by Richard Harshaw
In my last column, I discussed an important ratio for any HVAC business, the “M to L Ratio”, or the material to labor ratio. It was defined as the ratio between the company’s total expenditure for equipment and materials (condensing units, coils, furnaces, sheet metal, pipe, wire, etc.) and direct (field) labor. I pointed out that the higher this ratio, the better, as a dealership makes more money when it sells iron than when it sells just time.
So how can you bid jobs in a way that helps you get those high material jobs? By putting all your overhead on labor and just marking up the job costs for net profit!
There are two ways to do this: based on history and based on a forecast. I’ll cover the historical method in this column.
In the historical method, you use your last fiscal year’s income statement (P&L) and extract the total costs for overhead and the total costs for direct (field) labor. (If you can generate a departmentalized statement, the better! Then you can derive the ratio by department, and you will notice that it changes from department to department.) Let’s call this ratio the Overhead to Labor ratio (O to L). And we’ll call the bid method that uses it COWL (for “covering overhead with labor”).
Example: Fester Fonebone’s departmentalized P&L for 2008 showed installation overhead of $248,567 and installation labor of $133,923. His installation O to L ratio would be $248,567/$133,923, or 1.86. (On the service side, he ran overhead of $109,356 against labor of $93,256, for a ratio of 1.17. Had he not departmentalized his books, his ratio would have been 1.58.) He also computed the M to L ratios in both divisions and got 2.27 for installation and 1.08 for service.
So how could Fester use this knowledge at bid time?
Suppose he has a job to bid. His take-off gives a total for material of $78,356 and he estimates labor at $9,037. He runs a quick job M to L ratio and gets a whopping 8.67. Since this is way above his 2.27 historical ratio, this job is a MUST-GET job, as it will strengthen his overall M to L ratio. If he bids it his normal way—dividing the job costs by the quantity 100% minus the sum of his overhead and net profit—he would price the job at $136,552. But using his knowledge about his O to L ratio and the COWL factor, he figures the job price this way:
Labor $ 9,073
Overhead ($9,073 x 1.86) $16,876 <<< — the COWL factor!
Total job costs $104,305
To make 10% net, divide by
0.90 for a bid of… $115,894
This is $20,658 less than his normal method! Would that make a difference on this job? It certainly could. It could spell the difference between getting the job and losing it.
I have taught this method to thousands of contractors over the last 20 years and I know it well enough to tell you that the higher the job M to L ratio, the more drastic the difference in job bids between the COWL method and the normal divisor method.
In fact, you may have a job that you think would normally bid at $25,000, but your experience says the market will go to $20,000. You agonize over whether or not to bid the job. You then run a COWL price and get $16,000 and realize you COULD bid this job and be very competitive. Do you bomb the market with the $16,000 figure, or hedge your bet and bid it at $18,000? You’d probably win the job at $18,000 and make $2,000 more profit on it than the COWL method allowed for. That would be sweet, wouldn’t it?
I’ll cover the forecast method in the next issue, as it gets a little trickier.
Meanwhile, try computing your M to L ratios (by department, if possible) and then your O to L ratios. Take a few jobs that you bid on recently and run them with the COWL pricing method and compare them to the bids you submitted. Would the COWL method have helped you on a job you may have lost due to price?
This method will probably raise a lot of questions in your mind. If it does, email us at email@example.com and we will work on an answer for you.