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Labor Costing - Part I - Sep 13, 2008

Posted by: Keith A. Simmons in Articles

Billable Labor Hours

Is it possible that 90% of small and mid-size businesses are subject to incorrect costing? Surprising and disturbing, but that's been my experience. Cost estimating is often a poorly understood science. And if our cost estimates are incorrect how do we accurately price products and services, or determine profit margins? Or prepare a realistic budget? And if price is market driven, how do we determine if we are operating at sufficient profit?

When pricing is based on erroneous estimates a company will lose orders due to overpricing or capture unprofitable sales due to underpricing. In either scenario it is the competition who benefits and it is you who will eventually close your business. Since we are not in the business of aiding the competition, we need to take a good look at our costing model.

Cost estimating needs to be a clearly defined process, and by following the proper steps we will achieve accurate estimates. So how do we identify the necessary steps?

Today we document a procedure that allows us to identify the number of labor hours available for sale. But first, can you guess how many billable hours are available from the average employee in one year?

Your estimate here: _________

Now put that costing hat on, open up your cost estimator notebook and we'll fine tune that estimate!

Billable Labor Hours Worksheet

In our example we have an employee who is paid 40 hours a week, receives 3 weeks vacation, 10 paid holidays, 8 paid sick, and as we are one of the more benevolent employers they also receive bereavement pay and a few days off for good behavior (no overtime in this example). We find that a sizeable portion of payroll and benefits are paid for hours not worked.

Total Hours Paid 52 weeks x 40 hours = 2080 hours 100%

To calculate the Non-Worked hours:

Vacation 15 days x 8 hours = 120 hours

Holiday 10 days x 8 hours = 80

Sick 8 days x 8 hours = 80

Bereavement 3 days x 8 hours = 24

Other time off 2 days x 8 hours = 16

Total Non-Worked Hours - 320 -15%

Leaving us with Total Available Hours of 1760 hours 85%

So, we pay our employee 100% of the time while they are available only 85% of the time.

But wait, there is one final step in our labor hours costing process. At best we are in the position to bill 1760 hours to our clients (assuming we bring in enough business to keep the employee productive at all times), but this is rarely achievable. What other factors come into play? These will vary depending on the type of business and would include non-billable hours committed to administrative tasks, clean up, tardiness, etc. Manufacturers face machine inefficiencies and machine downtime that are non-billable. If we estimate these items require only 3 hours per week, we calculate:

Additional Unbillable Hours 52 weeks x 3 hours = -156 hours -8%

Total Billable Hours (also known as Chargeable Hours) 1604 hours 77%

It is important for owners to bring in enough new business to keep employees productive every hour they are available to us. If we work IN the business rather than ON the business we can be sure there will be times when there is not enough work for our employees (the Billable % will further decrease), but we will continue to pay them. Hiring anything less than highly qualified individuals, not having well-trained and competent employees, and having outdated or inefficient systems and procedures will cause us to hire additional employees to offset these added inefficiencies. This further adds to our costs and erodes our profitability. Owners who surround themselves with experienced advisors and effective systems are able to maintain a pro-active management approach and thereby ensure their company's operational and financial success.

In Part II we'll look at the true hourly cost of our employee.
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A B2B CFO helps business owners work ON the business. I work with owners to create timely and accurate reporting systems and build an effective infrastructure that allows owners to keep their finger on the Pulse. Owners are then freed to do what they do best... create goals and build their businesses! In B2B CFO terminology, you are the FINDER. Finders create businesses and maintain and build new customer relationships to ensure the future of their business. Our book "The Danger Zone" is filled with case studies of the problems faced by owners working IN the business rather than ON the business, and provides practical solutions to help you avoid these dangers and improve your opportunities for success.
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