Earlier in this series, we reviewed costs that are used to determine true estimating numbers. We will now look at the biggest part of the guessing game—overhead and profit! Don’t forget to take some time after you’ve read all three parts of this series to review the questions and issues discussed here. We recommend spending a few minutes with your boss and the accounting department to get the most value out of this series.
Did you miss part one or two? You can find the first two part articles here: Part One and Part Two. We hope this series has provided a few insights and ideas that you can take and use in your business.
What Makes Up Overhead Cost?
Let’s take a look at your overhead cost. Do you really know what this includes? When was the last time the accounting department confirmed, or has this discussion with your boss, the owner or the accounting department ever taken place? While the estimating department is not normally responsible for the balance of this section, we do recommend that you at least spend a few minutes considering these things and having that conversation with whomever is the best person to ask. No doubt, if you keep doing things the same way and expect different results—well, you already know how this story ends.
Indirect Fixed Expenses
Now, let’s talk about the term: indirect fixed expenses. You can think of this line item as the cost of doing business—even if you have no active projects. For example, how does your firm deal with association dues, personal development and training? Does this come out of your profits? Maybe there should be a line item on the budget and be calculated into the overhead line item on the bid.
How do you budget those vehicles that are non-job charged? It is also important to review whether you are allocating correctly between field and office for things, such as computers, phones and copiers used in the field.
Another big item is insurance, which frequently seems to be missed. Clearly, there are many insurance categories to consider. For example, the general liability policy is not normally charged as a direct job expense at bid time, but the project seems to always get whacked by accounting. How do you deal with the premium adjustments that occur at renewal time? Did you underestimate the volume and then owe a ton of money at premium renewal time? You should look at whether this should be dealt with as a separate line item on the bid specifically. Think about if it is a percentage, or cost, or cost plus profits. It might be a good idea to confer with accounting to see just how these premiums are paid.
You should also look at professional fees, attorney and legal costs, which are items not normally charged directly to the project. Are they effectively calculated in the overhead? What about those other “normally not used” categories, such as charities and contributions, executive coaching and business coaching? As the estimator, you’ll want a solid understanding of how your organization classifies these costs and their impact to your estimates.
What Makes Up Profit?
Profit is where the rubber hits the road. What is the true profit calculation on the project at bid time? For some, it may be 8 percent on top of all hard, direct, and indirect costs. Is the bond included before profit or after? Do you know what your markup is versus the gross profit margin?
We’ve discussed all the true costs of a project, or at least what data you can pull from as you prepare this estimate, so the last thing should be the profit. Well, maybe the time duration or sequencing durations you will quote for this project but let’s say it is now down to profit. What is profit? The textbook definition says it is the “the monetary surplus left to a producer or employer after deducting wages, rent, cost of raw materials, etc.” Similar to indirect cost, the definition of profit is different for everyone but should it be?
Define the Profit Formula
Simply put, profit is the cash you end up with at the end of the project. This is after all bills are paid, including rent. These are the funds you can use for other purposes to grow the company. Profit is not the excess cash you will need for cash flow to get you through your next wave of projects. It could be a part of the cash you collect and assign to cash flow, but not all of it. (Cash flow is another great subject we really should talk about, but we will let that go for another time.) To use an old saying, this is the cash that you take home to mama. It is not the cash you use to pay down your credit lines or pay off the trucks. You get the idea.
As mentioned in part one, how many times did you just input the $85, the X percent, and wonder why the boss kept cutting your bid 15 minutes before bid time? Maybe a lot of times. The reason is that your boss has lost track of these essential little nagging details and they know that the estimate has “built-in” fluff. Or they believe “we always work faster than the estimate.”
Questions to Ask
To recap our three-part series, we leave you with these final questions. What systems do you have to track all of these things effectively? What systems do you need to create to help with the tracking of any or all of these things we have discussed? (Systems will be discussed more in detail in a future article, keep an eye out.)
If you stumbled across an issue with the example of the truck delivery driver, maybe you need to evolve the process for tracking your driver. Your system might not be broken entirely, but maybe it needs a bit of review. How about a quick review of the paperwork you use to put your driver into action?
Improve Profitability with Better Bids
Imagine if your company spent six months methodically developing and documenting the true meaning and costs of these numbers. The result would be better estimates of your true costs with real, built-in productivity rates.
More importantly, these efforts would give your firm the confidence of accurate numbers—allowing you the power to affix a true markup or profit on top of your real costs. Think about what kind of results you would see and how this would improve your bid/hit ratio. Even better—how would this impact your bids at bid time and profitability?