|CWB March 2001
Making It Pay
Profitability through record-keeping and analysis: Step two.
By Anthony G. Noel
Last month, I related an all-too-common story about a woodworker who was totally stumped by the fact that his business was not making money. He was ready to raise his prices because his competitors said his prices were too low. But he hadn't tried to figure out his costs for himself.
I hope that at least a few readers can honestly answer, "Not anymore," because if you can, that probably means you've begun tracking the time you spend on specific tasks for every job in your shop. That's the first step on the road to profitability, and if you've taken that step, you're to be commended for it.
As this series continues, we'll look at establishing a base hourly rate in the shop; how to factor in overhead to attain a total rate; and how administrative work like customer service, sales, design and other office functions fit into the picture. All these issues are closely related, and this month's installment is devoted to recognizing and tracking the two types of labor practiced in every manufacturing operation: direct labor and indirect labor.
Last month we discussed the importance of developing a form listing all project-related tasks. Such tasks are known as "direct labor." It's a simple term to remember, since the tasks in question are directly related to the project in question.
You will spend a certain amount of time cutting, machining, assembling, finishing, delivering and installing every project you do. A form listing all direct-labor operations (from receiving materials to sanding) and their subcategories (from specific types of machining to the fabrication of subassemblies, like drawer boxes) allows you to accurately track the time spent in manufacturing any job. And using the same form on the front end for estimating makes the task of comparing your estimate to reality, when the job is complete, much simpler.
But how should you account for things that may not be directly related to one specific job? For example, phone calls you pick up while working on the Smith project may have nothing to do with that job. You can't include the time you spend on miscellaneous office functions in your analysis of the Smith project, so how do you make sure you are getting paid for them?
Similarly, you're not going to close every sale. Should you just give away the time you spend on "dead-end" sales calls and estimates?
And what about rent, electricity, trash removal, professional fees...in a word, overhead?
Let's begin with the matter of miscellaneous office tasks. Let's say that you are working at your bench when the phone rings. Whether you pick up the call or let your voice mail take it, that is time you will spend, be it now or in the near future, on something other than the Smith job. It's a perfect illustration of the line between working in the shop (direct labor) and in the office (indirect labor), which are distinctions you must deal with properly if you are really interested in making money. (You ARE in business to make money, aren't you?)
Indirect labor is time spent at work that you can't reasonably assign to a specific job. "Free" estimates, phone calls and a whole galaxy of administrative work fall into this category, which is a subset of the larger universe known as "overhead." To accurately charge and account for overhead, you first need to come up with a realistic idea of the number of hours worked in your shop each year, which count as "direct" labor. Doing so will allow you to distribute indirect costs across the whole of your annual production - or, put another way, it will allow each customer to "pay" an equitable share of your indirect costs.
Whether yours is a one-man or many-employee operation, you need to make an accurate estimate of the number of man-hours that will be worked as direct labor over the course of a year. To keep things simple, we'll illustrate on the basis of a one-man operation; but the basic rules about direct and indirect labor hold, no matter how many employees you have.
Let's say you are the whole show: You hunt down the work, design it perhaps, estimate it, put together a proposal, sell it, build it and install it. You likely work a minimum of 50 hours a week (I hear you solo owners out there saying, "Don't I wish! That'd be like a vacation!), more often something like 60 or 65.
The total number of hours you work per week is not that important (except, years from now, to your psychologist.) What we're interested in at the moment is how many of those hours, typically, you are devoting to direct labor on specific jobs, versus all the other stuff you do that just comes with being in business for yourself. And just as the tracking form we discussed last month is the best way to get an accurate picture of how long certain shop operations take, the only way you will get a good idea of direct versus indirect labor is by tracking that as well.
I can't stress strongly enough the importance of tracking your time over the course of several jobs. It would produce inaccurate (potentially grossly inaccurate) figures if you do it for just one week or just one job. Workflow patterns in any shop can be unpredictable; in a one-man shop, they can be downright ridiculous.
Start-up, one-man operations can find the owner spending weeks on end just on direct labor, then a full week or more prospecting for, pricing and selling the next job. Owners of established shops tend to balance these extremes better; they may work on projects pretty much all day, reserving a couple of hours to deal with administrative tasks.
But even in shops where things flow on a somewhat predictable basis, the unexpected can occur. The only way to account for as many circumstances as possible and to smooth them into an average you can apply over time is by taking the time to chart your hours, looking at what happens over a reasonable period. Otherwise, you are pretty much guessing.
Another word of caution: Even if you do have a predictable schedule for time in the shop versus time in the office, and even if you follow it religiously, you still need to track actual hours devoted to direct versus indirect labor. Deciding that your eight hours in the shop are all direct hours and your two in the office are all indirect will, again, lead to inaccurate results. That's because certain shop tasks can actually constitute indirect labor (i.e., tool maintenance and repair, and shop cleanup to name just a couple), and some office tasks can be counted as direct labor.
(For example, a customer who calls you every five minutes is something you'd want to consider direct labor. It may not help the job look profitable when all is said and done. But the next time you work for this client you will know to include plenty of room in your pricing for the constant interruptions and phone consultations.)
We are going to all this trouble, making this effort to get a realistic handle on direct versus indirect labor, in order to establish our shop labor rate, which must account for all our labor costs, both direct and indirect. We separate the two, just to refresh your memory, so that indirect costs can be shared equitably by all our customers.
So here's your assignment for the next month: While you continue to use the task tracking form in the shop, make note on a separate form of the actual time you spend on direct and indirect labor. Make up a form yourself, and keep it simple.
If you stick to the assignments I've given you thus far and those I'll provide in future installments, you'll have a reliable, adaptable way of establishing your costs and, ultimately, of becoming profitable.
Have something to say? Share your thoughts with us in the comments below.