Your Labor Budget: Know Your Costs. Make Profit.

Dan had been eagerly expecting Bill’s phone call.  He’d been wrestling with labor costs for a few years now.  On one hand, Dan felt like his crews’ productivity was poor, and yet two of his best guys, one of them a foreman, recently left to work for other companies.  Dan wasn’t sure whether they left out of frustration or for better pay, but he was pretty sure they jumped ship because they got better offers.  If Danscaping’s cash flow was better he might have fought harder to keep them around, but things were tight at the time and Dan couldn’t afford to budge. 

This caught Dan a little off guard as he felt that his guys were paid well—especially given their efforts of late.  The reality was that his core guys seemed to care less about the company with each passing month.  Their level of commitment was weak, so Dan didn’t feel any of them deserved salary increases, but at the same time he didn’t look forward to the prospect of trying to find replacements for all his foremen either!  He was anxious to hear what advice Bill would come back with.

 To Dan’s relief Bill’s phone call did come that evening.

 “Have you taken a second look at your sales budget?” asked Bill.  “Are you still confident it’s realistic, and that it’s the right direction for you?” 

“I am.” answered Dan.

 “Then your next task is to create a labor budget.” Bill stated calmly.  “You need to plan a realistic amount of wage expenses that will enable you to achieve your sales targets while keeping your business profitable.  Once you’ve established your labor expense targets, you must monitor them closely to ensure your labor is producing enough revenue to justify their costs.”

 “Well, I know last year we spent $720,000 in labor expenses.” said Dan.  “I can read that from our payroll expense records.”

“Yes,” paused Bill, “but not all those costs were associated with production.  For instance, there are the salaries for you and your wife, your designer…”

 Dan interjected to defend his calculations.

 “But I work on production,” said Dan, “and so does my designer.  We charge for our designs, so that means her time is production time, right?”

 “You’re partially right.” said Bill patiently.  “Some of your time is production time, or billable time, and some isn’t.  This also applies to your designer.  You have an office administrator included in that payroll summary as well—note that none of her hours are billable.  If you were to include these hours in your field labor budget you’d never recover their costs because they’re not included directly in your bids.  For example, you’re never going to show a customer a line item on their contract called ‘administration work – $1000’, or ‘sales time – $1500’.  So any time spent on non-billable activities needs to be separated from your field labor budget and included in your overhead budget.  By including them in your overhead budget, you ensure that your company recovers those costs across all your bids using what we call an overhead recovery markup.”

 Some of the terms Bill spoke about sounded vaguely familiar to Dan.

 “I did attend a seminar on that once.” said Dan.  “But once I got back to the office… it just fell off the table.”

 “Dan, you’ve admitted that you’ve never followed a budget, so no wonder it didn’t work for you.” noted Bill.  “And you’re here because your current system isn’t working.  I bet that if you’d have followed the advice in that seminar we wouldn’t be having this conversation right now.  Tell me something Dan; if you’re not exactly sure that your customers are paying enough to cover your overhead expenses, who is paying those costs?”

 “I don’t know exactly.  I just price it like I’ve always done and hope it’s covered.” said Dan.

 “Well where is the only place they could come from, Dan?  Think about why you have asked me to help you in the first place.”

 Dan knew the answer. “If my customers aren’t paying my costs, then my company is…”

 “You’re absolutely right—your company is paying for it out of profit.” said Bill.  “If your customers aren’t paying for something then you are.  We’ll discuss this point further when we get to the overhead budget, Dan.  For now I have a task for you.  Take your payroll expenses and divide them up into two categories: field labor expenses and overhead expenses.  For your time, your designer’s time, and anyone else’s time that gets split between both tasks, you need to include only the billable (field labor) costs in this budget.  You need to write down each employee who gets split wages and record how you split their wages.  Tell me Dan, how much of your time is spent in the field?” 

 “I couldn’t even guess.” replied Dan

 “Of course you can, and you must!  If a year is too difficult to calculate, think in terms of one week.  What percent of time do you spend working on hours that you build into bids and how many hours are you working that aren’t billed?”

In all these years Dan never thought to consider the exact amount of time he put into his business on a weekly basis, let alone on an annual basis.

 “I’m not exactly sure but I think I need to be billing my contracts for more of my time.” said Dan. “I always underestimate how much time I actually spend managing a job.  But right now I probably don’t bill more than 15% of my time…”

 “Okay Dan, then your first task is to ensure you begin properly billing your time to jobs.  If you’re working on jobs without billing your time to your customer, you are giving away your services for free!  Based on what I know about your business so far, I’m sure we can also implement some systems later on that will dramatically reduce the time you need to spend on jobs.  Look at my situation for example—do you think I want to spend 40 hours a week micromanaging my company’s work?  Not a chance.  I built systems that do all that for me,  but you need to take it one step at a time right now, Dan.  Start by dividing your labor costs up into your field labor and overhead categories.  You also need to contact your accountant to find out your labor burden percentage.  This is the percent of expenses that go to pay the taxes, insurance, and benefits on each and every wage.  Give me a call when you have those numbers ready.”

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