Top Reasons For Knowing Your Break-Even Cost
What is a break-even cost?
A break-even cost is the accumulation of all of your job costs. A break-even cost includes:
Labor Cost
Material Cost
Direct Cost
Prime Cost
Overhead Cost
If you can accurately capture these costs in the bid, then every dollar bid above this amount is a dollar of profit. However, every dollar below the break-even point is a dollar of loss. We will discuss the importance of this below.
It is essential to adjust the break-even cost depending on the job conditions. For example, your materials and tools are at risk of being stolen
when working in less desirable areas. You will have to increase the cost of storage and security to represent job conditions.
Determining the break-even cost is as much of a science as it is an art. It is essential to utilize your experience and knowledge of estimating to produce an accurate break-even cost.
Why is knowing your break-even cost important?
The ability to accurately predict your break-even cost is vital to your company's success. Accurate bids lead to profitable jobs. Knowing your break-even cost allows you to predict how much money you would like to make in profit. Each dollar you earn above a break-even cost will be profit, and each dollar you spend above a break-even cost is a dollar of loss.
Also, knowing your break-even cost can help steer you away from bidding on jobs with a low profit or possible loss. As a business, you want to focus on the jobs that provide you with the highest level of certainty for profit. Even though you might feel like you are limiting the number of jobs you are bidding on, this will save you from bidding on a job that will eventually lose your company money. You don't want to win every job; you want to win profit-producing jobs. The only way to know if a job will be profit-producing is to calculate the break-even cost accurately.
The more accurate your prediction for the break-even cost, the more it will help project management during each construction phase. If you can accurately predict a list of materials and the number of hours needed to complete a job, the more prepared your project managers are for material orders and labor requirements.
Knowing your break-even cost is essential to understand during the estimating phase of construction. It can be very harmful to a business if the estimators are unaware of the break-even cost, causing them to bid too low on a job and lose money.
How do you calculate your break-even cost?
Calculating your break-even cost is broken down into five steps:
1. Determine your Labor Cost
The first thing you need to do when calculating the break-even cost is to have a good idea of what your labor cost is going to be. Within your labor cost, you need to total up the labor hours from your estimate and then multiply the total labor hours by the average cost of your crew per hour.
For example, let's assume you estimate it will take 100 hours to complete a job, and you have a crew of four guys. The crew comprises the members working at the following rates: $20/hour, $24/hour, $18/hour, and $30/hour. To calculate the crew's average cost per hour, you first need to find their cumulative rate per hour, which is $92/hour ($20+$24+$18+$30). To get the average, you divide the cumulative rate per hour by the number of people on the crew, which is $23/hour ($92/4 crew members). Now that we have the average cost of your crew per hour, we can multiply that cost by the total number of hours to get a total labor cost of $2,300.
Crew Average Rate = Sum of Crew Hourly Cost / Number of Crew Members
Total Labor Cost = Crew Average Rate x Total Labor Hours
While estimating the total labor hours in a job, a quick reminder is to account for job location and conditions. These factors can severely impact the total labor hours needed to complete a job. If you underestimate the total labor hours, it will significantly reduce profits and can even lead to a loss on a job.
2. Calculate the Material Cost
You should have a material list since you have already completed a material take-off while reviewing the blueprints. You can send the material list directly to your vendors to receive current material pricing. After your vendor gives you quotes for material, you can determine the total material cost. You want to add up the total price for the quantity of material you sent out for quotes. Some vendors might send you a quote per quantity of 100, while the job needs a quantity of 50.
It is nearly impossible to account for every material item required for a job. It is possible (and very likely) that you might forget to add the cost of mounting hardware, tape, connectors, and other small items. Even though these costs may seem significant, they might have a noticeable impact on your profit margin. A common suggestion is to add around 5-10 percent of the total material cost to account for miscellaneous material.
3. Calculate Direct Job Expenses
There are more costs involved than only material and labor for any job. Counting and measuring cannot identify all job costs; you will have to review the blueprint specifications to determine the direct job expenses.
For example, you need to know if there is a need to buy or rent equipment to complete certain specifications for the job. Working in tall buildings will most likely require a man-lift rental or scaffolding. Also, you will need to consider the costs for permits and inspections. If you are new to contracting, you have likely forgotten to add a few of these costs.
Direct job expenses may not appear significant; however, all costs will come out of your profit if you don't include them in your break-even cost. Consider more direct job expenses, such as storage, trash/hazardous material disposal, temporary power, and much more.
After reviewing the specifications and blueprints, you should have a good idea of your direct job costs. Add all of those costs up and
4. Determine Overhead
The most challenging portion of calculating the break-even cost is determining your overhead. Overhead is the cost to operate and manage your company, generally referred to as indirect costs. Indirect costs are costs that do not apply to a specific job. Examples of indirect costs are rent, administrative salaries, vehicles, office supplies, and more.
To calculate overhead costs for your contracting business, you will need to keep track of your indirect costs for a specific period. For this example, let's assume you tracked your indirect costs for a month and found the total to be $20,000. Now, let's assume the sales you experienced during the same month were $100,000. To calculate your overhead as a percentage of sales, you would divide the total indirect cost. For this example, the overhead as a percentage of sales is 20% ($20,000/$100,000).
Overhead Percentage = Total Indirect Costs / Total Sales
Before applying your overhead to the break-even cost, you first need to determine the prime cost. Calculating your prime cost is relatively simple at this point in the process. The prime cost is the sum of your total labor cost, total material cost, and total direct job expenses. Once you have this number, you can multiply the prime cost by your overhead percentage to determine the total overhead cost.
5. Calculate the Break-Even Cost
After completing the other four steps, you can finally calculate the break-even cost. Your break-even cost is the sum of the total labor cost, total material cost, total direct expenses, and overhead cost.
Break-Even Cost = Total Labor Cost + Total Material Cost + Total Direct Expenses + Overhead
Tools to help you calculate your break-even
As you can tell, determining the break-even cost for a job is a time-consuming and challenging task. Using an Estimating Software to help calculate the total labor and material costs is much more efficient than doing it by hand. If you are an Electrical Contractor, you can read more about Electrical Estimating Software HERE.
Estimating Software can automatically calculate your break-even cost after entering the total labor cost, total material cost, total direct job expenses, and applying overhead. Since this calculation is automatic, there is no room for error and no need to have someone double-check your work. Automatic calculations increase efficiency and accuracy to reduce the chance of a big mistake.
How to use a break-even cost to grow your business
The reason for owning or operating a business is to make money. During the estimating phase of a project, you must be able to calculate the break-even cost to determine your final bid price. The final bid price must include enough profit to make the job worth bidding on. It is better to have no work than to have work that causes your company to lose money.
If you are consistently able to produce profitable jobs, banks will be more likely to finance your business. Bank financing will allow you to pursue more job opportunities and leverage that money to bid on more profitable jobs—knowing if a job is profitable starts with calculating the break-even cost accurately. Without the break-even cost identified, it is like shooting in the dark and hoping to hit your target.