If determining the right price for a specific job you are bidding requires that you know the direct costs and the overhead costs for that job, how do you find and figure those costs? And if those costs are too high, how easily can they be lowered?
We have already discovered, in a previous article over direct costs, that the costs you have because you get the job are fairly easy to determine. You already know the prices of the equipment, parts and materials you will use because those are published by your suppliers. You know the cost of the subcontractors you will use because they have already bid the job you are working on or have established prices for that work. You know what the charges are for permits and you have a pretty good idea what your freight costs will be. Once you gather all those direct costs together you can add them all up and determine a dollar amount for your actual direct costs for that potential job.
But, if you feel those costs are too high what can you do to lower them? In reality, not much. Sure, you can go to different suppliers and perhaps lower your equipment, parts and material costs. But how often can you do that? Certainly not on every job you bid, and changing suppliers comes with its own set of costs: familiarity with the part numbers, training on the equipment, new people and processes to figure out, new sales and technical people to work with. So eventually you choose your suppliers and stick with those suppliers because they offer the best all-around value for your company. This all leads to the fact that you have very little opportunity to change or reduce your direct costs. So, in summary, direct costs for a specific job are easy to determine and don’t change much.
Figuring your overhead costs for a specific job is a little more complicated. Overhead costs are basically all the other costs in your company that are not related to the actual jobs you get. But, you have to get jobs and the sales dollars those jobs provide in order to pay for the overhead costs (and the direct costs for that matter.) As we discussed before, in a previous article over overhead costs, it is fairly easy to determine the overhead costs for the entire company. They come from the invoices or bills you receive for such items as utilities and rents; or, they can be seen on the bills you pay for such things as taxes and governmental items.
And frankly, just like direct costs there is very little you can do as a business owner to reduce overhead costs; because, once you elect to have an overhead cost, it is difficult to reduce that cost. For example, if you decide to move out of your garage and rent a building for your company, then the new rent you are paying doesn’t go down as time goes on. In fact, it usually goes up. Or if you decide to hire a dispatcher for your company that expense doesn’t usually go down over time, it usually goes up (unless you decide to eliminate that position). Sure, you can diligently watch some expenses such as cell phones or warranty or unapplied labor and successfully manage (reduce or keep constant) those expenses, but normally overhead costs are constant and, if anything, are increasing every year.
So, as we have already stated, at the end of the year, all of your individual overhead costs are compiled into different categories and then added together to come up with a total amount of all the overhead costs. This compilation of all your overhead costs is usually shown on your financial statement as overhead costs, overhead expenses, or operating expenses. There is a specific dollar amount that is known and shown for these overhead costs. That amount is also shown as a percentage of your total yearly sales (also called revenue) for your company. For example, a company has total yearly sales of $300,000 and total yearly overhead costs of $90,000. $90,000 divided by $300,000 equals 30%. In this example, this company has overhead costs that are 30% of the total yearly sales.
It is this overhead cost percentage that will be used in the mathematical formula to determine the right price for a specific job. You use the overhead cost percentage to figure the right price because you know that the total overhead costs for your company are a percentage of the total sales. Therefore, the overhead costs for any one specific job have to be the same percentage as the overhead costs for ALL the jobs we have or will have (total yearly sales for the company.)
But, there are many companies that do not have financial statements. Therefore, those companies can’t determine the total overhead costs and the total overhead percentage they should use to figure the right price. So how is that overhead cost percentage determined? Over the years lots of data has been gathered from lots of different companies that give business owners a very good estimate of what the overhead cost percentage will be for most types of HVAC companies. The data shows that the overhead cost percentage is different for different types of activities within an HVAC company. Usually, the overhead percentage is highest for the service portion of an HVAC company, a little lower for the replacement portion, and lowest for the new construction portion. This is proven by the fact that the service portion of an HVAC business has a lot more overhead costs compared to the new construction portion: costs such as more warranty expense, more travel time, more unapplied labor, more vehicle expense.
The data also shows that these overhead cost percentages don’t change much for different companies. Therefore, based on the job you are pricing, you can use an average overhead cost percentage and be very close to accurate for your own company. Of course, it is always best to use your own overhead cost percentage when determining your right price for a specific job. Which makes it even more important for your company to have an accurate financial statement to be able to determine that overhead cost percentage. However, if that is not available for your company, then below are some average overhead cost percentages that can be used with confidence to determine your right price.
Service 40 to 45%
Replacement 28 to 35%
New Construction 22 to 28%
If you have any questions about setting the right price for your company, or determining your overhead and direct costs, let me know in the comments below, I’d be happy to try and help. You can also ask them on our Facebook page, fb.me/cfmdistributors, or tweet us @cfmdistributors. In Part 6 of this HVAC Pricing Series, I’ll start to get more into how profits contribute to finding the right price for your business.
Latest posts by Cal Berry (see all)
- Include Profit, You’re Worth It! | HVAC Pricing Series Part 6 – July 21, 2016
- Can You Change Your Costs | HVAC Pricing Series Part 5 – July 14, 2016
- Overhead Costs | HVAC Pricing Series Part 4 – June 9, 2016