Adjusting for Risk in Your Estimates
I’ve been asked on several occasions to explain “Risk Ratio” as it pertains to construction estimating. It sounds complicated but really, it’s just the total profit divided by the total labor dollars. Knowing how to use it could help your company to be more profitable.
Improperly estimated labor hours
There are many risk factors when taking on a new project, but labor is by far the biggest one. Nothing will eat into profits quicker than a job that goes over on labor hours. The team of skilled workers you put on the job will inevitably run into situations where the installation is more difficult than originally thought. Unscheduled down time is another problem. My first year as an apprentice back in the mid 80’s I learned a lot more than just electrical wiring. The first time I volunteered to work overtime on a Saturday, I was surprised to learn that the first hour was to be spent napping in the van. Fast forward to my time as an estimator, I was always worried we’d have some of those guys working for us. Like I said, labor is risk. So many things can go wrong and cost you money.
So, what can be done about labor risk?
The answer is in how you apply your overhead and profit. Many companies like to spread out their overhead and profit equally among material, quotes, labor, subcontracts, etc. To better account for labor risk, you’ll want to put more of a percentage of your overhead and profit on labor. This will reduce your risk on labor-intensive jobs and make you more competitive on less risky jobs. Of course, you’re thinking now that you’ll also be less competitive on the labor-intensive jobs and you’d be right. If you work on the riskiest jobs, you’re going to take a hit in profits at some point. With skewing your overhead and profit based on labor, if you win those jobs, you’ll have more of a cushion to absorb the pitfalls.
Estimators and business owners need to get back to the basics of business. The goal of any business is to maximize wealth in the form of profits. Making small changes to the way you bid your jobs could go a long way to improving your company’s bottom line.