The Generation Gap

Jan. 25, 2019

Using burdened labor costs to make a profit

About the author:

Michael Thompson is president of Applied Management Group. Thompson can be reached at [email protected].

Everything you do in business either generates or eliminates revenue. 

Let me say that again: Everything you do in business either generates or eliminates revenue. When you sign the checks on the front versus the back, it has a huge impact on your life.  

In a service-oriented business, if you are not charging enough for your services, you are eliminating revenue. Just because you are receiving payments from your customers, that does not mean you are making a profit; it just means you are receiving payments.

Let me share a story. We hired a tree trimming company to trim some of our trees. We were quoted $125 for the job. They did an exceptional job and received payment in full for their services, but they eliminated revenue in completing the job. How? They did not know their labor costs and quoted the job incorrectly. 

We see it all the time both in businesses we use and businesses we mentor. You cannot charge less than $300 for three men, five pieces of equipment and three hours of time. That business owner is buying himself a job. No matter how many jobs he completes in a day, week or year, he will never generate enough revenue. He will continuously be eliminating revenue until he has to close his doors and go to work for someone else. 

Know Your Costs

This happens when businesses do not know their costs—not just labor costs or general overhead costs, but all their costs. Whether it is setting labor rates or calculating job costs, knowing your true fully burdened labor costs is essential. In a service-oriented business, your costs are your lifeline. They are your link to generating revenue. If you know your costs, you have control over generating revenue and your level of profitability.  

If you do not know your costs it all is a guessing game. Did I make enough on that job? Can I make payroll this week? Can I pay rent this month? Can I pay myself this month? Have you had to ask yourself any of these questions? Do you currently ask yourself any of these questions?

The costs I am talking about that can resolve such an impactful aspect to your business are burdened labor costs. Burdened labor costs are the sum of your direct labor, vehicle costs and adjusted percentage of your indirect labor and overhead costs associated with a specific department or individual. More simply put, they are the sum of the costs associated with an employee and their vehicle per hour.

Do you know your burdened labor costs for each of your direct labor employees? If you do not, you miss the opportunity to align productivity and profitability. Waiting until the end of the month to decide if your work has been profitable is reactive. By calculating your costs and knowing your hourly costs and profit needs, you are able to tell hour by hour and day by day if you are generating the necessary revenue. If you are not generating the profits you need, then you immediately can make changes to ensure that you are.

Cost Calculation

Over the years, we have heard of many different ways to calculate burdened labor costs. We were on a call just last week where a gentleman said that he writes it all out on a napkin for his clients. Another person said they use a spreadsheet they purchased, but they have no idea how to use the spreadsheet, so they know the numbers are wrong. But my favorite one of all is the person who has their clients just throw all of their numbers together, like a blender, and use whatever number they come up with. 

For those of you who are really good at what you do and get frustrated when you see it done incorrectly, we know how you feel.

There is a very specific formula to be used to properly calculate your burdened labor costs. It starts with proper accounting, with correct numbers. 

When working with our clients, we go back to the beginning. We start with verifying that all of the numbers within their accounting system are in the correct accounts, that direct labor is in “direct labor,” not lumped in with indirect labor. We make sure their expense accounts are used correctly, and everything is not lumped into a miscellaneous category. We need to know that the numbers we are using are correct and up to date.

We then move on to creating departments within their income statement, such as service and installation. Departments provide a way to know exactly how much each department is making—the gross profit. Is one department more profitable than another? Is one losing so much money that it needs to be eliminated? Or are they making money but just not to the expected level? For burdened labor costing, the amount of responsibility that each department will be given when calculating burdened labor costs is required. 

Focus on Labor

We then can move on to actually calculating burdened labor costs. Burdened labor costing includes overhead, hourly wage, employment taxes, benefits and more. There are some specific items that are not included in the burdened labor costing calculation, such as parts and materials. Burdened labor costing is just that—labor costing. Parts and materials are completely separate on your work orders and when calculating costs. If you try to include parts and materials it will skew your numbers and render them useless.

Too often, individuals confuse burdened labor costs with income statements. Burdened labor costing tells you how much each direct labor employee needs to make every hour of every day, or how much revenue your revenue producers have to produce. In a service-oriented business, it is one of the most critical pieces of information needed to make informed management decisions, to be profitable and generate revenue.

Move your business forward by taking your burdened labor costs to create profitable retail labor rates if you are using time and material or flat rating. If you use a flat-rate program, it is your responsibility to enter the labor rates you want to use. The program provides the parts and equipment costs along with markups, but it does not provide your labor rate. We have seen multiple cases where clients believe that because they are using a flat-rate program, their labor is profitable. You can lose just as much money in flat rate as you can with time and material if you are using the wrong labor rates. 

Learn your burdened labor costs. At Applied Management Group, we use the Apex eSuite Burdened Labor Costing SaaS to calculate our clients’ burdened labor costs. The tool eliminates the confusion of the spreadsheets while providing real, up-to-date numbers where and when they are needed. 

There is nothing simple about labor costing or figuring it out, but the effect on your business if you do not know it is simple. We see it all the time. Many businesses go out of business because of incorrect pricing. It is very frustrating for us when we see it because it does not have to happen at all. This takes us right back to the beginning—everything you do it in business either generates or eliminates revenue. It is your responsibility to create a revenue producing environment for your business and employees. Allow your revenue producers to be revenue producers. Create that level of profitability you have always wanted. Create the growth you strive for. Create the business that will provide you with your retirement. 

About the Author

Michael Thompson

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