J. Miller and Company Blog

September 28, 2004

Never Fool Yourself – Estimate Labor the Right Way!

“Never Fool Yourself – Estimate Labor the Right Way!”

GOAL: to alert readers to a very common and very dangerous mistake: using the “billing rate” to estimate labor rather than the “cost rate”.

METHOD: to illustrate using a hybrid remodeling company 1) the affect of using “bill” rate rather than “cost” rate in job analysis and 2) how to accurately calculate true labor burden.

NOTE: because of the constraints of website space, the tables related to this article are contained separately under “downloadable files” Be sure to print these out separately.

My father used to say “never fool yourself – fool everyone else if you wish, but never ever fool yourself”. Years ago I asked an attentive JLC Live! audience what hourly dollar figure they used to estimate non-supervisory labor. 90% said “$35”. This represented the “bill” rate which they billed on time and material contracts and, to them, logically used as the estimating figure. Upon further questioning, we came up with a true labor figure for that $35/hour at about $27. This is the “cost” rate and included both the gross wage and applicable payroll taxes and benefits. So for every dollar of labor they estimated they included an additional $8 or 30%. The audience argued that they needed this padding to compensate for the huge risks labor entailed. I call this practice “fool yourself”.

With these arguments ringing in my ears, and knowing that I could not provide a forceful rebuttal until I had arranged all the variables in a logical manner, I asked the owner of a small remodeling company if we could break down the impact of using this rate. We were astonished at the ripple effect such a seemingly small decision had throughout the production cycle. Most importantly, job cost reviews during and after the project often show dollars remaining in the labor budget when actually hours expended are greater than those estimated. This leads to a false sense of complacency in the field and inaccurate estimating in the office. Even after pointing this out in subsequent presentations, I was surprised at how stubbornly many successful estimators clung to the practice.

Applying the 80/20 rule discussed in last month’s column leads many company owners to the conclusion that labor, both in dollars and hours, represents a primary risk to company profit and therefore an appropriate first application of the 80/20 rule. In calculating the true cost of labor, and using that cost in estimating, produces the best opportunity for job control and estimating accuracy

The answer, of course, lies in the dollar figure used to estimate labor which does not accurately reflect the true costs. After nearly 20 years in the construction industry, I have come to the unwavering position that by precisely estimating and costing labor, including every possible component which can be rationally associated with field labor, job control and estimating accuracy will be solid.

Table #1 illustrates the difference between typical “bill rates” used in estimating compared to the “cost” rates for various tasks typically performed in-house and the gross hourly wage on which they are based.

As jobs progress, project managers, lead carpenters and company owners all compare actual labor dollars to those estimated. Look at Table #2 which shows the estimated hours and dollars for a typical 12 week kitchen remodel showing the difference in dollars for each of the labor line items.

Now look at Table #3 which shows the effect of a 10% overage in labor hours where the dollars are estimated at the “bill” rate.

It would appear to everyone involved that nearly $2,000 remained in the labor budget. Production would be elated thinking that they had come in 13.6% UNDER budget for the job. Job bonuses might be handed out based on this happy outcome. And the worst is yet to come: estimating would consider that the next job of this type they bid they could reduce the estimating budget and still make money.

Now look at Table #4 which shows how the job truly performed. Production was 10% over on labor hours and truly 10% over in labor dollars. Now everyone on the field staff has a gauge by which they can measure the impact of their work efficiency. And, more importantly, estimating has an understanding of how much time it truly takes to perform a job of this sort given current field conditions and crew make-up.

To calculate the true “cost” rate, develop a spreadsheet for every field position in your company and associate the appropriate burdens and benefits to each. Table #5 defines all the possible components of the ‘Actual “cost” rate’ for various cost codes, including supervision which is typically performed by a project manager and both cost and billed at a higher rate than field employees.

The real cost of employing field people includes not only the gross wages and Federal and State mandated payroll taxes and workers’ compensation, but also each and every payment which varies with the amount of hours worked by your employees. Not only such obvious benefits as holiday/vacation pay and medical insurance but less apparent costs of field personnel such as small tools and cell phones must be calculated to accurately compare true costs to estimate.

These costs can be added to the payroll burden by relating the annual cost of, say, cell phones, to the annual total for field wages. Divide your cell phone costs for 2003 by total field wages to approximate the % of gross wages reflected by annual cell phone use. Do this with vehicle expenses and even small tools to calculate an approximate cost to be applied to the jobs through payroll (in Intuit QuickBooks Pro, set up a Payroll Item – Company Contribution; in Intuit Master Builder set up a Payroll Calculation – Employer Cost). Continue to book expenses for cell phones, small tools and vehicle expenses to the same overhead expenses you always have. Monthly balances in the overhead accounts will show whether you have over or under accrued and allow you to review and revise those percentages throughout the year.

Another method of accounting for small tools is explained by David Gerstel in his classic book, running a Successful Construction Company (for Pros by Pros) published in 1992 and updated in 2002. He calculated that small tools and other consumables such as sand paper, dust masks and carpenters pencils, typically cost about $.50 per hour of field labor. Either method does the trick of getting small costs which are truly related to the job into the job costs to be compared with estimate.

Notice that the total burden represents 56.17% of the gross wages. Although your company might not yet be able to provide such a broad range of benefits, it is important to understand what they must be as your company grows to attract, motivate and keep talented employees.

Now that you know how the huge impact produced by using the “bill’ rate rather than the “cost” rate to estimate labor and you know how to calculate the true costs of labor, modify these examples to fit your company. Review and revise assumptions with every job as you begin to develop a better labor estimating template. Make changes in the original budget, both for hours and true costs, whenever necessitated on the job by change orders. Use your standard estimating labor template for future estimates and modify as needed based on each job’s specifics. Note those modifications, whether based on site or architect/client conditions on the job specific estimate and only change the template when analysis dictates.

With a clear understanding of the true relationship between estimated and actual labor, both in terms of hours and dollars, you will be better able to manage current jobs and better prepared for future growth. Good luck!

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