# Sales Price Using Net Profit Per Hour, Part 2

Originally published: 08.01.06 by Ruth King

Last month, I described how to calculate your selling price based on net profit per hour calculations. This month, I'll give you examples of how to better estimate your selling price to the customer.

Whether you calculate your prices on a gross margin basis or net profit per hour basis, you must have accurate labor costs. Both require that you estimate the number of hours to complete the job. If you miss the hours, you will miss the estimate. Then, either your job will be at a loss or wildly profitable.

Assumptions:
Hourly cost is \$40 per hour (including burden)
Overhead cost is \$25 per hour
Desired profit is \$30 per hour
Gross margin is 35 percent

Exercise #1:
You estimate a job will take 16 hours. The estimated cost for equipment and materials is \$1,000. What is the selling price to the customer?

Using the gross margin method:
Total labor cost = 16 hours x \$40 per hour = \$640
Total equipment/material cost = \$1,000
Total direct cost = \$1,640

Selling price

to the customer = \$1,640 ÷ .65 = \$2,523
The total direct cost (\$1,640) is divided by 1 - .35 or .65 (the gross margin).

Using the net profit per hour method:
Total labor cost = 16 hours x \$40 per hour = \$640
Total equipment/material cost = \$1,000
Total overhead cost = 16 hours x \$25 per hour = \$400
Total profit = 16 hours x \$30 per hour = \$480

Selling price to the customer = \$2,520

The results for Exercise #1 are typical for cases where the labor cost and material cost are close. Let’s look at what happens when you have a high materials cost situation (Exercise #2) and a high labor cost situation (Exercise #3).

Exercise #2:
You estimate a job will take 16 hours. The estimated equipment and materials is \$2,000. What is the selling price to the customer?

Using the gross margin method:
Total labor cost = 16 hours x \$40 per hour = \$640
Total equipment/material cost = \$2,000
Total direct cost = \$2,640

Selling price to the customer = \$2,640 ÷ .65 = \$4,062
The total direct cost (\$2,640) is divided by 1 - .35 or .65 (the gross margin).

Estimated profit: \$4,062 (selling price) – 2,640 (direct cost) – 400 (overhead cost) = \$1,022

Using the net profit per hour method:
Total labor cost = 16 hours x \$40 per hour = \$640
Total equipment/material cost = \$2,000
Total overhead cost = 16 hours x \$25 per hour = \$400
Total profit = 16 hours x \$30 per hour = \$480

Selling price to the customer = \$3,520

In this case, the person estimating on a net profit per hour basis would win the job. The contractor bidding on a gross margin basis would say that he couldn’t do the job for that price. He wouldn’t realize that his estimated profit was \$1,022. To meet the other contractor’s price, he would have to lower his gross margin to 25 percent, which he thinks would be an unprofitable job when in actuality it wouldn’t be.

Exercise #3:
You estimate a job will take 32 hours. The estimated equipment and materials is \$1,000.What is the selling price to the customer?

Using the gross margin method:
Total labor cost = 32 hours x \$40 per hour = \$1,280
Total equipment/material cost = \$1,000
Total direct cost = \$2,280

Selling price to the customer = \$2,280 ÷ .65 = \$3,508
The total direct cost (\$2,280) is divided by 1 - .35 or .65 (the gross margin).

Estimated profit: 3,508 (selling price) – 2,280 (total direct cost) – 800 (overhead cost) = \$428

Using the net profit per hour method:
Total labor cost = 32 hours x \$40 per hour = \$1,280
Total equipment/material cost = \$1,000
Total overhead cost = 32 hours x \$25 per hour = \$800
Total profit = 32 hours x \$30 per hour = \$960

Selling price to the customer = \$4,040

In Exercise #3, by using the gross margin method you’ll only make a \$428 profit on the job. The contractor using the net profit per hour method keeps his profit per hour consistent at \$30 per hour or he can choose to lower his net profit per hour to meet the competition.

The high labor jobs are dangerous to use gross margin to calculate sales price. Let’s take Exercise #4:

For Exercise #4, let’s say that Exercise #3’s job actually took 40 hours to complete instead of 32. What happened?

Total labor cost increased to \$1,600.
Material cost stayed the same at \$1,000.
Total overhead cost increased to \$1,000.

Using the gross margin calculation the profit is:
\$3,508 (selling price) – 2,600 (revised direct cost) – 1,000 (overhead cost) = - \$92. You lost money on this job.

Using the net profit per hour calculation
:\$4,040 (selling price) – 2,600 (revised direct cost) – 1,000 (overhead cost) = \$440. The net profit per hour was approximately \$10 per hour rather than the estimated \$30 per hour. However, the job was still profitable.

It is much better to calculate your overhead cost per hour for each department and use it to calculate your selling prices to the customer. Assuming that you estimate your labor hours correctly, you’ll have a consistent net profit per hour worked. If you miss an estimate, you’ll still have enough profit in the job to survive.

Ruth King, a nationally-known HVACR industry expert who writes this column for HVACR Business can be contacted at rking@hvacrbusiness.com.

## Articles by Ruth King

Are you staffing for the busy times or the slower times? If you hire office personnel to cover all of the busy times, they will not be productive in the slower times of the year.
View article.

### Increase Warehouse and Inventory Profitability

Inventory is a bet. You’re betting your hard earned dollars that you will be able to sell parts and equipment that you buy and store in a warehouse or on trucks.
View article.

### Six Easy Ways to Increase Marketing Profitability

If you want to waste marketing dollars, then just burn the leads that marketing generates. You invest thousands of marketing dollars to produce those leads. Keep them productive. Keep them profitable.
View article.

### Three Ways to Increase Sales Profitability

Selling profitably, riding with your salespeople and tracking results will improve your company’s sales profitability.
View article.

### Increase Installation Profitability

At the end of the day or the job, these are the wasted materials that get left on job sites or damaged, rolling around in trucks. Returning materials at the end of a job is one of the quickest ways to increase your bottom line.
View article.