Are you really making the profit you think you are???
A comment I often hear from clients is “I make good margin, so why do the accounts show such a small profit?”. When I catch up with clients, I’ve noticed there are generally three particular areas where they can most easily trip up;
- Understanding and realising the true cost of staff
- Knowing the amount of chargeable versus non chargeable work
- Accurately tracking time spent by staff on a job
What is the true cost of your staff?
When costing jobs or products, the standard approach is to say that per job of ‘x’ size I will need one person for ‘x’ hours. I pay them $X per hour and therefore it’ll cost me $Y. The problem with this approach is that there is more to the employment or ‘cost’ of people than the hourly rate. In addition to paying staff for the time they spend in productive hours, it needs to be considered that as an employer you will also need to pay them for non-billable time as well, but this time needs to be paid for by that which is billable.
To accurately determine the true value of your product you must incorporate each team member’s true cost. When doing this, all expenses need to be considered, such as FBT, kiwisaver, sick and annual, bereavement and statutory leave. Once you know the true cost of each person for the full year, estimate the total number of hours in the year that the employee will be spend on productive work.
Do you know the amount of chargeable versus non chargeable work?
Chargeable time is also to be carefully considered, as not all roles are directly chargeable, for example training, admin and internal meetings. Once you have estimated the number of hours in a day that are productive vs unproductive then estimate how many working days there are in the year for that employee. Remember to deduct sick days, annual leave, statutory holidays. Once you understand the true cost for each employee and the number of productive hours that they will work during the year you can then calculate the amount that you will need to charge or recover per hour to cover your cost for that person. Then on top of this of course you want to make a profit!
To demonstrate this, consider the following example:
An employee is paid $25 per hour so if they work 40 hours a week you pay them $52,000 annually. There are 52 weeks in the year however after allowing for 4 weeks’ annual leave, 5 days’ sick leave and 11 statutory holidays there are only 44.8 weeks the employee is actually at work. There are 40 working hours in the week however after allowing for training, internal meetings and other down time only 35 hours are productive and able to be recovered via invoicing a customer.
The annual cost for the employee is $52,000. The number of hours they spend generating sales or income is 1,568 (44.8 weeks * 35 hours per week). This means that you must generate $33.16 per hour ($52,000 / 1,568 hours) of revenue just to cover the cost of this employee. This is 32.6% more than the hourly rate of $25 per hour.
Do you accurately track time spent by staff on a job?
Do you track the exact time your staff spend on work you can charge a customer for versus down time or unproductive time such as re-work? Whether this be an hourly rate or a part of a manufacturing process, it is essential to your success that you can track all time spent and allocate it as overhead versus chargeable. The only real way to do this accurately is for staff to maintain time sheets. Time and time again clients say, “oh this only takes them 2 hours so I make X% margin”, however, once they start tracking the exact amount of time spent, they find it often took longer than they thought.
Tasks such as dealing with customer queries before and after the project, travel time and re-work are often not considered when estimating time spent. Once this is tracked clients often find that instead of a job taking 2 hours as estimated, it takes 2.5 or 3 hours. 30mins or an hour here and there might not sound like a lot but if a job takes 3 hours instead of the 2 hours estimated, your costs have increased by 50%!
Truly understanding the cost and the exact amount of time spent by your team is a crucial step in putting yourself in a position where you accurately understand the true gross profit or margin and therefore if the price is right.