars by your forecasted net sales in dollars to get a percentage figure: your overhead expense as a percentage of forecasted net sales, or simply "overhead percentage." Knowing this percentage is essential to using the JPL system.

Do the math: Overhead percentage

A sample overhead expense of $197,500

divided by forecasted net sales of $450,000

= 43.88% overhead

Knowing this percentage allows you to calculate your breakeven point on any job down the road -- the lowest amount you can charge for a job before you start losing money.

Typical overhead percentages range from 40-50% for smaller horticultural entrepreneurs, and can go down to 17% for the largest companies. This should help you to realize why small companies are at a disadvantage in the tendering process.

Get your Magic Number

Once you know your overhead percentage, the JPL Estimating System prompts you to enter your overhead percentage, less 100%, and create a Magic Number for estimating purposes.

Do the math: Figure a Magic Number

Let's say your overhead percentage is 39%.

Take your overhead figure, minus 100%, to know your Magic Number; in this case, 61%. (100%- 39%)

Real life estimating

To use the Magic Number to quote jobs, start by adding up your direct job costs, called Cost of Goods Sold, for a specific job. In broad terms, these costs will include materials, disposal, labour, equipment rentals (all at exact cost to you less GST) -- everything you need to complete the job.

Note that determining accurate labour cost is a little tricky. The benefits you pay are significant, and are properly allocated here, rather than in your overheads. In the horticulture industry, benefits typically cost another 20% above base wages. You also should factor in down time, if you are charging your customers by the hour rather than by a quoted price. In addition, if you work alongside your crew on a job site, build in an hourly rate for yourself on top of the overhead portion of your salary. Note that subcontractors are not and never should be part of Cost of Goods Sold.

Take the dollar figure for your direct job costs, and divide by your Magic Number to arrive at your breakeven price for the job.

Do the math: A sample quote

You figure the costs on a job will be $1710.

Your Magic Number is 61%. Divide $1710 by 61% on your calculator to get your breakeven price for the job: $2803.

We have been using 61% as the Magic Number -- stated a different way, it means that your jobs must be quoted so 39% of your earnings go to cover your overheads -- and that is just to break even.

If you wish to make 15% profit on this job, then you take your breakeven cost of $2803 to do the job and divide it by 85% (profit of 15% less 100% = 85%). The quoted price comes in at $3298. Note that if you multiplied your breakeven cost to do the job by 15%, you would arrive at $3223. While this is not a big difference, you are invited to mail the difference to me, if it means so little to you!

As an experienced professional, you can jot down a few numbers and get a pretty good idea of your direct costs when you do a take-off. You can pull out a calculator, punch in your cost and simply divide by your Magic Number, then you build in your profit to quote the job. The client will have no idea what you just did, but you are confident all your costs, both overhead and direct, are covered, as well as your profit margin.

Beyond the formula

Your profit margin is what your whole business is about, and you set those goalposts. For contracting, 10% is a good target, and most well-managed companies achieve or exceed this margin.

There will be times, however, when you might want to "buy" a job, that is, bid at breakeven for one reason or another. The system allows you to do just that, by omitting the desired profit from your formula. The result is a bid that reflects a true breakeven cost. You achieve your objective, while you have all of your costs covered -- unlike so many contractors you see who work harder and harder to go backwards at a faster rate. I like to point out that once you meet your targeted sales figure for the fiscal year, all additional sales come with only a fraction of overhead, as you have covered your forecasted overhead for the year.

The JPL Estimating System is simple. Just complete the information to make the formula work for you. However, keep in mind that the accounting adage "garbage in = garbage out" applies here, too. If you enter the wrong amount for labour or miss the mark on cost of materials, then you will not arrive at the right price for your service.

The JPL System can be fine-tuned for more accuracy with factors like labour costs, depreciation and return on investment and working with subcontractors. Watch future issues of Landscape Trades for more detailed articles on topics like these. For more information visit www.jplbiz.ca