Ever wondered why so many quoting tools concentrate on direct costs, selling prices and gross margins but give so little attention to the cost of actually running the business?
Materials, labour, contractors and other direct costs are relatively easy to identify. But what about rent, electricity, insurance, administration, vehicles, equipment and all the other expenses that keep the doors open?
They still have to be paid.
I suspect many businesses are simply hoping that the margin they build into their quotes will cover these expenses. That's a risky way to price work.
Here is a simple example of why it matters.
A business quotes $2,000 for a job.
Calculation Amount
Selling price$2,000
Direct costs$1,200
Gross Profit (GP)$800
Gross Margin (GM)40%
Looks pretty good, doesn't it?
Now introduce an overhead recovery allocation of $500.
Calculation Amount
Gross Profit $800
Overhead recovery $500
Contribution after overheads $300
Contribution Margin 15%
Your Gross Profit might be 40%, but once you account for the overhead recovery required from that job, your contribution margin might be just 15%.
That is a very different commercial picture.
The question is simple: do you actually know how much overhead each job needs to recover, or are you relying on a markup and hoping it is enough?
You don't need complicated accounting to start answering that question. You do need to know your annual overheads and establish a reasonable recovery rate based on your business's productive capacity. Don’t wait to be told by your accountant at the EOFY you didn’t make a profit because you didn’t apply or didn’t understand what your overheads equation does to the outcomes
We've included a simple Gross Margin calculator on the FoundationStone website to get you started. Enter your direct costs and selling price and see how much remains to cover overheads and contribute to profit.
But don't stop at GP.
Look at the above example again
Knowing what you make on a job is important. Knowing what that job contributes towards the cost of running your business is even more important.
Don't just quote to get the job. Understand what you need to charge to make the job worthwhile.