High overhead costs could be keeping you from realistic profits.

Recently, my staff and I were trying to determine why one of our clients was not achieving realistic profits. When I asked the owner to calculate his company's overhead cost per hour, it was very high - and that was the problem.

You need to know your company's overhead cost per hour. If your overhead cost is $50 per hour and your competitor's is $25, for every eight-hour job, your overhead cost is $400 and your competitor's cost is $200.

Your competitor can sell the job for at least $200 less than you can. If your selling prices are similar, then your competitor is earning $200 more on the job than you are. Either way, your costs are much higher than the competition's.

How can that be, you may wonder, when labor costs and gas prices are about the same. If you think you've cut your overhead to the minimum, it's time to look at some other possibilities.

Let's assume that your overhead costs are similar to the competition. Then, if your competition is spreading their overhead costs among four crews while you spread it between two crews, your competition has a lower cost per crew.

Or, if your competition's sales volume is two to three times higher than yours, their overhead per sales dollar is much lower than yours.

So, what do you do about it? First, you need to know what your overhead costs are. There is no correct way to answer this question. I've based figures on space and labor costs because they are the two components that create overhead. The issue is to calculate it based on a method that you feel comfortable with and then continue to use the same method to compare it to years past.

Department discussions

Departments can be one of the greatest sources of discussion and disagreement among owners and managers. I've had managers in a room fighting over the dollars they are going to have to pay for each overhead item.

So the issue is how do you do it fairly so that each department gets its share of the overhead that should be allocated to that particular department? You might say just do it by sales figures.

If you have $1 million in new-construction sales and $1 million in service sales, service obviously has more overhead. However, if you calculated overhead by sales in this case, each would get 50 percent, which means that the service department wouldn't be getting its fair share and the new-construction department would be paying more. Don't use sales figures.

Either people or space causes overhead. There are five things that contribute to space expenses: rent, utilities, building maintenance, building taxes and building insurance. Determine the total amount of "productive" space used by each department. Productive space is the area occupied by either people or things related to revenue-producing departments. For example, your bookkeeping space doesn't count; your reception space doesn't count. The spaces that are used by financial people or other people who are not generating revenue do not count in this equation. The only areas that should be accounted for are those related to service, new construction, replacement or whatever departments you have.

For example, if you have a 5,000-square-foot building and of those 5,000 square feet, 1,000 are being used by the service and replacement departments and 3,000 square feet are used by new construction, that is a total of 4,000 productive square feet.

25 percent of the space-overhead costs are assigned to the service department and 75 percent of the space-related overhead costs are assigned to new construction. If the monthly rent is $1,000, then the service department gets charged $250 for rent and new construction is charged $750.

Next month I'll write about how people figure into overhead.

(Copyright 2004, Ruth King. All rights reserved. Write to Ruth King, 1650 Oakbrook Drive, Suite 405, Norcross, GA 30093. Call (800) 511-6844.)