You Did the Work. Why Doesn't the Margin Show Up?

An individual named Bob runs an HVAC company. He has a dozen technicians and several office staff that keep the business running smoothly. They've had a productive week and have finished jobs without any hiccups. Everything within their control has gone as well as it could've.

Right now, however, Bob is sitting in his office, staring at an array of financial documents, shaking his head in confusion. "We've been profitable," he thinks to himself, "but why don't all these statements show that?"

Why HVAC Pricing Goes Wrong

The problem isn't bad work; it's bad math. Many owners, like Bob, often anchor to what a job "should" cost based on memory or what competitors charge. However, they don't always consider the four crucial elements that determine accurate pricing:

• Materials
• Labor at true cost
• Overhead allocation
• Target margin

Let's discuss each one in more detail.

Materials: Expectation Versus Reality

This one can be missed for several reasons. Maybe the supplier increased their price on something, and that wasn't accounted for. Sometimes after all the receipts are pulled from that material purchase, it's discovered that the materials costs, which were showing a markup of 25% on average, were actually marked up 35% to 40%. Upon deep inspection, none of the prices from the preferred supplier were confirmed prior to the project bid. That supplier had gradually raised its prices for the last six months, and no one had checked.

The following is an example of how this would play out in the numbers: materials had a projected cost of $1,000 before the markup. Per standard procedure, the company marked up the projected costs by 25%. However, no one had checked with the supplier, who had incrementally increased the material cost. The new cost of the materials was 10% higher than projected, so instead of making $250 on the materials, the company only made $150. A decrease of $100 in net profit might not seem like much, but compounded over 20 similar jobs, that small decrease will compound with each job. Also, since there is no oversight, the decrease will continue to grow as suppliers raise their prices.

That scenario, though not good, would not negatively affect the company. However, vendor markups are often not caught until long after the project is complete. Imagine the same scenario except that the vendor has increased the cost of the materials by 40%, so now the materials cost $1,400. That's $150 more than the company was planning to pay. If this occurred with just one job, it would be recoverable, but multiply $150 by the 20 jobs the company has scheduled for that week, and that's an additional $3,000 the company has to pay.

These hidden and unmonitored costs are most often the largest strain on cash flow.

Labor: The True Cost

This is where the biggest mistakes happen. True labor cost isn't just the hourly wage. It also includes payroll taxes, workers' comp, benefits, and unbillable time (drive time, callbacks, training). All of those things can add up to an additional $10–$15/hr more than the hourly wage.

To get to the true cost of a technician, a company needs to include payroll taxes (state and federal), workers' comp, benefits, retirement contribution, and any additional costs that are a direct result of the technician working. In addition to the aforementioned costs, there are additional costs from technician efficiency and overhead.

For example, a job has been bid for 50 hours with an average hourly rate of $100/hour. The company has set that rate because it's what everyone else charges. However, a deeper dive into the numbers reveals that the technician costs $38.50/hour, and the overhead costs for the project are $47.50, giving the company a margin of 14% ($700). This essentially means that if the technician works an additional three hours on the project, the net profit margin will drop to 11%. None of these changes by themselves seem large, but each of them will consume a job's profit if left unchecked.

Overhead: Proper Allocation

As mentioned above, overhead needs to be accounted for in the job estimate. It's often included in the hourly rate for a technician. Overhead costs are operational costs that are not directly related to the work performed. This includes office costs, software, vehicles, insurance, and owner salary. It all needs to be distributed across jobs.

The overhead rate per hour is simply the total monthly overhead amount divided by billable hours. So if a business owner pays $3,200 in overhead each month, and there are 1,600 billable hours in a month, then the hourly overhead rate is $2/hour.

Here's another example that shows how this subsidizes a business's fixed costs: let's say a company pays $7,000 in overhead in a month, and there are 1,600 billable hours. This means that the hourly overhead rate is $4.38. However, if the company is only able to bill out 1,400 hours, then the new overhead rate increases to $5/hr. For every hour that is not billed, the overhead cost increases.

Not sure what your true overhead rate is? Our HVAC Overhead Job Costing Calculator walks you through it in a couple of minutes.

Margins: The Goal, Not the Perk

Margin isn't a bonus; it's the point. Let's take a second and clarify the difference between markup and margin. Markup is how much a business owner charges above what they've paid for the services they're providing, while margin is how much of the customer's payment is left after all the costs have been paid.

Most companies charge a markup and call that the margin. However, the reality is the margin is often significantly less than the markup. This is why understanding the true costs of any project — known as the break-even number — is the first essential for business owners trying to build a profit into their jobs.

Bringing It Together

Let's take a deeper look at one of Bob's recent jobs. He installed three mini-splits on a job that was 30 minutes from the shop. The accepted quote was for $40,000. In preparing the quote, Bob estimated that each unit would cost $7,500, the site work would be $1,500, and the labor would be $3,200 (two technicians, five days), which would give him a profit of $12,800, or 32%.

After the job was complete, Bob calculated his margin and discovered that his net margin was closer to 15%. Upon further inspection, he noted that the units had cost an additional $750, the technicians had actually worked 10 hours of overtime, and the travel time to and from the jobsite cost an additional $600. That's $1,350 in unforeseen costs — not surprising. But then he looked at the costs of maintaining the shop and office, and discovered that those costs added up to $5,000 that had not been accounted for in the initial bid.

This is not an uncommon situation; many jobs do not account for indirect costs of running a business. It is, however, a solvable problem. That solution goes back to understanding and monitoring the business's costs so that quotes are accurate. Running each job through a repeatable process — like our HVAC Job Costing Calculator and Gross Margin Calculator — closes the gap between the margin you expected and the margin you actually keep.

Call to Action

Pull out your last three jobs and review each one for materials, labor, overhead, and margin. Most owners will find at least two elements they estimated instead of calculated. That's the gap between where your pricing is and where it needs to be.

If you'd like a second set of eyes on your numbers, schedule a complimentary consultation with Joseph.

Disclaimer: The information in this post is intended for general guidance purposes. For advice specific to your business finances or taxes, consult a licensed accountant or financial advisor.