That costly unsold hour factor

 

BY RICHARD DiTOMA, L.M.P.,

contributing writer

 

As a human, your primary language is second nature to you. But it had to be taught to and absorbed by you to give you the ability to speak without consciously thinking about the actual words you say. However, you should keep in mind that putting your brain in gear before opening your mouth is always the wiser way to utilize the gift of speech.

 

As a plumbing contractor, you rely on Drainage Fixtures Units (DFUs) to determine the size of drainage piping needed to allow for the proper flow of waste from plumbing fixtures. Many plumbing contractors probably don’t consider DFU calculations every day because the methodology of pipe sizes becomes second nature to plumbers who are in the field everyday.

 

The same holds true for heating and cooling contractors with regards to Btus. These measuring units are examples of things that are presumably constant. Even so, it’s always wiser to calculate the loads of each situation to make certain that your pipe sizes and heating/cooling equipment are properly sized before quoting any prices and performing any tasks.

 

As a business person, the use of the correct application of formulas needed to be successful is also a constant. However, circumstances revolving around factors used in those formulas are in a constant state of flux. Therefore, the costs to run a business must be constantly monitored in order to be certain that you will recover the cost you incur to do the job and give yourself an opportunity to make a profit for your performance. That’s what business is all about.

 

You must correctly calculate your budget in totality. You probably figure your jobs on the time and material needed to perform the task. A correct budget calculation will allow you to interpolate your total operational costs for labor and overhead into your actual cost per technician hour. Even so, as soon as you itemize your costs and add them up the total amount is subject to change because any of the items included in the budget may have increased in cost to you. Therein is one of the causes of the constant state of flux.

 

After you become adept at calculating and monitoring your budget constantly and correctly, you will develop the ability to build in buffers that will address the everyday fluctuations. To arrive at your labor/overhead cost per tech hour, you would divide your total cost of operation by your annual maximum available technician hours to arrive at your labor/overhead cost per tech hour. But, if you leave anything out or use a wrong number, you will get a wrong result.

 

In a 5-day/40-hour workweek, a 52-week year will present you with 2,080 annual hours of payroll and overhead expenses per technician. An annual two-week vacation, six holidays and 244 non-billable tech preparatory hours (for daily checking and restocking of truck, etc.) per tech drops your maximum available billing time to 1,708 hours per tech year while you pay for 2,080 hours.

 

Labor/overhead costs

 

As of 2009, the overhead cost for one set up truck stocked to deliver phc services in the USA is probably between $75.00 and $150.00 per tech hour without the tech’s salary and salary-related expenses. The size and structure of any business could make the overhead cost of any business higher or lower than that particular range. The $75.00-$150.00 range is based on contractors selling all 1,708 annual potentially productive hours for every tech all the time.

 

At an annual technician salary of $25,000, you would have to add to your overhead cost about $25.00 per tech hour to cover the salary and salary related expenses for which you pay. That would make the minimum labor/overhead cost to you per tech hour $100.00. At a $60,000.00 annual technician salary, your minimum labor/overhead cost per tech hour would be about $125.00. And at $90,000.00, it would be about $147.00.

 

The key word to consider is “minimum.” Your overhead costs could be higher. At the $150.00 overhead cost those hourly labor/overhead costs are $175.00, $200.00 and $222.00 respectively. And, in either case, if less than 1,708 hours are sold your labor/overhead cost per sold tech hour will rise even higher.

 

The 1,708 hours is the maximum possible per tech without overtime. It’s a benchmark. By using the maximum available hours, no one can accuse you of padding your cost with regard to any service performed. Figure 1 is based on the aforementioned maximum 1,708 hours per tech. At the top of Figure 1 you will see a range of labor/overhead costs to the contractor starting at $100.00 per tech hour and increasing in $25 increments to $250.00 per tech hour. The majority of contractors across the country will probably fall in the $125.00 to $200.00 range. Figure 1 shows the effect upon your labor/overhead cost per tech hour when all your maximum available annual tech hours are not sold. 

 

The lower left portion of the chart shows different levels of average daily tech hours sold in a year. The left most column describes the economic times. No one sells all their tech hours all the time. You probably only sell an average of four to six hours per tech per day during normal economic times and less during recessionary times.

 

The column to the right of the economic times indicates the annual percentage of hours sold compared to the hours that were available. Next, you will see the average annual hours sold per tech. After that, the average number of hours sold per tech starting at seven hours per work day and decreasing in increments of 30 minutes. To the right of the hours sold is the real cost of the hour to you as it relates to the number of hours sold.

 

For example, if your true labor/overhead cost based on 1,708 potential tech hours is $100.00 per hour and you only sell an average of five hours per day, your labor/overhead cost per tech hour is really $140.00. Since your total annual cost of operation is constant; and you only sell an average five hours per tech day (1,220 annual tech hours-71% of your potential tech hours) the unsold hour factor causes your $100.00 cost to rise to $140.00. The unsold hours become an unapplied labor expense. A budget cost of $175.00 per tech hour would cost you $245.00 at an average of five sold hours per day.

 

Choosing the correct profit margin

 

You must now consider your unapplied labor expense. Except for the liars and deniers, no one sells all their available tech hours all the time for all their techs. Therefore, the selling price must reflect a profit margin that considers the unsold hour factor and seven-hour benchmark cost calculation. If you don’t choose the proper profit margin, you will surely fail to attain your goals. As the risk increases so should the profit margin. Before delving into an example, I should first clarify the difference between a profit margin and a markup.

 

A profit margin is that portion of the selling price which is left after the total cost of the selling price is subtracted from the selling price. If your selling price to perform a service was $1,000.00 and you wanted a 10% profit margin, the cost for labor, overhead and material would be $900.00. The $100.00 profit would 10% of the $1000.00 selling price.

 

That’s different from a markup on cost. Ten percent of the $900.00 cost for labor, overhead and material is only $90.00. Taking 10% of your cost which is $90.00 and adding it to that cost would make your selling price $990.00 instead of $1,000.00.

 

You can use this method, but keep in mind, it doesn’t give you a true 10% profit margin. If it did, you could deduct 10% from the $990.00 selling price and recover all of your $900.00 cost. But, 10% of $990.00 is $99.00. Since you only charged $990.00, deducting $99.00 would only give you $891.00 to cover the $900.00 labor, overhead and material cost you incurred. With the $1,000.00 selling price a 10% reduction would give you the full $900.00 cost.

 

Figure 2 shows that a certain profit margin is needed just to recover contractor cost. Example, at an average of five tech hours per day, the contractor with the $100.00 hourly tech labor/overhead cost (based on all available tech hours being sold) has a $140.00 cost reality. He/she would have to apply a 28.57% profit margin to the $100.00 cost just to break even. $100.00 divided by 71.43% (the difference between 100% sell price and 28.57% profit) would give him/her a selling price of $140.00 for an hour. Unfortunately, that selling price would still defeat the only reason for which businesses exist. That is, to make a profit.

 

To make a 10% profit that will cover the risk, that contractor would have to charge $155.55. That means a 35.71% profit margin must be applied to the original $100.00 cost. The proof is $100.00 divided by 64.29% (the difference between 100% sell price and 35.71% profit) = $155.55. When you subtract the $140.00 cost from the $155.55 selling price, $15.55 is left. When you divide the $15.55 profit by the $155.55 selling price you get a 10% profit margin.

 

In the current recessionary times you may sell even less hours. Since the revenue that keeps your business alive only comes from consumers, if you don’t use correct numbers you will make your situation worse not better. Fewer hours sold increase your labor/overhead cost per hour. That means lowering your prices without thinking will only serve to hurt you, not help you. You can lower your profit margin. But, keep in mind the effect of the unsold hour factor. In the aforementioned example, the contractor could choose to lower his/her profit margin to 29%. That would make his/her selling price per hour $140.85. It covers his/her cost and makes an 85 cent profit. It is a meager profit for the value that contractor delivers. But, it’s still above his/her cost.  If he/she lowered his/her profit margin another ½ %, he/she would lose money.

 

The percentages you would have to use are determined by the factors surrounding your business. Don’t go and use the aforementioned example numbers without being certain that they will address your situation. That means you must do some calculating.

 

I realize I have thrown a lot of numbers at you. Don’t panic. Just keep in mind the logical proportion between the numbers and apply the correct factors to arrive at your selling prices. It’s easier than it initially seems. And, if you need help, I am as close your phone. Just call me at 845/639-5050.

 

Denying the importance of factual information is a trait of the proverbial ostrich who buries his head in the sand while leaving his butt exposed to face reality. When he gets kicked in the butt, he is to blame.

 

As always, I wish you good health and much prosperity.