With the economy in the mess that it is and 20% of our nation unemployed or underemployed and the profits of corporate America being scrutinized, the word profit is fast becoming a four letter word. I thought it was time we took a look at what earnings and overhead are and why they’re not as bad as the media portrays them to be.
Let’s imagine that your boss called you into his office and asked what your household expenses were, just what was necessary, and then reduced your salary to that level. That is exactly what happens every time he asks his contractor to lower his price. Now, don’t get me wrong, I don’t want you to blindly accept every price from every contractor every time, but I urge you to do your homework to find out what price range your particular project should be in. Check out some of my other articles where I talk in depth about how you should calculate cost parameters.
Every time a contractor prepares a proposal or bid for a project, they have to calculate their actual costs. These costs include many parts such as material, labor, overhead, and profit. Let’s take a closer look at these parts so you can better understand them.
The example project we will use for this article is a minor bathroom remodel. Replace the vanity, vanity top and faucet, toilet, mirror, and light bar. Also remove the existing tub surround and install new ceramic tile in the tub/shower area. Change towel rails, toilet roll holders and paint the entire bathroom.
First we have the actual material, which would include the items listed above plus glues, adhesives, grout, putty, nails, screws, and anchors. Then there are the plumbing parts such as shutoff valves, supply tubes, trap, and pop-up drain assembly. We will need some drywall compound to patch and paint the roller sleeves and tape. Many homeowners forget all the little things that go into completing a project like this.
Labor is always a major cost for any project. In the actual cost of labor is, of course, the actual hourly wage paid to a tradesman, plus the employers’ share of social security and Medicare, state and federal unemployment, workers’ compensation, and benefits. they can include paid sick days, vacations, and health insurance. I break down the benefits package into an hourly cost, but some employers calculate that as part of overhead.
Overhead is where a lot of people get lost. Many people describe overhead as operating costs attributable to that particular job, when in reality overhead is operating costs attributable to running the entire business. Examples of these costs would be, liability insurance, vehicles, auto insurance, gasoline, oil changes, rent for office or storage space, telephones, pagers, Internet access, computers, and filing cabinets. All expenses for office supplies, such as stationery, pens, stationery, clips, forms, and ink cartridges, would also be included.
Another line item that should be included in overhead is the replacement cost of tools and vehicles. These things wear out in the natural course of work and will need to be replaced at some point.
Now that four letter word, benefit. I hope that after reading this far you see the investment and capital risk involved in owning your own business and understand that there should be a reward for this risk. A profit of 8% to 12%, with an average of 10%, is totally acceptable and legitimate. That said, I don’t know of any contractors that are earning anywhere near that 10% margin in this economic climate. Most have written off the profits and replacement costs and are happy to break even.
To better illustrate my point, let’s take a look at your investments, your 401k. You take money and buy/invest it in a mutual fund and, in turn, for putting your capital at risk, you receive interest/earnings back. How is this different from a contractor who spends thousands of dollars on tools, vehicles, office equipment and receives a reward/profit in return? The obvious answer is that it is the same.
So the next time you have a project, do your homework so you know how much it should cost, follow my advice in a previous article I wrote “Destroying the 3 Offers Myth”. Hire a competent contractor and know that you have already earned the right to make a profit by being in business.