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The average crew wage needs a bit more explanation. Step 1 is to add the wages of the individual workers expected to work on the project and divide by the number of workers; Step 2 adds the labor burden. The concept is to find an average crew wage because this ties in directly with the information from Figure 6–7. An average crew wage is the average paid to one worker while the time required per task is the amount of time required for one worker to complete the task. If K&K Contracting decides to place one two-person crew on the project, the wages of the two workers are $18.75 and $12.50:
Step 1: ($18.75 + $12.50) ÷ 2 = $15.625 per hour = average crew wage
Step 2: $15.625 × labor burden percent from Figure 6–1
$15.625 × .421 = $6.58 = average labor burden per employee
$15.625 + $6.58 = $22.21 per hour = average crew wage
Therefore, we entered $22.21 in Row 11 of the spreadsheet and used the time per task information to calculate the total cost of labor for the project (Row 12).
The method used in this example is very beneficial because it can be used even if the number of workers on the project changes. Using the spreadsheet, it was determined that it will take one worker 22.60 actual hours to complete the project; with two workers the project should be completed in 11.30 actual hours. Should the owners decide to add another two-person work crew, they’d be free to do so without worrying about the effect on the bottom line.
“The worst crime against the working people is a company which [sic] fails to operate at a profit.”
—SAMUEL GOMPERS, WHO FOUNDED THE AMERICAN FEDERATION OF LABOR IN 1886
Budgeting is one thing, but spending is another. For example, you may have budgeted $5,000 for advertising and marketing. The question is which is the most cost effective, efficient way in which to spend that money? Major corporations spend a great amount of time determining the most efficient ways of spending money. You want to find cost-efficient ways of purchasing items and paying for services, but you will also need to determine how these choices will or will not benefit your business. Like playing a game of chess, you need to consider the repercussions of each move before you make it. This makes the difference between efficiently and inefficiently run businesses.
Thus far we’ve discussed only the cost of doing business, without regard to revenues or profits. You’ve learned that there are costs that are directly related to the process of implementing a project; then there are overhead costs, some of which are related to the direct costs and others that will be incurred regardless of the amount of direct costs.
Profit is what you have left over after paying all of your expenses. If you were to study the income statement of a large corporation like the Walt Disney Company, you’d find columns and rows with data showing “gross profit,” “operating income,” “income before tax,” “income after tax,” “income before extraordinary items,” and “net income.” The discussion of these items is left to the accounting professors. The focus here is on net income.
stat fact
According to industry sources, the average net income as a percentage of revenues within the contracting industry ranges from 3 to 5 percent. This means that a company with $1.2 million in revenues can expect to have a net income, after all expenses, of between $36,000 and $60,000.
However, net income is not the only measure of financial success. Investment advisors and specialists consider many factors when studying the financial statements of corporations. Again, it can be a very complex and time-consuming process to understand the profitability and success of a business. For our purposes here, we’ll keep it simple. While every owner must determine what level of profit is acceptable, we’ll use 12 percent as a profit goal when pricing services. Using this as a benchmark will allow for payment of year-end bonuses or dividends, upgrading buildings and equipment, and building up an emergency fund.
Accountants, financial officers, and investors study financial statements in many different ways. I’ll touch on three terms that sound similar but are quite different. While there are no “magic numbers,” it may be an interesting and useful exercise to track these ratios on an annual basis. If the ratios increase, you can smile; if they decrease, don’t frown—just work harder and more efficiently.
1. Return on equity equals net profit after taxes divided by stockholders’ equity. It measures a company’s efficiency at generating profits from dollars invested in the business. Return on equity is irrelevant if earnings are not reinvested in the company.
2. Return on assets equals net profit after taxes divided by total assets. It’s an important gauge of profitability as it gives insight into the ability of management to generate profits from the assets available to the company.
3. Return on capital equals net income after taxes divided by long-term debt plus common stock. It is a measure of how effectively a company uses the money, both borrowed and owned, that is invested in the company.
The question is how to determine the price to charge and make a 12 percent profit. If you refer to Figure 6–8 on page 82, we see that the break-even point for the project is $1,996. Many people would venture a guess and say “to make a 12 percent profit, just multiply $1,996 by 12 percent and add the two numbers.” Well, they are wrong. If you just read this sentence and shook your head, you are not alone. Now read the next sentence carefully and memorize it:
To make a 12 percent profit on a project, divide the break-even point by one minus the desired profit (shown as a decimal).
Read it again. To make a 12 percent profit, you divide the break-even point