MRCA 60 th Anniversary Convention

1. MRCA60th Anniversary Convention Welcome to: Overhead 101 – Identifying Your Costs

2. Overview • Determining Job Costs • Describing Overhead • Defining Profits • Comparing Markups/Margins • Bidding with Proper Markups

3. Evidence indicates that 90% of all companies that obtain a business license as a contractor will fail within 10 years.

4. Why do businesses fail? • Dunn and Bradstreet has been keeping tabs on business failures since 1920. • They list “insufficient profits” as the single largest cause of business failures. • The companies who fail had more bills left at the end of the month than they had money.

5. What does this mean to business owners? • Lack of understanding and properly applying overhead and profit to the selling price • Lack of projections for cash flow needs and long-term funding • Lack of “profitable” sales

6. How can you have profitable sales? • Calculate your job costs • Know your overhead costs • Understand your markup • Bid accordingly

7. Definitions • Job Costs: All costs directly related to a job/project • Overhead: All operational costs and all indirect job related expenses • Profit: What is left over after all of the bills have been paid

8. Job Costs

9. Job Costs • Definition: All costs directly related to a job • Any bill you would NOT have to pay if you were not working a specific job • Sometimes referred to in accounting as direct costs

10. What is included in Job Costs? • Materials • Sales Tax • Freight and Delivery • Labor • Labor Burden • Subcontracts • Equipment Rental • Warranty Charges • Dump/Disposal Fees

11. What is Labor Burden? Labor Burden is an amount that must be added to your hourly wage rate in order to cover the actual cost of labor. It includes: • FICA • Social Security • Medicare • Unemployment Tax • Federal • State • Insurance • Worker’s Comp • General Liability • Fringe Benefits • Health Insurance • Pension

12. Sample Labor BurdenBased on $18.00/hr wage rate

13. Summary of Sample Labor Burden

14. Actual Labor Cost Including Labor Burden per hour

15. Overhead Expenses

16. Overhead Expenses • Definition: A combination of ongoing operational costs and all indirect job related expenses • Any bill you would have to pay even if you were not working a specific job • Also, any job related or field expenses that are too involved to divide among specific jobs

17. What is included in Overhead Expenses? • Fixed Office Expenses • Indirect Job Expenses • General Expenses

18. What are Fixed Office Expenses? • Salaries • Payroll Taxes • Fringes • Rent • Utilities • Phone • Office Supplies & Postage • Computers – Hardware & Software

19. What are Indirect Job Expenses? • Vehicles including maintenance • Gas & Oil • Small Tools and Supplies • Unapplied Labor • Leaks • Call Backs • Meetings

20. What are other General Expenses? • Insurance • Auto, Gen Liability, etc. • Accounting Fees • Legal Fees • Interest on Loans • Depreciation of Vehicles & Equipment • Bad Debts • Licenses and Fees • Association Memberships • Education & Training • Advertising • Donations & Contributions

21. What are the most commonly missed expenses? • Labor Burden (Actual Total Cost) • Unapplied Labor (Call Backs, Meetings) • Depreciation • Small Tools & Supplies • Maintenance & Service for Vehicles/Equip. • Cost of Retainage • Interest on Loans • Bad Debts

22. What are the affects of missed expenses? • Missing these costs means you may not be able to cover all your bills. • These missed costs come directly out of your profits. • They lead to your business becoming part of the statistics.

23. Profits

24. Profits • Definition: The money left over after all of the bills have been paid • There are two profit references: • Gross Profit: The money left over when you have paid your direct costs (job costs) • Net Profit: The money left over when you have paid ALL your costs including overhead and indirect costs

25. Comparing Markupsto Margins

26. Comparing Markups and Margins • Definitions • Markups: a percentage of your direct costs added to those costs for your final bid amount • Margins: a percentage of your total selling price that represents what is left over when you have covered your costs

27. What are common misconceptions about Markups and Margins ? • Some contractors need to raise their markups in order to actually get the margins they think they are getting. • Mainly, they believe that if the project costs are marked up 40%, then the result is a 40% gross profit margin. • Actually, a 40% markup produces a 28.5% gross profit margin.

28. What is the selling price using a 40% Markup? Job Cost Total $10,000 Markup at 40% ($10,000 X 40%) + $4,000 Selling Price $14,000

29. How can you calculate the Gross Profit Margin? Selling Price $14,000 Less Costs - $10,000 Gross Profit $4,000 Gross Profit Margin % = Gross Profit/Selling Price * 100 $4,000/$14,000 * 100 = 28.5%

30. Markup vs Margin Chart • 15% Markup = 13.0% Gross Profit • 20% Markup = 16.7% Gross Profit • 25% Markup = 20.0% Gross Profit • 33.3% Markup = 25.0% Gross Profit • 50% Markup = 33.0% Gross Profit • 100% Markup = 50.0% Gross Profit

31. How can you calculate the Net Profit Margins? • Net Profit Margins are calculated in the same manor as Gross Profit Margins, but they factor in overhead and indirect costs. Selling Price – Direct Costs – Indirect Cost – Overhead Costs – General Expenses Net Profit Net Profit Margin % = Net Profit/Selling Price * 100 • Net Profit Margins are usually calculated in relation to a period of time rather than for a single job.

32. Bidding with Proper Markups

33. Bidding with Proper Markups • You must run your business as a business. • Your main reason for being in business isn’t to provide jobs for other people or to rack up impressive sales numbers • You’re in business to provide a service for your customers and to make a profit doing it!

34. NOT ALL BUSINESS IS GOOD FOR YOUR BUSINESS!

35. Summary of 2006 NRCA Management Performance and Financial Summary (207 Respondents)

36. What does the NRCA survey mean? The percentages in the chart are compared to sales, making the overhead (37%) and profit (5%) combine to be a 42% MARGIN. Please note that this will take a 72.41% MARKUP to achieve these profits.

37. Real World Example Case study: A company has determined that they can sell $1,500,000 in one year. They have examined their historical overhead and found it is $25,000/month or $300,000 per year. Their 2010 goal is to achieve a 7% net profit margin or $105,000. What should they use at their markup to achieve this margin?

38. What Markup should the company use? Start with projected Sales $1,500,000 Minus Projected Overhead - $300,000 $1,200,000 Minus Desired Net Profit ($1,500,000 X 7%) - $105,000 Job Costs $1,095,000 Find the Markup ($1,500,000/$1,095,000) = 1.3699

39. What does the Markup mean? • In order to achieve their goal using the numbers in the case study, the company should multiply the job costs by 1.3699. • Using these overhead numbers: • a 36.99% markup achieves • a 27% gross margin and • a 7% profit margin.

40. How can you increase Net Profit Margins? There are only two ways to increase your profit margin percentages. • Decrease Costs • Operate more productively/ efficiently • Lower Overhead Expenses • Increase Selling Prices • A marginal increase in selling price has a large effect on net profit margins.

41. What happens when you increase your selling price? Start with the same Job Costs $1,095,000 Increase Your Markup from 36.99% to 38.99% ($1,095,000 X 0.3899) + $426,941 New Total Sales for the Year $1,521,941 Calculate the New Net Profit Use the new Sales for the Year $1,521,941 Minus Job Costs - $1,095,000 Minus the same Projected Overhead - $300,000 New Net Profit for the Year $126,941

42. How does increasing your price change the bottom line? • Your net profit has increased from $105,000 to $126,941. • A 2% increase in your markup yields a 21% increase in net profit.

43. Acknowledgements: The following publications were used in the preparation of this presentation: • “Markup & Profit – A Contractor’s Guide” By Michael C. Stone • “2006 NRCA Management Performance and Financial Survey” NRCA Publication • Various series of short articles By Mr. Monroe Porter