Above or below the line: Do you feel lucky?

Clint Eastwood was being interviewed and the discussion turned to his directing of numerous very successful films. He’s considered one of Hollywood’s best directors because his films always came in on budget, on time, and they’re usually very successful. He mentioned cost accounting in the interview, and he used the terms “above and below the line” costs.

I then realized that costs “above the line” were the direct ones — salaries for actors, costs to build the sets, and so forth. “Below the line” costs were the general and administrative (G&A) costs for all other ancillary expenses. Gross profit margin (GPM) is what is left once you subtract “above the line” costs from revenue.

All about costs

Direct costs (materials, field labor, subcontractors and field trucks and equipment) are those expenses that can easily be directly attributed to the cost of performing a service or producing a project. Indirect ones are those costs that cannot be so easily connected to a specific service or project. Since all reasonable costs need to be passed on to your customers with an appropriate margin on them, the question becomes, “How do you charge your clients for your electric, rent, marketing bills and so forth?”

Cost estimating is all about estimating your costs (both direct and indirect) accurately. When estimating your costs and pricing your work, it’s important where you put your costs in your estimating model. Including indirect costs in direct ones or direct ones in indirect costs can cause you to calculate your costs too high or too low. If you overstate your costs, you’ll win less work in a competitive market. If you understate your costs, a competitive marketplace will give you plenty of work!

One area where this confusion takes place is including field truck and equipment (T&E) costs in G&A overhead (indirect) costs. Typical benchmarks for these costs as a percent of revenue are as follows:

Commercial maintenance contractors often price their work by putting all field T&E costs in their indirect G&A overhead costs and pricing work at a 50% GPM (G&A overhead costs [without field T&E costs] 25% + 15% NPM + 10% T&E = 50%). This can be accurate as long as your ratio of field labor and T&E costs remain the same. However, this 50% formula often isn’t accurate if you perform diverse types of maintenance work such as residential, municipal, recreational parks and athletic fields. It’s especially inaccurate for the pricing of enhancement work or larger installation projects.

Don’t underprice

When you put your field T&A costs below the line in your G&A overhead costs, you’re averaging these costs when pricing your work. As long as your jobs require this average amount of T&A costs, your pricing is accurate. However, when you migrate into other kinds of work, accuracy suffers and your pricing can be either too high or too low. Remember, the market ain’t stupid. If you underprice your work, it will give you plenty of work (to lose money on).

Think of it this way: You decide to simplify your pricing by putting all of your material costs (plants, trees, pavers, fertilizers, etc.) in with your G&A overhead costs. Customers can then pick and choose any plants or materials that they want for their projects. You estimate the field labor man-hour cost and mark it up 65%. What materials would your customers pick — the most expensive ones? The ones where you lose money and/or your margins are extremely low.

Let’s say that the politicians in your state pass a law where all hotels had to charge $100 per night (the price doesn’t matter) for any/all rooms. Where would you choose to stay? I bet it wouldn’t be at Motel 6. You would pick to stay at the Ritz-Carlton. If you’re willing to underprice your services or projects (or hotels, materials, etc.), you’ll get plenty of work.

During the recession of 2008-2010, I received lots of calls from contractors who were using the Dual Overhead Recovery System (DORS) where you put your T&E costs into your G&A overhead costs for the purpose of pricing your work. They found that they weren’t being competitive with their pricing — especially on enhancements and larger install projects. It was primarily because their pricing was inaccurate and included too much T&E cost. Once corrected, their pricing was much more competitive.

I actually average field T&E costs when I am pricing maintenance types of work where the ratio of field labor and T&E costs remain relatively constant. However, once I migrate to other kinds of work (enhancements, large install projects, athletic field maintenance, and so forth), I re-evaluate the cost structure for them — especially T&E costs. If you don’t do so, chances are that you’ll either underprice or overprice your work.

Travels with Jim follows Jim Huston around the country as he visits with landscapers and helps them understand their numbers to make smarter decisions. He can be reached at: jhuston@giemedia.com.