# Finance

Finance

##### Originally published: 1/5/2024

Last month I gave you the first step: Know how you generate revenue and maximize it. Now, let’s move to the second step.

To determine how much profit drops to the bottom line for each billable hour, you must calculate your overhead per billable hour.

How to calculate the overhead cost per hour: Determine for every billable hour or revenue-producing hour, how many dollars you need to add to cover the overhead cost of the department.=

For smaller companies where a field person performs service, maintenance, and replacement, simply calculate the overhead cost per hour for the company.

Formula to calculate the overhead cost per hour calculation for smaller companies:

Total overhead divided by the number of billable hours.

Overhead Payroll Costs vs. Cost of Goods Sold

Make sure that your overhead payroll costs include only overhead personnel.  Field labor costs should be in the costs of goods sold.  If they are in overhead, make the payroll corrections necessary to put them in the cost of goods sold.  Otherwise, your overhead cost per hour will be inflated.

Departmentalization

Departmentalization is important when one field person works in only one department.  You have technicians who don’t do installation and vice versa except on rare occasions. Then you can see which departments are the most profitable based on their overhead cost per hour.

Different departments can have different overhead costs per hour. Generally, the highest overhead costs per hour are for service and maintenance.  The lowest overhead costs per hour are for new construction.

There are two types of overhead costs: space-related and people-related.

Space overhead.  Five things cause space expenses: rent, utilities, building maintenance, building taxes, and building insurance.  These include security systems, snow removal (in the North), landscaping, janitorial services, and other building maintenance.

Productive Space. Determine the total productive space used by each department. Productive space is the space occupied by either people or things related to a revenue-producing department.  Do not include common areas such as a conference room, kitchen, and bathrooms or space occupied by accounting and other overhead-related people.

If the warehouse contains parts and materials for several departments, make an educated guess as to the square footage for each department.

People overhead.  Every overhead item is not included as space overhead is related to people.  For example, the more people you have, the more office supplies you have.  The more people you have, the more telephone calls you have.

If you know the exact amount of time that somebody spends in a particular department, then take that percentage rather than the overall estimate. For example, you, as the owner, should estimate the amount of time you spend in each department. One of my clients spends 75% of his time in one department. This is the department that he personally manages.  So, 75% of his payroll costs go into that department’s overhead. The other departments split the remaining 25% of his time for oversight.

Then, there are specific overhead expenses that are not shared.  For example, the installation department should not be responsible for the service manager’s salary and vice versa.  These people spend 100% of their time in a specific department.

Likewise, truck expenses. The truck costs for installers should go into the installation department, etc.  The only vehicle expenses that should be shared are those for owners, operations managers, and others who do not work in a specific department.

If materials or services are bought only for one department then that department gets 100% of that expense.  New construction is generally word of mouth and referral marketing.  This department should not share in advertising expenses because they don’t benefit that department.

Marketing and advertising expenses should be shared among the departments that benefit from these expenses.

Once you know the total amount of overhead for each department, then calculate the overhead cost per hour by dividing each department’s overhead by its revenue-producing labor hours.

This value will be critical to determining proper pricing, the next step of a financially fit business. Next month I will address the question: what if the overhead cost per hour is too high? This will be the second part of the overhead costs section before moving on to part 4 of the financially fit series.

Ruth King has more than 25 years of experience in the HVACR industry and has worked with contractors, distributors and manufacturers to help grow their companies and become more profitable. Contact Ruth at ruthking@hvacchannel.tv or at 770-729-0258.