I have heard this saying several times throughout the years: “It
takes a lot longer to starve to death than it does to choke to
death.” It is very simply stated but quite profound in its meaning.
We could probably keep the doors of our businesses open
longer from a lack of work than we could if we had a lot of work
in progress that was secured at a low margin.
You might have the idea that all estimates should have the same
markup. Well, I’m here to tell you that it just isn’t so.
Even though the same personnel might perform the tasks for
the large and small projects alike, there is an actual cost difference. For the sake of this illustration, I will use an actual case study that came out of a meeting with a large subcontracting
company. One of the primary goals of this meeting was to determine
why the company wasn’t profitable. They had plenty of
volume, but the bottom line for the year was way below their
expectations.
The company had thought they might need to reduce their
overhead by eliminating some estimating and management
positions. Maybe having everyone take a reduction in salary
would be the answer, at least for the interim. I would have
agreed with some of these cost-cutting measures, however, the
volume of work they completed for the year was impressive,
and from this volume of work they should have realized a nice
profit.
After reviewing the cost accounting records, I could see that the
actual (labor and material) costs for the projects was very close
to the budgets, so that told me the deficiency was probably in
the markup they were applying to the estimates. I asked what
percentage markup they were using for the overhead and profit
on their estimates. The response from the chief estimator was
that they applied a combined 16 percent gross markup for their
overhead and profit to each estimate. That markup percentage
would be marginal for even the large projects, I thought. I then
asked if they were also applying this 16 percent markup to their
estimates under $20,000. The chief estimator confirmed that
the markup was 16 percent straight across the board.
I asked how many projects they performed in a year that were
under $20,000. Their answer astounded me! The number of
projects below $20,000 for the previous year was in the neighborhood
of 300. Those combined figures represented almost
half of their total dollar volume for the year. With that information,
I asked them how many steps were involved in a small
project from beginning to end. They identified these steps, and
we applied a cost to each step. Keep in mind that the cost for
each step is an educated guess, but probably not far off the
mark. This, of course, depends on where you do business and
where the project is located in proximity to your office.
Even if you are tracking job cost on each small job, you will
probably not realize the cost and impact associated with the
(direct) overhead for each job. The overhead is applied to your
financial statement as an operating expense and is deducted
from your total gross profits.
This subject will be continued in next month Estimator’s
Edge.
Comments? Send your e-mails to [email protected], or fax
to (703) 534-8307.
