Calculating a Shop Labor Rate

      What shop labor rate will enable this cabinet shop turn a profit? Here's an extensive and detailed discussion of setting a realistic value on labor time. March 4, 2006

Question
We have 5 people in our shop (3 full time cabinet guys, 1 bookkeeper/secretary, and myself who handles sales and administration, but occasionally builds in the shop).

I rounded up our costs in every category, figuring the little extra would add to the bottom line each month. I figured it as follows:

Overhead: $10,000 (includes mortgage, insurances, all utilities, my salary and bookkeeper's salary)
Labor: $20/hr per guy (this includes taxes) plus 33% of non-productive time at $6.50/hr (the $6.50 may be high, but again I'm trying to be very conservative)
Consumables: $300/month
Machinery payments: $400/month
Misc. expenses: $1,000/month
Profit: $4,000/month

So the way I see it, if I add up the overhead, consumables, misc. expenses and profit, it comes up to $15,700/month. I then divide that by 3 guys which comes up to $5,233 per guy. That number gets divided by 160 (40 hrs/week X 4 weeks) = $32.70 per hour. I add the $32.70 to the labor cost of $26.50/hr and come up with a shop rate of $59/hr.

We then price our work by adding up the materials (usually very accurate) and finishing costs (we sub our finishing so that cost is firm, also) to the labor costs (number of hours to build X shop rate).

The key to profitability, as I see it, is estimating the time to build accurately. I try to be conservative here also, because I know everything takes longer to build than one thinks. If we finish on time, or heaven forbid early, I should reach my profit goal. What am I missing?

Forum Responses
From contributor C:
Is the $6.50/hr for non-productive time figured at 33% of the $20 per hr employee rate? Also, I know you're being generous with your figures… How accurate is 33% non-productive time? What are other shops' figures for this? 25% seems very generous to me.



From contributor I:
I'm confused by your profit statement. Why is your profit margin a fixed monthly amount instead of a percentage of each job?


From contributor C:
I think he used a previous month's profit to come up with that figure. You probably would update your shop rate each month if that figure changed by much. If you based it off every job, that would be more accurate, but more of a hassle to do. Some shops would be changing their rate daily. A one person op would be okay, for you would only have to recalculate every couple of weeks or so. I think...


From the original questioner:
Yes, the $6.50 is 33% of the $20. I figured that it isn't possible for every man to be totally efficient on every job. I also believe it helps me in meeting the time to build each project. As far as the profit amount, that is the amount above and beyond my weekly salary, which is relatively small, that I want to make each month. That doesn't mean I can't charge more for any individual job, but by charging the $59/hr and meeting my project deadlines, I would guarantee myself at least that much.

Are my formulations correct or close to it? If I'm way off in my thinking, please let me know. What this post is about is trying to make money. Nothing more. I was hoping that maybe some of the guys who ran successful shops could give me a little feedback, positive or otherwise.



From contributor J:
Bit off thread, but that $10,000 monthly rent, salaries, etc. looks like a tough nut to crack for a 3+ man shop.


From contributor P:
"Labor: $20/hr per guy (this includes taxes) plus 33% of non-productive time at $6.50/hr (the $6.50 may be high, but again I'm trying to be very conservative."

20% is probably closer.

"So the way I see it, if I add up the overhead, consumables, misc. expenses and profit it comes up to $15,700/month. I then divide that by 3 guys which comes up to $5,233 per guy. That number gets divided by 160 (40 hrs/week X 4 weeks) = $32.70 per hour."

That should be x 4.33 weeks or 173.2 hours = 30.21.

"I add the $32.70 to the labor cost of $26.50/hr and come up with a shop rate of $59/hr."

Sounds a little low, judging by the cost of your labor. You might want to consider 65-70. If you consider an average of 100k per man, sounds like your numbers should work.

"The key to profitability, as I see it, is estimating the time to build accurately. I try to be conservative here also because I know everything takes longer to build than one thinks. If we finish on time, or heaven forbid early, I should reach my profit goal."

Exactly, check every job when finished to see how your estimate compares to your actual time. Basically, you're trying to reverse engineer your P&L statement. If each estimate is a smaller picture of that statement, you're okay. But in order to do that, you have to mark up your material accordingly.



From contributor L:
One thing that helped me understand all the costs involved was to go back over the YTD expenses. Or review last year's expenses. I found things were quite higher than I budgeted for. For example, the cost of vehicles. By the time I added in oil, fuel, insurance, repairs, tires, etc., it actually came out much higher than I estimated. I also was quite surprised to find that "supplies" was such a high percentage of costs involved.

I also think the $59 is a little low. That might be the actual cost, but I'd charge a little bit more ($65?). You could ask some of the other shop owners in your area what the going rate is for shop time. Remember, you should sell stuff for as much as people will pay, not the lowest dollar you can. It's a free market and the customers will ultimately set the price at which goods and services will sell, regardless of the cost to produce.

I know that might sound crass, but I finally figured out that I was taking money from my wife and kids and giving it to strangers when I was trying to sell everything for the lowest dollar. As long as I have a backlog of work, I'll continue to slowly raise labor rates until my supply reaches their demand. Then I'll adjust from there as needed to keep the shop busy.



From contributor S:
When calculating billable hours, remember to account for the following. Vacation time, holidays, sick/out days. Based on 3 shop guys, this would be the billable hours I would calculate.

52 weeks x 5 = 260 days
-10 days vacation
-6 paid holidays
-4 misc. off days (sick, etc.)
240 total work days
75% of that time that is productive billable hours
or
180 days x 3 men = 540 days
540 days x 8 hours = 4320
4320 billable hours a year
4320/12 months = 360 billable hours per month

Now your labor rate costs 20 an hour, but that is for all hours.
20 x 40 hours a week = 800
800 x 3 men = 2400
2400 x 52 weeks = 124,800
124,800 per year labor costs
15,700 x 12 months = 188,400
188,400 a year overhead
+124,800 a year labor
313,200/12 months = 26,100
26,100 a month/360 billable hours = 72.50
This would make your hourly rate $72.50 per hour.



From contributor P:
If you assume all of your profit and overhead is going to come from labor, you could have a problem if you do a job with expensive material and little labor. In this situation, your O/H and profit will not be covered.


From contributor A:
I take it you are setting your hourly rate for T&M jobs. None of your numbers reflect the reality of our business. If you are estimating based strictly upon your shop rate, you are going to be way off your eventual gross for the year. Your numbers do not reflect the markup we all place on labor and material when doing fixed price contracts.


From the original questioner:
You're right. I just went back and recalculated the numbers by going over the Quickbooks figures for the past year. The true numbers were:
Overhead: $11,514
Consumables: $300
Misc. Expenses: $1,650
Tools: $200
GAS!!!: $500
Total: $14,164
Plus Profit = $18,164 per month

So if I recalculate my formula, I end up with a $64.35/hour rate (that sounds better.) This is what I am considering my bare-bones number. I can and will charge more whenever possible, because I don't like leaving money on the table any more than you do.

Contributor S's formula looks like it makes sense, but his rate adds up to $79.35/hour with the new costs. No offense, but I hope your formula is off, because that rate would be a little hard to swallow.

A question for contributors P and A. If I use my formula, which would cover all my costs (labor, overhead, profit), and add it to the materials I'm using for any particular job, whether it's made out of 2X4's or mahogany, how can it throw my numbers off if I accurately estimate the time it takes to build? When I come up with an estimate, I always build in working loss and waste. Granted, I understand that marking up the materials only adds to the bottom line, but what I'm looking for here is a gauge so that I (and only I) will know what price I cannot go below. If it takes me 4 hours to build a breadbox (unfinished) made out of scraps from the trash, that breadbox would sell for no less than $260 (4 hrs at $65). The same breadbox out of mahogany would still take 4 hrs to build ($260) but I would add the cost of the materials. The profit remains the same.

Please don't take this question as being argumentative. I'm using an exaggerated example, but I believe it applies to any project you are building if the only thing you change is the price of the materials. I really am only trying to get my thinking cap on straight on this issue.



From the original questioner:
Contributor S, a little follow up on your formula with one minor tweak. Tell me if this is skewed thinking. I used all of your numbers, which definitely made sense, but changed the billable hours and increased the hourly rate, which had the non-productive time built into it. Therefore, I considered that the guys would be in the shop for their full 8 hours each day, but I would be paying up front the extra $6.50/hr (33% of the $20 hourly cost). Also, the guys only get 5 paid holidays and I calculated an additional 6 misc. lost days.

52 X 5 days = 260
-5 vacation
-6 misc. =
249 days
249 X 3 guys = 747
747 X 8hrs = 5,976hrs
5,976/12 = 498 hrs per mo.
Labor
$26.50 X 40 hrs = $1,060
$1,060 X 3 guys = $3,180
$3,180 X 52 = $165,360/year
Overhead
$18,164/mo X 12 = $217,968/year
$217,968 + $165,360 =
$383,328
$383,328/12 = $31,944/month
$31,944 per mo./498 billable hrs =
$64.15 per hour

What do you think? It's $.20/hr off my other method, but they could both be completely out of whack.



From contributor P:
For example, say you buy the bread box from someone else for $100.00 as part of a larger job. Let's say you have to do the finishing of the bread box, and this takes 2 hours. So you quote the job at your rate of $65.00 per hour and add on the cost of the bread box, and you get $230.00.

Let's say you make 15% profit on your hourly rate or $19.50 on the job. $19.50 is 8.5% of $230.00 At the end of the year, your sales could look real good, but your profit would not be there.

A more realistic example would be working with Corian, where your material costs are high in comparison to your labor. Another one I have seen is the silkscreening business, where they only get $1.00 a print on a tee shirt. They have to take the risk of ruining the shirt and are only profiting on the silkscreening portion of the job. Risk should = Profit. If you buy expensive material or components, the risk is still there. You should profit from the transaction.



From contributor C:
"Then you could have a problem if you do a job with expensive materials and little labor. In this situation, your O/H and profit will not be covered."

Contributor P, wouldn't the overhead associated with these types of jobs be lower than usual? What about your 30% or so materials markup?



From contributor S:
Based on your paid days off, yes, your formula makes sense. I would like to comment on your total amount of working days.

"Also, the guys only get 5 paid holidays and I calculated an additional 6 misc. lost days."

52 X 5 days = 260
-5 vacation
-6 misc. =
249 days

From these numbers, I see you are not calculating either paid holidays or miscellaneous sick/off days. 5 vacation days plus labor day, memorial day, July 4, Thanksgiving, Christmas and New Years would be a total of 11 days. I say 240 days because of 2 weeks paid vacation instead of one. You say 249, so take off the one week paid that I figure and you would still only have a total of 244 days.

So:
244 x 3guys = 732
732 x 8hours = 5856
5858/12months = 488
31,944 per mo./488 billable hrs =
$65.45 per hour
So to calculate for the 5 day discrepancy, you would only add $1.30 an hour or only a 2.03% increase.

Contributor P also makes a very valid point. This is only calculating profit on labor and overhead. It roughly calculates to 14-15%. You also must add profit onto all materials. Calculate net materials, add waste factors, then add profit. I would say that 15% would also be the minimum markup on materials. Customers can't go out and buy what we buy for the prices we can. Why should we not make money on them? This is the point of all businesses.

Contributor A also makes a very good point. What the market will bear. These figures should be the bare minimum that you charge. For more unique projects or when other factors make it possible, always try to get more.

Also, one more thing. You posted that you pay yourself a small salary. If I were you, I would figure out what it would cost to replace you with employees and recalculate your numbers. Most owners would take 1-1/2 to 2 full time employees to replace. Whatever the cost would be to replace you is what you should be paying yourself as a salary. With that in mind, I would say your target hourly rate would be in the mid to high $70/hour range. Charging $65.45, you will be doing okay, as long as all your other numbers jive. However, you should be calculating what it would cost to run the company by itself without your daily involvement. It does not mean that you actually have to stop working, but this assures that if you decide to continue to work in the day to day operations, that you are compensated accordingly for it in your salary plus the almighty profits.

Another comparative benchmark for seeing how your hourly rate works in your market would be to see what plumbers and electricians are charging per hour. Your rate should be more. We have roughly the same costs as these trades plus the additional costs of carrying the shop space (rent/mortgage, heating/cooling, building and contents insurances, waste disposal, etc.).



From contributor A:
To the original questioner: Maybe I'm way off on this view, but when calculating my annual (which I believe is maximum of change) increase in shop rate, I am not calculating based upon last year's overhead. I am trying to anticipate my future overhead. At what point should I raise my rate? Liability goes up 20%, auto 20%, health (you can never guess too high with this one), fuel (auto and heating). My heating fuel bill will conservatively double this year. I've got to build a big white kitchen (spraying 4 coats) in December/January.

The expensive material argument is very complicated at the least. (A complicated cherry/mahogany kitchen has very high material cost, yet also has a high labor cost. The same kitchen built out of maple would have a lower material cost, but the proportion of markup on the material makes this irrelevant.) Besides, if I am working with SS or teak or any really, really expensive material, I either throw in a stress/screw up factor on contract, and I actually charge a higher shop rate if done T & M (normal rate $65 vs $75 teak rate). At the very least, the customer should be told up front we will take our time cutting $15 bd/ft wood.



From contributor P:
One more small point on this subject. If you buy into the idea of reverse engineering your profit and loss statement, then make sure you divide for profit for labor and material. In other words, if you want the profit to be 15%, divide by .85
100*1.15=115 or 13% profit
100/.85=117.65 or 15% profit


From contributor B:
Be careful of the term "markup". What does it mean? Overhead, profit, both. Instead call overhead, overhead and profit, profit. Don't forget your insurance and taxes in your calculations. As a point of reference, a miscalculation of $ .50 in your hourly rate for a 3 man shop would equal $2,916.00 per year out the window. The average miscalculation is $3.00 per hour. That comes to $17,496.00 for a 3 man crew.


From the original questioner:
I started this post because I have found that most of the small projects we have been doing don't seem to make any money. We have always charged a good amount for the larger projects, but I always had a sneaking suspicion that the smaller jobs were becoming a major drain.

Looking at the historical data of the last dozen or so projects shows me that all the kitchens, and some of the entertainment centers and libraries, have had a much higher hourly rate than $65. It's just those gosh dang little projects that I have had a hard time charging what needed to be charged for them. I'm sick of giving them away, ergo the new shop rate which is now our new minimum on all projects.

P.S. We don't have heating oil costs in south FL, so no need to work that one into the budget.



From contributor A:
No air conditioning in balmy Florida? I hate to hear people suffer.

I have read a lot of business books directed specifically at contractors. (That's besides the umpteen general and cabinet industry books.) Here's one interesting number I will always remember. Take a typical small contractor (under, let's say, 1-2 million gross). That company might have 4 carpenters and decent management. According to a few books/magazines, the most profitable projects are often the $12k decks. 2 carpenters, 3 weeks. They typically have less callbacks and you are in and out real quick. The bigger jobs often get slowed down by so many things they just eat up your time. They quote 25% profit vs. 12%.



From contributor G:
Shop rate? Usually it is total overhead plus 20% profit. Down time is total loss, not 33% of loss. So, down time eats into your profit, no? I did my number a year ago and my overhead was too low, so my hourly rate came to below 40 an hour.

Learning a thing or two from this forum, I adjusted my rate until my client base improved. Cheap rates attract cheap clients, you see. I think it is more important to find your marketable rate than a "shop rate."

My point is that if you come out at 59 an hour, you could possibly push it to 66. That way, you make more profit to fill in the money lost on idle time. And be competitive. You don’t want to be the cheapest guy on the block, because you will be inundated with problematic clients. Also if you’re the highest priced guy on the block, you could end up short unless you’re a marketing god and can pull it off.

So work out total cost of your business and add 20% for profit and then raise the rate until you find your marketable rate.



From contributor D:
To the original questioner: Your formulas are basically good. Contributor A's point about using next year's numbers is important, so use last year's as a base and add any expected increase. Also, make sure you are not missing any expenses and include machinery/tool purchases, repairs, and upgrades.

The biggest question I have about how you combined contributor S's formulas and your own has to do with how you are accounting for non-productive time. You are adding $6.50/hour to compensate for lost time, but you are not actually paying that much. Then you calculate billable hours as if everyone works 8 hours per day. You are allocating your overhead based on 8 hours of production each day, but if you lose 25% of the time to non-productive tasks, the overhead (as well as the labor for those non-productive tasks) has to be borne by the 6 productive hours each day. In other words, contributor S's numbers are more accurate, even if they are higher than yours (and even if they are higher than you can charge and keep work coming in).

If you are not keeping track of productive vs. non-productive hours, you need to start now. Just as a $.50/hour miss on the labor rate adds up to thousands each year, so will a bad guess on the labor efficiency. You need to know how many productive hours each person will contribute over the year, not guess.

Also, I would remove the shop supplies from overhead - if you had no jobs you would need no supplies, so that's a job cost, not an overhead cost. That's where the material markup comes in. I markup a minimum of 15%, up to 25% if I can get it, and I expect that to cover shop supplies, tooling, sharpening, small tool purchases, and even a little profit. The better you can keep track of all these expenses and hours, the easier it will be to fine-tune your numbers every few months.



From contributor H:
There are lots of different ways to calculate the appropriate minimum charge. And most of the contributors are right in what they say. I am learning a lot.

I used to sell very high end auto repair shop management software and do a little advising. Auto repair is also T&M business, although the T/M ratio is typically 50-60% M (parts). But the principles are very similar. I always advised shops to charge a fixed percentage of labor to cover shop supplies with a threshold. In auto repair, rags and chemicals were considerable costs - typically 5% of labor. I am too new to WOODWEB to know your business well, but I suspect that it should be a relatively easy sell. [Note: I hated the idea for my shop! I caved because I could reverse it easily and I wanted to prove that it would antagonize customers. Not one customer mentioned it (I did have a sign posted explaining what it covered), and when I explained, he thought it made sense.]

If you don't charge it as a line item, then you need to add it to your overhead. Overhead included everything - rent, phone, interest, accounting, signage, cleaning, parts guy, etc. I recommended calculating OH costs and total worked (not billable) hours every year. Dividing OH by actual hours gave me OH per actual hour.

Since I knew the costs of all parts and sublets, and I knew exactly how many actual hours the shop had invested in the job (the SW had a time clock, of course), I could juggle parts prices, labor charges, and sublet charges until the gross profit per actual hour was acceptable (or I realized we had screwed up and the job was a loser).

Advantages of this system were that my total focus on GP/ActHour freed me from worrying about productivity, or parts margin, or whatever.

Illustrations:
1) If I sold a $1200 exhaust system with a 25% margin (considerably lower than my average) and only billed 2 hours for 3 hours spent, I knew I was still making money (I would have loved 10 jobs like this every day!).

2) I had a nut case who found a "click-click" annoying. It would only happen over medium-sized bumps at moderate speeds. 30 hours later (all billed!) I squeezed the forked door-restraining strap to cure the problem. I also re-installed his dash properly (the dealer had done a lousy job, and it made lots of noises - but they didn't bother the owner). 30 hours billed ($1500), 30 hours actual ($500), no parts or sublet profit, and this deal stunk ($33 GP/ActHr). My target was $50 minimum (typically there would have been 40% of GP on $1500 worth of parts which would have meant $53 GP/Act Hr).

Side note: one shop that did normal repairs and restoration started using this system. A year later they had almost stopped doing restorations - it became obvious that it just wasn't as profitable.

Another benefit of this system, in my case, was that it made me more professional and more confident in my billing. Lots of jobs had very rough estimates - you just can't know how long it will take to find a mysterious noise or electrical problem. I seldom billed under 90% actual time - after I discussed the reasons and the actual hours spent with the customers. Within two months of using this system, productivity went from 70% (pretty typical in AR) to 90%.

So, in conclusion, information is key to knowing what's happening and it can be useful in talking to your customer when problems do arise. Also, it is crucial in educating you so you are less likely to make the same problem again.



The comments below were added after this Forum discussion was archived as a Knowledge Base article (add your comment).

Comment from contributor A:
I've looked at most of these posts and have not seen the most logical way to add in your profit. Take your overhead, fixed costs, and labor and that is your hourly rate. Total your materials and add a markup that reflects the profit you can manage on the job, given market position etc. I usually use a divider as mentioned in a few other posts of divided by .8,.75, .7, or if I'm feeling lucky a .6. I find that on smaller jobs I'll tend to use a larger multiplier, but most times the percentages just aren't there to make as much in terms of dollars. I do find a bit more information is available when using a divider on materials. You can manipulate the number easier and your fixed costs are covered.



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