Travels with Jim follows Jim Huston around the country as he visits with landscapers and helps them understand their numbers to make smarter decisions.
Trucks, field equipment and their related costs can cause big cost estimating challenges for green industry contractors. As mentioned in my February article, the total cost of trucks and equipment (T&E) for a landscape or irrigation company is usually 12% (+/- 2%) of revenue. Tree care companies usually run a little higher at 15% (+/-2%).
The primary issue facing contractors is how to accurately estimate T&E costs and ensure that their costs are included in their pricing and passed on to customers with an appropriate profit margin applied to them.
To do so, a contractor should first accurately calculate the cost per hour (CPH) for a truck or piece of equipment. Then, when pricing project or services costs, he or she should multiply the CPH for a specific item by the estimated hours that the item will be used on the project or in the service provided. (In rare instances when pricing tree care or lawn maintenance packages, I will average the daily run-time hours for mowers, chippers, saws, etc.) Too often, contractors average their T&E costs in their pricing. They often do so by including them in with their general and administrative (G&E) overhead costs. Another form of averaging is to allocate T&E costs in a bid by multiplying the man-hours in a bid by a company-wide average T&E cost per billable man-hour. The issue is accuracy – either overstating or understating T&E costs. The following example should help explain the problem with this second method.
The peril of using averages.
Mary owned a design/build company in the Northwest United States. Annual sales were just at $1 million. Her T&E costs (fuel, straight-line depreciation, repairs, mechanic and misc. costs) totaled $120,000 or 12% of revenue. She had three, three-man crews working an average of 42 man-hours per week for forty weeks (42 x 40 = 1,680 per man year or 15,120 for the entire crew). Minus vacation and holiday man-hours, total billable field man-hours were about 15,000 for the year. She calculated her average T&E cost per hour at $8 ($120,000 ÷15,000 man-hours).
Mary would price her projects with a 20% net profit margin (NPM) applied to her break-even point. She would include her T&E costs in the bid by multiplying the total man-hours in a job by her $8 company-wide average T&E cost per man-hour. However, she would rarely see more than a 10% NPM on her year-end profit and loss statement.
The problem: Mary would estimate her T&E costs in a job having 500 man-hours in it at $4,000 (500 MHrs x $8). The $4,000 would be accurate if the job required the average amount of T&E on it. However, this was rarely the case. For instance, if the job only required a three-man crew with a pickup truck and wheelbarrows, Mary would over-estimate her T&E costs. If the pickup truck CPH was $12 per hour, it would cost $4 per man-hour ($12 ÷ 3 men = $4). She would overstate her T&E costs by $2,000 (500 MHrs x $4). Add a 20% NPM to the $2,000 and she would over-price the job by $2,500 (($2,000 ÷ (1.0 - 0.2)).
On the other hand, if a 500 man-hour job required her skid-steer, Dingo and pickup truck, the total T&E costs would probably be in the neighborhood of $12 per man-hour or $6,000 (500 x $12). Mary would subsequently underprice the job by $2,500. Guess which jobs Mary would win? She’d win the jobs that she underpriced and lose the jobs that she over-priced.
The solution: Mary has a cost estimating accuracy problem. She should estimate her T&E costs in her projects by estimating the number of hours that a Dingo, skid-steer, etc. would be used on a project by its specific cost per hour. If a skid-steer is estimated to be used on a project for ten hours and its CPH is $350, the bid should include $350 cost plus a 20% NPM or $437.50 (($350 ÷ (1.0 - 0.2)).
Watch how you’re estimating your T&E costs when bidding a job. You could wind up overpricing yourself and missing out on opportunities.
When it comes to including your truck and equipment costs in your pricing, you want to be as accurate as you are practical. One exception to this rule is cost estimating packages of labor and equipment, such as tree care or lawn maintenance packages where it is almost impossible to be precise with the amount of hours a mower, chipper, chain saw, edger, blower, etc. will be used. In these cases, it is reasonable to average such hours.
Remember, every reasonable operational cost in your business should be passed on to your customers with an appropriate profit margin applied to it.
The challenge is not to overstate or understate such costs. If you do, you’ll tend to win the jobs that you underprice and lose the ones that you overprice. The more work that you do, the less money you make. I don’t think I have to tell you that’s not good!