What Should You Charge? Try These Tested Formulas
Marcus G. Metoyer Jr. sure did throw out the equations and formulas in his presentation “What Should You Charge?” at the Air Conditioning Contractors of America’s annual convention, held here recently at the Rio Casino Resort. The president of Omega Energy Consultants, Ltd., admitted that he enjoyed math.
“My wife thinks I’m crazy,” he joked.
Metoyer — who also doubles as general manager and president of Fay Lett & Sons Heating and Cooling Co., Inc., Lansing, MI — provided attending contractors several equations, all designed to help them make their respective businesses profitable. His methods include the “single division method,” “turning divisions into multipliers,” and the “dual overhead method.”
“Every contractor wishes to make a profit,” he said. “This entails selling goods and services for more than the contractor’s total costs of doing business.”
Pricing BasicsBy his definition, costs of doing business include direct job costs and overhead. The former, he said, includes labor, equipment, permits, subcontractors, ductwork, line set, etc. The latter entails taxes, utilities, advertising, bad debt, trash removal, uniforms, training, owner’s salary, et al. With this in mind, he said his profit-and-loss statement format is:
Sales dollar amount minus direct job cost dollars equate to gross profit dollars. To determine net profit before taxes, however, one must subtract overhead dollars from gross profit dollars.
In regard to measuring overhead, he said, “It is impossible for any business to operate without overhead. All hvac businesses must, regardless of size, get to the job with a vehicle, which uses gas and oil, repair and maintain that vehicle, replace worn and lost tools, carry many forms of insurance, pay for travel time, pay for invoices, etc., etc.
“Oftentimes a small contractor mistakenly thinks that since his overhead is small, in terms of dollars, that he may sell his products and services for less than his larger competitors and still make a profit. While a smaller contractor will have lower overhead dollars, the more important measure is the percentage to total sales.”
In this case, his working formula is:
Overhead % = 100 x Overhead dollars
divided by total sales dollars
To illustrate his point, he noted that Contractor A had an overhead of $14,000 and total sales of $50,000. Determine his overhead percentage as follows:
Overhead % = 100 x 14,000 divided by 50,000 = 28%
Meanwhile, Contractor B has an overhead of $1.4 million and total sales of $6 million. To determine his overhead percentage, the equation is as follows:
Overhead % = 100 x 1,400,000 divided by
6,000,000 = 23.33%
“Though Contractor A has a much smaller overhead dollar amount than the larger Contractor B, the smaller operator must sell his jobs at a higher price in order to make the same profit as the larger contractor,” noted Metoyer. “Knowing the overhead percentage is important.”
Single Divisor MethodMetoyer admitted there are nearly as many ways to price hvac jobs as there are contractors. He added, however, that all methods, other than guessing, do have a few things in common.
“Always remember that whichever pricing method you use, you must always recover all of your direct job costs and overhead before you will be in a position to earn a profit,” he said. “However, when direct costs and overhead have been recovered, but there is no profit, the contractor has broken even: no profit and no loss.”
The least complicated of his “formulas to profits” is his “single divisor” method. In this setup, determining a selling price assumes that all jobs will have the same ratio of labor to materials and equipment. This formula is as follows:
Divisor = 1.00 – (Overhead percentage + Net profit before taxes percentage)
For example, if your overhead as a percentage of sales is 28% and your desired net profit before taxes is 10%, to determine the divisor, the equation shapes up this way:
Divisor = 1.00 –(.28 + .10)
= 1.00 – .38
Once the divisor is known, Metoyer said he uses the following formula to calculate the selling price:
Selling price = Direct job costs divided by Divisor
Therefore, if a contractor is quoting a furnace replacement where the cost of materials, equipment subs, and permits equals $900 and labor (two men, 8 hrs each, paid $17 and $12 per hour, respectively) equates to $232, the direct job costs would total $1,132. To determine the selling price, the equation shapes up this way:
Selling price = $1,132 divided by .62
Turning Divisors Into Multipliers“Some contractors would rather multiply their costs by a number rather than use the divisor method when calculating a selling price,” admitted Metoyer, which is why he passed along his “turning divisors into multipliers” method:
Selling price multiplier = 1.00 divided by Divisor
Going back to the previous example, remember that the divisor was .62. Metoyer finds the selling price multiplier with the following calculation:
Selling price multiplier = 1.00 divided by .62 = 1.61
With the selling price multiplier in hand, the selling price formula is:
Selling price = Direct job costs x selling price multiplier
If you plug in the numbers from the previous example, the selling price will, again, equal to $1,825.81.
“We obtained the same selling price using the divisor method of pricing as we did using the multiplier method,” said Metoyer. “Also note that we have marked up our direct job costs by 61.29%.”
Dual Overhead MethodMetoyer cautioned that the above methods assume that the ratio of labor-to-materials/equipment “must always be the same for this method to assure the recapture of overhead dollars on each job sold.” It’s why he prefers to use his dual overhead method to determine pricing.
“This method [dual overhead method] of pricing assumes that the sales of labor accounts for a much higher percentage of overhead than does the sale of materials and equipment,” he said. “If analyzed, it is easy to see that most overhead items on a budget or profit/loss statement are necessitated by the need for a contractor to employ people, trucks, workers compensation, uniforms, training, radios, health insurance, etc.”
To illustrate his point, he gave two job examples. Job 1 entails $2,500 in materials, equipment, and subs cost plus $500 in labor cost. Meanwhile, Job 2 entails $500 in materials, equipment, and sub cost plus $2,500 in labor cost.
“The same total direct job cost exists for the two jobs: $3,000,” he said. “Single overhead methods of pricing will price both jobs the same. However, Job 2 will take five times as much labor, so it only makes sense that Job 2 will consume many more overhead dollars than Job 1.”
Translation? Job 2’s asking price should be higher. To determine cost, one must know the material overhead multiplier (or MOM) and the labor multiplier overhead (or LOM). The respective formulas are:
MOM = (Labor dollars divided by Material
dollars) x (Overhead dollars divided
by (Material dollars + Labor dollars)) + 1
LOM = (Material dollars divided by Labor
dollars) x (Overhead dollars divided by
(Material dollars + Labor dollars)) + 1
Therefore, if the material costs from a contractor’s budget are $400,000, his labor costs are $100,000, and his overhead costs are $220,290.
“These figures could have come from last year’s profit/loss statement, or, better yet, from this year’s budget,” explained Metoyer. Plugging in the numbers you get:
MOM = 100,000 over 400,000 times
220,290 over (400,000 plus 100,000) plus
1 = 1.11
LOM = 400,000 over 100,000 times<
220,290 over (400,000 plus 100,000) plus
1 = 2.76
Going back to the two job examples, per above, the equation for Job 1 is:
Equipment and materials ($2,500) x MOM
(1.11) = $2,775.36
Labor ($500) x LOM (2.76) = $1,381.16
Adding $2,775.36 to $1,381.16 will equal
the break-even selling price: $4,156.52
The equation for Job 2 is:
Equipment and materials ($500) x MOM (1.11) = $555.07
Labor ($2,500) x LOM (2.76) = $6,905.80
Adding $555.07 to $6,905.80 will equal the
break-even selling price: $7,460.87
Of course, the idea is to make a profit, not break even, said Met-oyer. Therefore, one more step is needed to determine actual selling price. One must multiply the break-even selling price by the profit multiplier (provided in Table 1).
Price It Right“Single overhead recovery pricing methods work fine when your jobs all look very similar,” concluded Metoyer. “However, when your costs for labor are a much higher percentage of the total job cost, your selling price will be quite low because you will not recover all of your overhead. “Conversely, when your material/ equipment costs are a higher percentage of total job cost, your price will be high, thus making you non-competitive on the quick in-and-out jobs with a high material-to-labor ratio.”
To be safe, Metoyer recommended seeking the advice of an attorney, CPA, or other qualified financial advisor.
To reach Metoyer or Omega Energy Consultants, call 517-882-0902; 517-371-4105 (fax).
Sidebar: Table 1.
Publication date: 03/26/2001