The Ins and Outs of Job Costing

by Sally Bouorm | March 1, 2012 12:05 pm

By Brian Van Bower

The first step toward revamping costing procedures is to evaluate whether the products the company offers (e.g. pools, spas, landscaping services, etc.) are considered commodities when it comes to marketing and pricing them.

For many in the pool and spa business, money is looked upon as a taboo topic not to be openly discussed. It is true that in any form of business, be it Canada or the U.S., competitors are restricted by laws from getting specific when discussing pricing, overhead and profit margins with one another. However, understanding these factors in broad, general terms (which are legally discussable) is at the core of the success of any profitable business—especially in the world of pool and spa contracting.

The reason pricing, overhead and margins are so critical is that they reflect a businessperson’s core values, and those of his or her company, with respect to both money and overall business philosophy. In this industry, it seems as though too many contractors severely undervalue what they do, which impacts what they charge for the services they provide. For these people, taking a step back to get a fresh perspective at how job costing and pricing should work can provide an invaluable benefit to them and their business.

The big picture

The first step toward revamping costing procedures is to evaluate whether the products the company offers (e.g. pools, spas, landscaping services, etc.) are considered commodities when it comes to marketing and pricing them. If so, the business may well be doomed to failure. In other words, by categorizing a pool as a quantity of tons of steel, yards of concrete, feet of pipe, number of fittings and square footage of decking, the overall picture is lost.

Many builders mistakenly believe price is the most important issue in the client’s decision to buy.

Granted, it is easy to quantify projects in this way, especially for those who mistakenly believe price is the most important issue in the client’s decision to buy. In fact, price is much further down the buyer’s priority list than many people assume. Worse, there is also a misconception that price is the easiest thing to alter or trim. This is a slippery slope that leads to cut corners, unprofitable jobs and, ultimately, unhappy clients.

By contrast, when projects are viewed as a means to provide clients with beautiful projects that will enhance their lifestyles, it informs everything the company does, from the way the principals interact with the client to the manner in which they formulate their prices. At the most fundamental level, this ‘value-added’ mindset helps eliminate the notion that garnering business must be a game of simply cutting prices.

Instead, pool and spa professionals can work with an understanding of, and insistence upon, what they need—and deserve—to make. This approach is all about having confidence in the work and feeling entitled to make what it is truly worth. Until this transition is made, it is difficult to price work using anything more than the standard ‘time and material plus markup’ formula, instead of a clear methodology in which price reflects value.

Tackling take-offs

Establishing this type of methodology begins with a good ‘take-off,’ a thorough cost analysis, breaking down a project item by item.

Back when I was first working in construction, I had a partner who came from a general contracting background. For a long time, he made his living by estimating huge construction projects and taking off the details of the job, right down to the number of screws and hinges on the doors. When we started working together, he taught me to do that very thing on every single job. Then, when the job was finished, we would go back and run the numbers again so we could learn exactly what we were spending to get the job done.

By categorizing a pool as a quantity of tons of steel, yards of concrete, feet of pipe, number of fittings and square footage of decking, the overall picture is lost.

This exercise emphasizes the difference between each job, even among those that, when they begin, might seem similar to past projects. Through the before-and-after take-off, one can see exactly where things changed. This helps teach pool and spa professionals to anticipate and accommodate those variables in the future, to avoid shortchanging themselves.

When estimating a project, all materials must be counted- steel, concrete, plumbing and fixtures, valves, tiles, skimmers, equipment and all the little parts and pieces that go into the project.

The key to this process is thoroughness. All materials must be counted—steel, concrete, plumbing and fixtures, valves, tiles, skimmers, equipment and all the little parts and pieces that go into the project. Then, additional costs must be added, including those for plans, permits, trenching, backfilling, supplying soil, hauling trash, pre-filtering fill water, startups and customer instruction. Basically, everything that costs money, even the smallest amount of time or materials, must be factored into the equation.

Contractors must also calculate other factors that are not easily defined, such as warranty work. In order to be a top-flight firm, a company must have freedom in its pricing structure to be able to do absolutely everything necessary to make the client happy. To that end, builders can incorporate an anticipated, relatively small dollar amount for warranty work as a line item. This can be included on every job (and marked up, which will be discussed below). This way, when the client eventually needs or wants something, the money is already in to cover the extra expense (with even more money to be made on the new work).

bigstock_782830 — To establish a clear methodology in which price reflects value, a pool and spa professional needs to perform a thorough cost analysis by breaking down a project item by item.

Of course, these costs do not come up on every job; however, in some cases the amount of warranty or extra work can run high. In time, it all balances out. Plus, it can help put the pool and spa professional’s mind at ease. Instead of dreading calls and worrying about what client requests will do to the bottom line, builders can meet clients’ needs comfortably and enthusiastically. In some cases, a ‘miscellaneous’ line item can be included (and marked up) to add further to the builder’s comfort level.

The bottom line is to include and mark-up every single thing that contributes to the design-and-build process, from the point the clients sign on to the day the project is completed. These things add up to a number commonly referred to as the cost of goods sold (COGS). Only once a builder has fully and accurately estimated a project’s cost can he or she confidently add a mark-up to the project. This mark-up is a key calculation.

Estimating overhead

Every business owner should periodically take the time to estimate overhead costs—in other words, all non-job-related costs that go into keeping the doors open, the lights on and the wheels turning.

This includes a range of items such as office space, utilities, supplies, office furniture and equipment, support-staff salaries, travel, training and education costs, insurance, taxes, depreciation, association dues and entertainment. Overhead also includes salaried employees involved in general, non-job-specific positions necessary to keep a business running, such as office administration, general management, etc.

These expenses should be tallied and related to each job as a percentage. If, for example, a business does $1 million in annual volume and it costs $120,000 to keep the business operational, overhead can be calculated at 12 per cent. As such, every job taken should clear that percentage in order to create profit margin.

Overhead can vary substantially, of course, depending on the size of an operation, its marketplace position, advertising and salaries. It also fluctuates greatly with volume, which is why it should be periodically recalculated to correspond to changes in direct costs.

PERFECTING YOUR PRICE PROCEDURES
Many pool and spa professionals operate under the false impression that clients view price as the most important factor in their purchasing decisions. In fact, firms can easily work themselves right out of jobs by continuing to cut the price of a project, degrading it to a point where the client has moved on to a more quality-focused competitor. If builders explain everything that will be going into a project from start to finish and ask the customer to give their own estimation of what the price would be if they were doing the job, the client will often come up with a number that dwarfs the pricing the builder calculates. When questioned on price, being blunt is sometimes the best approach. Tell them, flat out, “Given what’s involved, this is exactly what we need to be paid.” You may even want to add, “If you were in my shoes, doing this project the way we’re doing it, you’d charge at least this much!” Clients are very unlikely to balk at the cost when given that explanation. The following is an example of a formula a company can use to calculate a final price for a building project. The numbers and percentages presented in the example below are strictly for illustration purposes. Costs and margins are a matter of each owner’s preferences and circumstances.Example of price formulation In this example, the following formula is applied to arrive at a base selling price (BSP) for the project: BSP (X) = cost of goods sold (COGS) + overhead + desired profit For the sake of this illustration, the following figures are assumed: ● Overhead: 12 per cent ● Profit: 30 per cent ● Cost of goods sold (COGS): $38,000 If the overhead and profit comprise 12 per cent and 30 per cent of the final price, respectively, this means the COGS will end up being 58 per cent of the base selling price (BSP) (100 per cent – 12 per cent – 30 per cent = 58 per cent). Given these variables, to determine the BSP, the COGS should be divided by 0.58. $38,000 (COGS) ÷ 0.58 = $65,518 To arrive at a final selling price (i.e. the price ultimately billed to the client), sales commission must also be added, which can be done using the following formula: BSP + sales commission = final selling price Assuming a sales commission of five per cent, the commission figure can be calculated by multiplying the BSP by 0.05 and adding that total to the BSP. $65,518 x 0.05 = $3,276 $65,518 (BSP) + $3,276 (commission) = $68,794 (final selling price) Note: Since commission has been added to BSP, it must be deducted before calculating overhead and profit, because the commission is actually part of the COGS calculation. Therefore, this price yields 12 per cent of the BSP ($7,862) for overhead and 30 per cent ($19,655) for net profit.

PERFECTING YOUR PRICE PROCEDURES

Many pool and spa professionals operate under the false impression that clients view price as the most important factor in their purchasing decisions. In fact, firms can easily work themselves right out of jobs by continuing to cut the price of a project, degrading it to a point where the client has moved on to a more quality-focused competitor.
If builders explain everything that will be going into a project from start to finish and ask the customer to give their own estimation of what the price would be if they were doing the job, the client will often come up with a number that dwarfs the pricing the builder calculates.
When questioned on price, being blunt is sometimes the best approach. Tell them, flat out, “Given what’s involved, this is exactly what we need to be paid.” You may even want to add, “If you were in my shoes, doing this project the way we’re doing it, you’d charge at least this much!” Clients are very unlikely to balk at the cost when given that explanation.
The following is an example of a formula a company can use to calculate a final price for a building project. The numbers and percentages presented in the example below are strictly for illustration purposes. Costs and margins are a matter of each owner’s preferences and circumstances.Example of price formulation
In this example, the following formula is applied to arrive at a base selling price (BSP) for the project:

BSP (X) = cost of goods sold (COGS) + overhead + desired profit

For the sake of this illustration, the following figures are assumed:

● Overhead: 12 per cent
● Profit: 30 per cent
● Cost of goods sold (COGS): $38,000

If the overhead and profit comprise 12 per cent and 30 per cent of the final price, respectively, this means the COGS will end up being 58 per cent of the base selling price (BSP) (100 per cent – 12 per cent – 30 per cent = 58 per cent). Given these variables, to determine the BSP, the COGS should be divided by 0.58.

$38,000 (COGS) ÷ 0.58 = $65,518

To arrive at a final selling price (i.e. the price ultimately billed to the client), sales commission must also be added, which can be done using the following formula:

BSP + sales commission = final selling price

Assuming a sales commission of five per cent, the commission figure can be calculated by multiplying the BSP by 0.05 and adding that total to the BSP.

$65,518 x 0.05 = $3,276

$65,518 (BSP) + $3,276 (commission) = $68,794 (final selling price)

Note: Since commission has been added to BSP, it must be deducted before calculating overhead and profit, because the commission is actually part of the COGS calculation. Therefore, this price yields 12 per cent of the BSP ($7,862) for overhead and 30 per cent ($19,655) for net profit.

Approximating profits

Once the COGS figure and overhead percentage have been calculated, builders begin to enter the mysterious and wonderful world of profit, something every business is entitled and expected to generate.

Without profit, there is no reason to be in business. Those who continue without earning a profit are not only essentially working for a salary, but carry the additional burdens and responsibilities of operating a business with no margin for error.

Gross profit comprises the total receipts of a business, minus the initial COGS, but before deduction of operating expenses and taxes. Net profit comprises what is left after all expenses have been deducted from the gross profit amount.

Exactly what a company’s profit should be is a decision only the builder or business owner can make. There are many important questions one must consider when establishing a profit margin, such as:

What has been invested in the business to date?
How much could the business generate if all of its assets were liquidated and the proceeds invested in income-producing vehicles such as stocks, mutual funds or real estate?
What value should be assigned to the risks the business owner or manager takes?

bigstock_2725598 — Professionals in this business provide what is, for most people, the second- or third-largest purchase of their lifetimes.

It is also critical to consider the nature of the pool and spa business itself when determining profit margins. Professionals in this business provide what is, for most people, the second- or third-largest purchase of their lifetimes. This is also a business that requires the knowledge and application of skills from a range of different trades, working in variable environments while tearing up clients’ property.

Business owners and managers are responsible for workers who drive large vehicles, operate heavy machinery, dig huge holes and pump tons of water. From technology and technique to blood, sweat and perhaps the occasional tears, pool and spa professionals create environments that will, if successful, provide clients with an ongoing source of pleasure and enjoyment.

Compare this, for example, to what furniture retailers do. They basically acquire a manufactured item from a factory and place it in a showroom or warehouse, where it sits awaiting a buyer. While still valuable, it is a much less complicated activity carrying much less risk. Still, items such as couches, chairs, tables and beds carry huge mark-ups. If furniture retailers are entitled to a significant profit margin, so too are pool and spa professionals. In fact, the latter is likely entitled to more.

Another key factor to consider is the size of the companies that comprise the pool and spa industry. In many cases, they are quite small, with the owner out in the field doing the work or supervising the project right along with the crews. In these cases, owners must calculate what they would have to pay someone as capable as themselves to do the same work.

Owners should not view themselves as people working for a wage, but they do need to ask what they would have to pay to replace themselves. How this is factored into the overall profit and/or overhead equation is a personal issue. The point is that the owner must consider his or her own value; by not doing so, they shortchange themselves.

Getting involved

Aquatic Consultants — In today’s market, especially in custom work, ‘ballparking’ a price can never accurately reflect both the true costs and appropriate profit margin for a given project.

There was a time in the pool and spa industry when a majority of firms applied certain sets of standard factors to come up with prices. For example, charging a standard cost for a certain square footage of pool-surface area, deck or landscaping. It can be argued this approach is now obsolete. Not only is it ultimately the lazy way to go, it does a disservice to the work and the workers. In today’s market, especially in custom work, ‘ballparking’ a price can never accurately reflect both the true costs and appropriate profit margin for a given project.

There are several different formulas pool and spa professionals can use to calculate a final selling price. Whatever method one chooses, the key is to consider the full cost of what is being done for the client and how much the builder wants to make. When costing and pricing are based on hard data and confirmed with real numbers, pool and spa professionals can approach the often grueling challenges of the business with an increased sense of tranquility.

Brian Van Bower has more than 40 years of professional experience in the swimming pool and spa industry. He is president of Aquatic Consultants Inc., a Miami, Fla.-based international consulting/design firm specializing in upscale and unusual pool and waterscape designs. Van Bower is also president and co-founder of Genesis 3 Design Group, an international company specializing in instructional and educational schooling for those involved in the design, engineering and construction of swimming pools, spas, water features and outdoor living areas. He has won more than 100 industry design awards and his work has been featured in many national periodicals, magazines and television shows including Bob Vila’s Home Again, CNN News, NBC News and CBS News Sunday Morning Show. In addition to being a featured speaker at the International Pool Spa Patio Expo each year in Las Vegas, Nev., he has also done speaking engagements at the Canadian Pool & Spa Conference & Expo, as well as various international shows in Australia, France, Germany and Indonesia. He can be reached via e-mail at bvanbower@aol.com[8]. For more information, visit www.aquaticconsultantsinc.com[9].

Endnotes:

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www.aquaticconsultantsinc.com: http://www.aquaticconsultantsinc.com

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