Question
When marking up labor and materials on a wood manufactured project I'm curious to know how others deal with very expensive material inputs outside of the norm you typically work with. Do you just run the mark up percentage like a typical job or apply some discount or factor that takes in to account capacity?
Forum Responses
(Business and Management Forum)
From contributor S:
Make sure a portion of your markup covers the additional risk you are taking by working with costly materials. Mistakes happen, and when they do you have to pay out of your pocket. Otherwise you’re providing insurance to yourself, free of charge.
If you only mark up the material for profit you will not cover your overhead. In other words if the job requires less labor than a typical job and you cover your overhead only on your labor you will end up losing money as your overhead is not covered.
I prefer to markup both material and labor so that your overhead is covered no matter what the relationship of material and labor. This may seem expensive if the material is expensive but it still works with the idea of reverse engineering the profit and loss statement.
Each of those components needs to be accurately figured to have a profitable long term business. If you leave anything out or don't estimate your time accurately, you impact your profit. If you don't pay yourself a salary and you work for "profits", then your mistakes come directly out of your pocket. Even woodworkers are not immune from those facts.
Obviously a job with a 25k material would have more relative labor for handling, and higher quality work but theoretically it’s the same issue that needs to be addressed and that is do you reduce your overhead billed to the job or not. I think if you want to be competitive in the marketplace you need to at least think about it. On the other hand in my experience higher material jobs with higher wow factors usually have more management time, coordination with other subs and the GC, and more delivery so I deal with those as separate additive line items.
The argument is often made that more expensive material needs more "markup" (an inaccurate use of the term) because of the "risk". This should already be covered be the normal waste/remake factor. I figure 20% waste on case work, 30% on panel doors and 35% on lumber. I do not assume we will make more mistakes on a more expensive material. In fact we generally are more careful causing us to have less loss. Increasing the labor rate based on expensive material because "the client is likely more picky" assumes your shop is sometimes producing higher quality work than others. This indicates there is another problem in the shop altogether. I can think of a few situations in my shop where I have ordered extra material to cover the fact that the material is very difficult to get, but this was not an arbitrary "markup". I simply ordered an extra quantity of the material to hedge the risk.
Labor and overhead are not supposed to be related. There is a small connection when certain office and management items are considered, but it should not be applicable to job level invoicing or hourly shop rates. Because most shops have full-time employees that are paid regardless of the amount of work scheduled our labor can easily be thought of as overhead; but it is a good practice to keep it separate. Buying a new machine is usually justified by the amount of labor cost it can save. If you do not have numbers on your labor output per dollar it can be hard to make a rational choice.
In my shop I have three different "shop rates" to cover different types of jobs/clients; they are retail, commercial and wholesale. The only cost difference to me is the overhead. There is a lot less overhead on a wholesale job than a retail job. Materials and labor do not vary on these projects only my cost to generate a Job Order. Once the JO is created it behaves the same.
I do occasionally tack on a "high end markup" for special jobs. This has nothing to do with materials and nothing to do with mistakes in the shop, risk of damage to materials, or even my overhead. I am simply adding to my profit margin because I know that I can get away with it. This may seem arbitrary or contrary to my previous statements but it is not. I am treating my profit margin completely separate from the other factors of labor, overhead and materials. I am choosing to add to my profit margin because I know that my price is still competitive on the market. I would not be able to stay competitive if I applied this higher margin to all jobs.
Ideally overhead items such as proposal generation, site visits, samples, invoicing and material ordering can be applied at the job level instead of to the shop hour. For example I could calculate that these items cost me an average of $400 per job and add that to the whole job. This would keep the cost tracking more accurate when looking specifically at the job level overhead. It is even possible to do this with electricity and tooling maintenance, but it becomes difficult. Finally it becomes nearly impossible to come up with a rational way to account for rent and insurance at the job level. Therefore these items are prorated over the estimated "shop hours" we will plan for on a monthly basis.
In many cases it is literally impossible to apply overhead items to the job level. In my case I have a published catalog with set prices. I do not have a minimum order so I must try the best I can to accurately compute my overhead on a per shop hour basis. By keeping the labor and overhead separate in my books I can easily look at the number of shop hours I billed last month, how much of that was intended to cover overhead and if it did. The same is true with my labor costs.
I do most of this in QuickBooks by having the "shop hour" being calculated by sub-items (labor, profit and overhead allocation). Because my overhead costs are tracked in QB I can see nice charts showing my revenues in each item and how they match up to my actual costs. It gives a great way to very accurately see if you are charging for everything in proportion. As the sop becomes more efficient and I upgrade machines I can see that my labor portion of the shop hour is starting to far exceed my actual labor costs.
In fact two months ago I literally pulled in several times more than my labor cost, the same happens with the overhead number. This means I have a choice - I can reduce my allocations for labor and overhead in the shop hour rate, or I can increase the profit margin to compensate! The same happens with my material cost/revenue tracking. I do not markup materials and I separately track their costs and the revenue from them. If I see that I am consistently losing money on materials I look for what is causing this. I tend to clear around a 5% profit on materials but this is not intentional, I am only trying to accurately charge for materials. The reason that I sometimes clear a profit is because of items like lumber where my estimated value was higher than the purchase price; hardware and panels are not marked up at all so the revenue and costs cancel out perfectly.
This might all seem complicated but it is a heck of a lot easier than what I used to do. In my quick books I am only billing the client for a few things. I do not use QB for the invoice only for the bookkeeping. Invoicing is done using a relational database that builds pricing on various parameters. All I enter into QB is the jobs shop hours, delivery cost, material cost and a couple other details. All of these numbers come out of the database/Cabinet Vision.
So I agree that overhead is a time related factor and I have a fairly accurate way of separately tracking it from labor even though both are tallied using the shop hour. I do believe it is better to allocate job level overhead to the job as a whole, but for me this would mean a lot more time programming my behemoth of a database, and I would not be able to do it on the catalog sales clients.
Reviewing your P&L from the past year will tell you if you need to charge more for materials or labor (do your markups give you enough to cover overhead and make a profit)?
Making a profit is often a matter of volume. That customer probably won't accept your rates if you want to work one month a year and want to charge enough to cover a year’s worth of overhead! Silly example, but you do have to produce enough work to make the numbers work. High volume of work with minimal overhead is the way to make money!
