Ask the expert

by Mike Rudd

Contractors are urged not to overlook issues that help determine profitability.

For many businesses, on-the-job training can be an important part of success. No matter how well a student learns the craft, the teacher still retains a certain amount of critical information. If a secret technique or important concept is withheld, the student can lose his or her edge. Never underestimate the importance of on-the-job training. It takes good business sense to sustain growth and profitability.

In the construction industry, most contractors come up through the ranks with little or no formal business training. They must rely on what former employers have imparted to them. In this model, critical issues such as effective bidding procedures and professional management skills must be addressed.

Can a contractor guarantee increased profit?
Increasing the percentage of jobs awarded does not necessarily guarantee higher profits. Consistently underbidding the competition without taking into account the entire cost structure can cause a business to run out of working capital and face difficult times. A contractor should not just add up the cost of materials and labor and then add another 10 percent for overhead. Unexpected expenses must be considered when figuring out the bottom line in order to avoid underbidding on future jobs.

What should be considered when developing a bid?
There are two main components that should be considered: direct job costs and overhead.

Direct job costs are the estimated variable costs associated with completing the project, such as labor, labor burden, materials, subcontractors and equipment rental. These costs vary in proportion to the size of the project.

Overhead includes direct business costs such as administration, wages, insurance, rent, utilities and owners’ wages. Indirect costs include transportation and consumables that must be allocated across all of the company’s jobs.

When calculating overhead, simply adding a percentage of a job’s direct costs does not make sense. Overhead costs for a certain time period, usually one year, are divided by job costs over that same period. New businesses should use best estimates for jobs first and then adjust them on a quarterly or more frequent basis. All costs must be included to determine the break-even point.

Using break-even calculations in the bidding process helps determine the true cost of doing business and provides a return on risk. Profit margins may vary depending on the situation. Contractors must be aware of competitive bidding practices, credit histories and other factors.

For example, if a new client is being groomed for future business, it can be beneficial to keep profit margins low. But once the break-even point is determined, the bid should not fall below that number. That could put the business at risk.

What is the importance of motivation and incentive programs?
This is yet another aspect that many business owners fail to share with their employees. Here are some key points to consider.

• Without an incentive program, employers risk internal fraud.
• Keep it simple. Employees must understand how the program works to be motivated by it.
• Incentives must be tied to specific cost areas where the employee has control. Example: A worker or crew of workers is given an estimate of 500 hours to complete a job. If the job is done in fewer hours, they are rewarded with a percentage of the overage.
• The incentive plan must reward a group as a whole. A good solution is a bonus pool that covers the incentives for all jobs in a certain time period. As employees function more efficiently, the bonus pool grows.
• Two sides: The incentive plan must consider all outcomes, helping employees focus on costs. In the 500-hours example, if the job is done in less time, it adds to the bonus pool. However, if costs exceed that figure, a percentage is subtracted from the pool.
• Incentive payouts should be made often enough to provide motivation but not become an administrative burden. Bonuses should be paid at the end of the entire job or on a regular basis such as quarterly or monthly. Smaller time frames are likely to increase administrative overhead.