Uncovering Production Rates and Overhead Costs
by Len Hijuelos
that either comment on the same articles or are looking for additional information and/or clarifications on the same things.
Two of those things are very important. One was a problem in discussing production rates — a critical factor in developing pricing or costs for a job. As I have said before, production rates must be based on reality, not guesswork. Unfortunately, there are no magic numbers that I or anyone else can give you.
The second problem seems to be understanding what overhead is, and how overhead fits into the pricing structure. I did an earlier article on overhead (PaintPRO Jan./Feb. 2003), but it appears that it might be appropriate to do a review.
A major fallacy in thinking about overhead is that a small shop has a lower overhead factor than a large shop. This is not necessarily so. In fact, more often than not, the opposite is true. A large company's overhead may range from 55 percent to 65 percent of labor, while a small shop's overhead may run as high as 125 percent of labor or more. The key to understanding this is first to understand what overhead is. Most simply put, overhead is the cost of doing business, or to put it another way, the cost of opening the doors every day.
Overhead is generally divided into two parts, fixed and variable. Fixed overhead consists of those costs that are ongoing and not necessarily related to the volume of work or the labor costs. Variable overhead are costs directly related to labor costs and therefore the work volume.
There are some estimating programs and guides that suggest that 60 percent or 65 percent of labor is an average overhead burden for painting contractors, and many contractors use these figures without really knowing what their actual overhead burden is. It is only smart and good business practice to know precisely what your own overhead costs are. The best way to make this determination is to have an accountant run the numbers for you, which can be done rather quickly. If this is not feasible for whatever reason, you can do it yourself. The math simply involves a comparison of fixed and variable costs with total direct labor costs, for example:
— 2005 Direct Job Labor Costs $87,000
— 2005 Fixed & Variable Costs $44,955
— $44,955 divided by $87,000 equals 0.517, or 52 percent.
Fifty-two percent then would be the overhead burden applied to labor cost. This is a pretty simplistic example, but it will serve to demonstrate how this works.
The accepted method throughout the painting industry is to apply an overhead and profit figure directly to labor. For example, using 52 percent overhead burden and 10 percent profit:
— Estimated Labor $5,000
— Overhead & Profit $3,100
— Material $2,000
— Total Selling Price $10,100
This is the traditional way of treating overhead and profit in our industry, but that does not necessarily mean it is the only way. This treatment can and does often present problems in dealing with change orders or T&M (time and materials) work. Many contractors separate fixed costs to both labor and material and apply a profit figure to that total. Either way will work, keeping in mind that like so many other pricing options, you must be dealing with known and realistic numbers.