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Are you pricing your jobs correctly? If you don’t have a good understanding of your job costs and overhead percentage, the answer is probably no. This week on the podcast, we’re discussing how to get a handle on these numbers and make better financial decisions for your construction company,
Topics we cover in this episode include:
- What you should and shouldn’t post as overhead
- Ideas for contractors trying to wrap their head around their numbers
- Carving out Materials & Subs
- Overhead grows when you top line grows
LINKS
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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com
TRANSCRIPT
[00:00:00] Wade Carpenter: Welcome to the Contractor Success Forum. In this episode, we are talking about pricing your jobs and the relationship between overhead and your job costing. How do we know we’re pricing correctly?
What is your true overhead and how can we figure that out? We’ll kick that around and more today. So if that’s of interest, stick around and let’s get into it.
If you’re new here, I’m Wade Carpenter with Carpenter Company CPAs. Here with me is my co-host Stephen Brown with McDaniel Whitley Bonding and Insurance. Stephen. What are we talking about today?
[00:00:34] Stephen Brown: Well, it’s huge. I can tell you that if you think you know everything about pricing a job correctly and applying the overhead correctly and tracking job costs, you can always learn something new at the Contractor Success Forum.
And so I think it’s a great topic, Wade. Let’s talk about it a little bit.
[00:00:53] Wade Carpenter: Why this is on my brain right now. I’ve taken on three in the last few months that had questionable numbers for their job costing. Some of them had no job costing. Some of them had zero idea of where their overhead was.
Some of them had rules of thumb on their pricing, and they’ve been losing money and they’re looking to get out of that. And they’re otherwise great contractors. They’ve got great reputations, but they’ve been losing money.
The importance of understanding your overhead
[00:01:23] Wade Carpenter: And so what I’m gonna get into today is number one, yes, we’re gonna preach about the job costing, we’re gonna preach about the overhead, but that’s one of the common things that people ask me. How much is my overhead and how do I really get job cost records?
In working with these guys, I thought about it a little differently from a cash flow standpoint. I know I talk about probably too much the Profit First system, but what is really unique about that for contractors is if you carve it out in the buckets properly, you can see pretty easily that if you got an X percent for job costing and X percent for overhead, and you’re trying to have X percent for profit, and you’re not marking it up that much, then you’re never gonna get there and it becomes pretty evident pretty quick.
[00:02:13] Stephen Brown: Yeah. I was just impressed by your contractors that asked you how much their overhead were. Be cause believe me, a lot of contractors, they don’t like to recognize overhead at all. It, it doesn’t exist. But i t does exist and it eeks into your profit. Even replacing worn out equipment that eeks into your profit, what are all the things that eek into your, your profit?
I had once a a large contractor of mine that was, had literally sold the business and they were going out of business and I asked them if they would have lunch with me and a smaller general contractor that I was trying to help out. And the, the one thing that he said was, you gotta be so good at job costing that if you have a shovel, you build in the price of the use of that shovel on that job.
And that really hit home with my customer. To this day, he’s obsessive about it and he makes more profit. It’s all a part of paying attention to what your costs are, right?
[00:03:10] Wade Carpenter: Absolutely. And you know, what you said is absolutely true that some of the most profitable contractors I have, they try to look at everything as a job cost, even when it really shouldn’t be a job cost from a Generally Accepted Accounting Principle standpoint. But trying to cover the owner’s salary and trying to cover some overhead in that number. And the project managers hate it because it’s like, hey, that’s not really my cost. But you gotta cover it. So that’s one good lesson that I really wasn’t going into today, but I think that’s a great point.
[00:03:44] Stephen Brown: Sure. And also I might add that the bonding companies love it when the owners make distributions, large distributions. They like their clients to make money, but only at the point that it’s not sacrificing the bonds that they’re need, the bond credit they’re gonna need.
So all of this ties in together in what you take home at the end of the day. You talk about pricing, you look at specifications and you see a certain job that has a lot of moving parts to it. You see a unit cost projects bid that seem a little bit maybe more simpler if you have your unit cost, right? You go to the bid opening, you see where your competitors are, way off on your unit cost, and you wanna know why.
These are all good questions to ask when pricing your job, but if you’re not pricing in your profit in your overhead properly, and you don’t understand what your overhead is, how can you ever make money on a job?
You need to use the right factor to estimate your overhead
[00:04:38] Wade Carpenter: Well, you can’t if you’re using the wrong factor. And I say it all the time. I see people use an industry standard factor or a factor that they used at the big company where they learned to do construction and they took it out, same factor where they spun off their own company and no two companies have the same overhead rate.
You can say it’s industry standard, but if it’s costing you 15% for overhead and you’re bidding it at 10 or 12, then that’s not enough.
So, I just kinda wanted to relate a couple of stories.
So I had this contractor that recently came to me, and this company is actually 70 years old. They go back to the fifties and the grandfather started it. The father’s still in it, and the son is now trying to work in it. And over the last few years they have just been losing money left and right, and they can’t understand it.
And they came to me. They have really poor books. Which I see it all the time. If you’ve got QuickBooks and can do all the bank feeds and the banks are never reconciled– there is a process to look and see if there’s reconciling, and that’s one of the first things I look at, but never been reconciled, their balance sheet is a complete wreck and they have zero job costing.
So he’s like, help me save this company. I don’t wanna, we’ve got a great reputation and it’s been in the family and we don’t want this to go away. So we’ve gone in there and we caught up like the last six months or so of doing the books and got them some, at least, from the top level, this is what you’ve been doing in materials, labor, and had them classified properly. We don’t have them split out by the jobs, and that’s the next step.
But they had all this overhead as well, and they had several people working in office and they simply could not afford it. And they kept cutting costs. And they were still not getting back to profitability.
And so I dove in with the father and a estimator slash salesperson that they had and started asking them questions. Well, how do you bid this? Well, it’s by a certain unit of measure. Linear feed or, square yards or whatever. I started asking about well, the prices of the materials had gone way up and they were proud of themselves and they said, well, we did price out the material separately. And we’ve tried to bump those up for what they’re doing, but we’re still losing money.
And I started asking, well, do you win every job? Well, no, but we win most of them. And then I started diving in a little further and I said, well, it sounds like to me maybe you’re winning most of them based on the fact that you’re the lowest price in town, maybe. That’s the classic example, but they said no. A lot of times we’ll give them the price for doing the work and it’s competitive, but then we do a turnkey kind of thing. So we add on all these subcontractors to it and make sure that the job is done. And overall it’s usually cheaper for the customer to let us do it.
Well, they were not bidding the subcontractors properly. They hadn’t changed these linear fe equations in many years and they’ve continued to run into cash flow problems. They’re continually sinking. And the salesperson was also incentivized to bring in more cash for cash flow purposes.
And so if he brought in X amount of money in a single month, his percentage of commission went up. And of course he started bidding lower to get these bigger jobs, which were the ones that they were losing money on the worst.
And we still don’t have a full picture of it, but, we’ve made some changes. We’re implementing Profit First, and I’ll go into that part in a little bit. But, they’re slowly turning it around. But it’s sad to see that, we all think we’re doing the right thing where we’ve made changes for prices, but they still were losing the game and they couldn’t figure out why.
[00:08:40] Stephen Brown: Yeah, it makes sense. And as you delve in and they were just repeating the same egregious, horrible mistake over and over again. Paying any commission salesperson on volume instead of profit is scary enough right there. And I certainly don’t blame the salesperson. They told them this is the rules. Okay. Got it. Got it.
But anyway, it’s interesting. You had to go in there and you had to put together an accurate statement, which was hard enough. Then you had to go in and explain what the statement was telling you. And then you had to dig deep into finding out why they were losing money. And it’s all about everything we’re talking about today.
Pricing, overhead, tracking job cost, your profitability. Wade, do you think we talk enough about job costing and profit in our podcast? Because maybe we need to ramp that up a little bit, huh?
[00:09:38] Wade Carpenter: Well, I know we’ve done a lot of shows on that over the years and we preach it. And in that particular case, unfortunately we got some measures of the job cost, but they’re still having to improve on that and it’s taking some time, but they’re slowly getting it.
What you should and shouldn’t post as overhead
[00:09:54] Stephen Brown: Okay, well, can I ask you a couple of questions about what you should post overhead and not. For example, sometimes I’ll see a financial statement where insurance costs are totally posted as overhead. But I always say your workers’ comp and your general liability insurance are based on payroll, so that’s real easy to post insurance to job cost.
You can also take what do you do with vehicles, equipment, and other overhead expenses, and then your office administration overhead. Would you tell us what generally you should put into jobs and not put into overhead?
[00:10:29] Wade Carpenter: I absolutely agree with you. Things like workers’ comp, general liability definitely should be job costed. And unfortunately, the programs today, the QuickBooks online does not do the job costing, like the old QuickBooks Desktop payroll would. If you set it up properly, you can get that done. Otherwise, it’s a very manual process.
Ideas for contractors trying to wrap their head around their numbers
[00:10:49] Wade Carpenter: I want to get to some ideas for contractors if they’re trying to wrap their head around what their numbers are and they’re trying to get out of a loss situation.
Let me tell one more story and that kind of leads into trying to get some kind of working number to base your pricing off of.
So I had another contractor that recently came to me. He’s been around five, six years. He does four to $5 million a year. And he was losing money for five years straight. He’s still relatively new to me and I don’t know his personal situation, but he’d been borrowing money from family. He’s also loaned the company $200,000. And he had decent books, no job costing records, but he had no idea what overhead should be.
So he was throwing in a flat percentage for overhead. He was throwing in whatever he felt like he could get as a profit figure. And I started asking him like, what is your job cost? And we started diving into this and we went down the road of the Profit First.
I’ve had several of these where we’re using this as a surrogate measure of how to price your jobs. So in this case we’re trying to implement Profit First, and he had decent, classified books over the last five years, but nothing was job costed.
Carving out Materials & Subs
[00:12:10] Wade Carpenter: So in Profit First I always advocate carving out a separate materials and subs account. That’s money that’s for somebody else. And we can talk about what else goes into job cost, whatever goes into overhead. But materials and subs are other people’s money. So if we carved that number out and we put that in a bucket, and we are going to put that in a bank account as a percent, and then for oversimplification, we have this operating expense bank account.
Now, a lot of times if a contractor is self-performing their own labor, I will have them always carve out a separate payroll account and put a separate number aside for that. And then we have the operating expense account. And that is supposed to cover everything else to cover the overhead and paying things like debt payments.
It’s not supposed to cover profit, it’s not supposed to cover taxes, it’s not supposed to cover the owner’s compensation. We have separate accounts for that. So my surrogate measures of this, that’s where we’re using these factors to say, what’s a reasonable number for estimating?
Because in a couple of these cases, we just, we don’t have the records and like we’re trying to make a turnaround. Right?
[00:13:24] Stephen Brown: Makes perfect sense. Yes.
[00:13:26] Wade Carpenter: Okay. So I start off with talking about the materials and subs. And I asked the guy, well, what should the materials and subs be? 70%. Okay, I have five years of records.
And you start looking back at what the five years of materials and subs really was 90% or more every year. And you can, especially if you look at it on a short term period, that can fluctuate. If you look at it one year over another and you’re trying to cover your taxes and trying to knock down your taxes, maybe those can be manipulated.
But over a five year period of time, you’re not fooling anybody. You are not doing 70% materials and subs.
[00:14:05] Stephen Brown: Is that when you slam your fist down on the table and go, wrong! It’s 90, not 70. No, I know you handle it more diplomatically than that, but go ahead.
[00:14:14] Wade Carpenter: Well, I mean, that was a huge eyeopener for this guy.
[00:14:18] Stephen Brown: Yeah.
[00:14:18] Wade Carpenter: Most years it was actually more than 90%. So that was the huge epiphany for this guy. And at the time he was doing a little bit of labor. He’s not one that self performs like in the previous example, that trade, they self-perform most of the labor.
So, if that’s the case, we would carve out the payroll number and put that in there. And we’ve gotta cover that in our bids for the job cost.
So the next piece of this is the overhead part, where number one, we’re like, what do we have to cover for overhead? I’ve just been using a flat 10%. Well, when we start looking at. His debt payments and what he had to cover– and this guy actually works out of his house. And he was wanting to get a building and start adding people, but his overhead already was more than the factor he was putting on.
But we could see that by seeing hey, we’ve only got X amount left to put into this cash account to cover our debt payments, our office supplies, and all the other overhead that goes into that factor. So again this kind of eliminates like, if you put this in this particular bucket for job costing versus what goes in bucket for overhead, well what do we pay out of each? And that for a lot of people, that is a much clearer definition of, this is what I gotta–
[00:15:39] Stephen Brown: This is what I gotta price it. Yeah.
[00:15:42] Wade Carpenter: Well, so the monthly nut is the, the term that a lot of times we use in Profit First. That’s the monthly nut you gotta cover. So, huge eye-opener for this guy. I was like, well, you’re never gonna get yourself out of debt if you don’t have some profit.
So that’s where the last three factors I was talking about, covering owner’s comp, covering the taxes, and covering the profit. I think it added up to 12%. Well, it’s like there’s no way he could get to 12% with the factors he had left over. So, sometimes just the point of this, number one, is coming to that revelation that, hey, I gotta do something different.
But it was a surrogate measure of if we don’t have good job cost records, if we don’t have a good handle on our overhead, it’s some kind of figure to say, hey, we’re gonna lose the game if we don’t price it this way.
[00:16:35] Stephen Brown: Well that makes perfect sense. And then you say to yourself, okay, now I’ve learned my true cost and price that I need to bid my work, but I can’t get that in my marketplace. That’s too high. So at that point you’re saying, what can I do for you better Mr. Customer? Whether it be a general contractor, what can I do faster and better for you to earn, to earn my profit?
What makes me different? What makes me better? And then also a longer range plan to working out with your accountant how you’re gonna deal with these losses that have occurred and keep things moving forward. It’s all about planning, and there’s always something you can do, but putting your head in the sand and pretending like it’s not happening is just not the answer.
[00:17:21] Wade Carpenter: Right. Well, again I think a lot of these guys don’t know how to measure the overhead and, that’s not the point of today.
Overhead grows when you top line grows
[00:17:27] Wade Carpenter: But one of the other things, we actually put Profit First in a Contractor about two and a half years ago. And I think you probably see it as well. We have contractors that grow their top line revenue. This one I’m thinking about went from like 2 million to about 7 million over the last two or three years. You could see overhead, I see it all the time, and you probably do too, that as the top line grows, the overhead grows at a higher rate, so your overhead gets higher.
So if it was 20%, it goes to 23% or something, whatever the number is.
[00:18:00] Stephen Brown: Yeah, and then you justify it because your sales are higher. But a percent of higher revenues means the same overhead number. I guess you’re thinking that because the jobs are bigger, there’s more overhead costs.
[00:18:13] Wade Carpenter: Well, you think there’s more profit to cover that, so–
[00:18:17] Stephen Brown: Oh, okay.
[00:18:18] Wade Carpenter: You don’t realize that, hey, can I really afford to hire this person? Can I really afford to go get in this new office that’s gonna cost me more money? Can I expand my overhead? So this is one of the other benefits I’ve seen of doing this basically on a cashflow basis.
And this is absolutely, I am not preaching that you should not be going out there and figuring out what these job costs are in overhead. But you know, one of the other major benefits for this guy that I was telling you about, by having the cash constraint with the overhead percentage.
As the top line grew, the percentage in the bank account allocated to that stayed the same. So overhead would go up, but there was a constraint on being able to spend more than what’s in that bank account. So if you start doing that, it becomes pretty evident that, hey we’re doing something wrong.
[00:19:15] Stephen Brown: Yeah. I love that about Profit first too, Wade. It helps you think so clearly and understand all the elements that affect your income. We had these certain contractors, and it was like, well, people always told me that every personal cost you have that you can run through the company is tax free.
But I would counter that by saying I know a lot of contractors that have gone bankrupt playing that game. And it happens. But with Profit First, at least you say, okay, well, this is my money. This is how I plan to do it. And with a good construction CPA such as yourself, Wade, they’re gonna help you maximize your tax deductions legally.
And it’s all a part of a mindset, isn’t it?
[00:19:57] Wade Carpenter: Well, it is, and I guess it’s a topic for another day, but I never met a contractor that liked paying taxes, but if you continually pay the deferral game and you never have any Profit, and then you’re–
[00:20:09] Stephen Brown: How are you ever gonna know if your numbers are legitimate? How are you ever gonna know if you’re playing that game? You can’t. You can’t be that smart that you’re tracking all of that and its effect on your performance. And then what shows up on paper, the financial statement that you’re showing, the bonding company that, that becomes very apparent, and they’re not gonna wanna bond an underperforming contractor. No, no, no. I perform great. Just look at my lake house, I perform great, so anyway, these are some great points, Wade. I really appreciate it.
[00:20:42] Wade Carpenter: Okay.
[00:20:43] Stephen Brown: How would you summarize what you wanted people to know from the podcast?
[00:20:46] Wade Carpenter: I know we didn’t dive too deep in the weeds of what goes into each, but I was trying to give our listeners some kind of thought about, are you really pricing correctly and maybe a simpler way to at least do a gut check on, are you pricing properly?
[00:21:04] Stephen Brown: Okay.
[00:21:04] Wade Carpenter: And I really haven’t talked about it here, but next month I’m actually launching a course on Profit First, more or less do it yourself.
And I started writing these case studies and it’s really is amazing to me that there, there’s a lot more power to, I say Profit First, but controlling your cash in construction because, I used to always say that contractors should never look at what’s in their bank account because you’ve got one bank account and when it’s fat, you feel like you can go spend everything and–
[00:21:36] Stephen Brown: That’s a fact.
[00:21:37] Wade Carpenter: If you do it with Profit First and you carve it into these buckets properly, it can go a long way to actually giving you some kind of surrogate measure, even if you have poor books. I always preach the great books.
[00:21:52] Stephen Brown: Sure. Well, how can our listeners find out more about that when you do launch that?
[00:21:57] Wade Carpenter: We’ll put it in the show notes or contact information if you’re interested in some of those things, but, what I would say is that, if things are not working out for you, maybe it is your pricing. Maybe you’re bidding the wrong types of jobs. I know you say you possibly can’t get that particular margin where you are, well, maybe you need to be looking at doing different types of work or specialized work.
[00:22:20] Stephen Brown: And I might also add the more moving parts to a job that you’re doing, the more potential risk. You have to look at each element when you break the job down of the potential risk. And of course you do that anyway. But what if that risk is new to you and you don’t know how to allocate the risk to it?
That could be a chunk of the job that could take all your profits away. So have to really think long and hard about it. And then all the historical data that you’ve used on past bids is huge to go back and to put your finger right on it and screw that down before you bid the job.
[00:22:53] Wade Carpenter: But the problem there is if you bid it a certain way, but you don’t look at how it actually came out from the job cost standpoint.
[00:23:00] Stephen Brown: Oh, sure. I was just talking about all the elements. One small element of measuring risk, so you’re exactly right.
[00:23:07] Wade Carpenter: All right. Well, thank you all for listening to the Contractor Success Forum. If you’re listening on a podcast somewhere, check out the show notes at Contractor Success Forum dot com or the Carpenter CPAs YouTube channel for more information.
Consider subscribing to this channel. We posted each post a new episode every week, and we will look forward to seeing you on the next show. Thanks.
