Smart Business Chicago

Accelerate business profitability

What your last boss never taught you By Mike Rudd

Nearly everything an entrepreneurial contractor learns about the business of being a contractor comes from previous business experience.

Most contractors who start their own business do so because of their expertise and skill in the field, and generally do not have formal business training. In this business situation, critical issues such as implementing effective bidding procedures and exercising professional management become acquired skills. The following are techniques geared to addressing the issues that your last boss never taught you.

Improve bid-to-award ratios
Increasing the percentage of jobs that are awarded does not guarantee higher profit — volume does not always equate with profit in any field. In fact, the contractor who successfully and consistently underbids the competition without understanding the actual cost will most likely run out of working capital and imperil the health of the business.

The two main components in identifying costs are direct job cost and the application of overhead. The first, direct job costs, is the estimated variable costs associated with completing the project such as labor, labor burden, materials, subcontractors and equipment rental. Those items that vary in cost correlate with the size of the project.

The second component is overhead application. Overhead can be a combination of indirect overhead such as estimating wages, supervisor wages, fuel and oil, and consumable supplies. These costs are job-related, but must be allocated over all of the company’s jobs.

The other overhead component is the total fixed cost related to the operation of the business. Administration, wages, insurance, rent, utilities and owners wages are components of the fixed cost.

The overhead rate is calculated from the annualized budget. The formula is overhead expense divided by direct job cost, which gives you an overhead rate that can be applied to all of your projects. To calculate the break-even point for a given project, the overhead rate is added to the direct job cost.

This number allows the contractor to cover the estimated job cost as well as the actual overhead expense. If the project is sold for less than this number, there will be a loss associated with this project.

The remaining factor in the equation is profit. The amount of profit you add to the job is dependent on factors such as how the project fits into your existing workload, competitive environment and pay history of the client. Using break-even calculations in your bidding process will help you understand your true cost of doing business and provide a return on your risk.

Develop incentive systems to increase profits
You or your designee may sign the checks, but your employees spend all the money. The best incentive programs take that simple fact into consideration.

There are also other factors that must be taken into consideration when developing an incentive plan.

If you do not provide an incentive program, employees will develop one on their own by cheating hours or stealing materials.

If employees do not understand how the program works, they will not be motivated by it. It must remain simple.

Incentives must be tied to specific cost areas that the employee has control over.

The incentive plan must reward the group as a whole. Performance will improve each employee’s work affects the bonuses as a whole. This tends to reinforce good behavior.

Supervisors should be compensated at a higher rate than laborers, as they have direct responsibility for the performance of the crew, including financial accountability.

The incentive plan must have positive and negative components. This forces the employees to focus on costs.

The incentive payout should occur often enough to provide motivation, but not become an administrative burden.

Using these simple techniques will allow you to apply better cost controls in the field from the ground up rather than after the fact from the management team. Learning to improve bid-to-award ratios and develop incentive systems to increase professional management skills can play a vital role in your company’s success. When done correctly, these steps can substantially increase productivity and profit.

MIKE RUDD (mike.rudd@ipa-iba.com) is director of client services for International Profit Associates. IPA’s 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach Rudd at (847) 808-5590 or at www.ipa-iba.com.