Effective Estimating – Part 6 of 6
In our prior Effective Estimating post of this series, we talked about our Estimate and Proposal ACCURACY. In this final post of the series, I want to remind all cabinetmakers (me included), that when it comes to manufacturing cabinets for profit, “The end depends upon the beginning.”
No matter how effective we design, engineer, machine, assemble, finish, hardware, deliver and install a project, if our Estimate was bad, then there is a good chance our Proposal was bad, and if they were exorbitantly high, we just might earn a reputation that is not conducive to future projects, and if they were too low, we may lose money on the project, and just a few of these loser projects can break even a strong company.
We need to know our costs, and we need to know them well. We need an Estimating System that can take Material and Labor costs and build upon them the appropriate markups that will cover our overhead. Our overhead must include things that we don’t think of on a day-to-day basis, but we must force ourselves to do so.
- If you want to retire one day, you must build in the cost of funding your retirement.
- If there is any chance you might damage and/or cut off a useful part of your body, you need to insure for that (Disability Insurance).
- If you own a building, you must build in the cost to own, insure and maintain that building.
- Whether you own your building or rent your building, you must build in costs for utilities.
- If you own equipment, and what cabinetmaker doesn’t, you must build in the maintenance and replacement cost for that equipment, and the cost to keep it insured. Keeping in mind that the new breeds of CNC and/or NC equipment live in dog years (1 year is the equivalent to 7 years).
- If you own tools, and what cabinetmaker doesn’t, you must build in the maintenance and replacement cost for those tools, and the cost to keep them insured.
- If you own vehicles, you must build in the maintenance and replacement cost for those vehicles, and the cost to keep them insured.
- In addition to covering your labor, you need to cover the cost of labor (i.e., paid vacations, holidays, taxes, workers comp insurance, etc.).
- If you own and use computers, you must build in the maintenance and replacement cost for those computers, and the cost to keep them insured.
- If you own and use software, you must build in the recurring subscription cost or the upgrade and support costs for all those software programs.
- In addition to the direct labor that is part of your cost-of-sales, you must build in indirect administrative labor costs (some portion of your pay might fit right here).
- If you want to continue your business over many years, and who doesn’t, you must build in your cost of sales (i.e., advertising, commissions, etc., some portion of your pay might fit here).
- If you are operating on borrowed money, you must build in the cost of operating on borrowed money.
- If you breathe oxygen and/or have a pulse, you must build in the cost of taxes, lots and lots of taxes.
- If you breathe oxygen and/or have a pulse, you must build in the cost of complying with regulations, lots and lots of regulations.
- AND, if you want to survive long enough to quote another project, you must build in a healthy profit margin.
I know, it can feel overwhelming to think about, and then you have to think, what if the market won’t bear all of this material cost, labor cost, overhead and profit? AND, how do I apply overhead to a single Project? I can’t answer the first concern, other than to say, you might be surprised what your market will bear. As far as how to apply your overhead, the best way I know of is to utilize an Estimating System that reverses the process we use to evaluate our profitability (the Income Statement, aka: the Profit and Loss Statement). In other words, determine the percentage your overhead is of sales, and reverse that process adding it to your costs.
Well, back to my earlier quote from an unknown author, “The end depends upon the beginning.” Our Estimating System has to be rock solid so we are NOT guessing at what to charge our customers, and we know that EVERY job is not only covering our costs, but is PROFITABLE.
Not everyone will agree with me on this, as a matter of fact, I suspect the majority would not, but based on my life experience, using outsourced cost for everything I possibly could took care of the Material and Labor portion of my cost. What I mean by that is that I never had a problem with coming up short on my job cost if I based my Estimates and Proposals on my outsourced cost of; cabinet components, doors, drawer fronts, drawer boxes, applied end panels, wainscot panels, trim, molding and finishing (especially finishing).
Very early in my cabinetmaking career, I learned that we live and work in a cyclical economy (what goes up seems to always come down, and then back up, and then back down), and I had little if any control over the cycles (most cycles in either direction are controlled by nothing more than consumer perception of the economy, and the rest are based on good or bad Black Swan events, and most of those events are created and/or caused by government officials, who profit enormously if they are right, but pay no price for being wrong).
I needed a way for my company to be able to make money in both the up and the down cycle, and also everywhere in between the highs and lows. I found very quickly that manning up (hiring) when we were on the up slope, and manning down (layoffs and/or firing) on the down slope, even though it makes sense in your head, does not align with reality. The reality of manning up (hiring) when you get busy, and manning down when your workload slows just does not work. No matter how good your systems are, and how experienced your new hires are, there is a learning curve to working in your system, and in most cases you’re forced to hire people that need to not only be trained in how you do it, but in how to do it period. New employees are least effective when you need them to be most effective, and about the time you get them trained, some bone-headed government program will create the next dip that requires you to shed those now experienced, good employees, OR bear the cost of them through the dip at great expense to your net profit and personal income.
On the manning down side, we all try, we really, really try to be optimists, and not layoff or fire until we absolutely must. For me, the 2007-2008 recession did not hit my company until early 2008, and I believed, based on my life experience up to that point, that once the newly elected President took office, things would cycle back up. I was not only wrong, I was wrong by many, many, many months, adding up to several years for cabinet manufacturers in some areas of our country. The time I delayed in manning down cost me over $70,000 in losses (costs exceeded revenue every month for 4 months). Once I bit the bullet, and did the dastardly deed of trimming fat, I was profitable again within 4 weeks.
And even though I had already built my system around the up and down cycles, I don’t think it’s possible to account for these types of Black Swan events, you see what a 2 to 4 month delay in the cost cutting decision cost me in early 2008. My system was built on the premise, theory, hypothesis, or whatever you want to call it that I wanted a manufacturing system that could expand and contract with the market, much like our lungs expand and contract as we breathe. To do that, I wanted to utilize out-sourcing instead of manning up or down to empower this flexible company that could make money in a down cycle or an up cycle (unless you are a lot smarter than me, I’m not aware of any way to avoid some loss in a Black Swan event like the recession of 2007 through whenever it ended for you). Many of the companies that buffered the up-cycle with men and machines simply could not sustain their high investment, high overhead plants through that Black Swan event, and had to close their doors.
The upfront work to enable this flexible production system was first and foremost, make my Estimating System allow me to price a job both ways (i.e., out-sourced verses in-house), which I did. The second step that was somewhat painful was to remove everything from my showroom that I could not outsource and replace it with things I could outsource (I had no doors, drawer fronts, trim, molding or finishes displayed in my showroom that I could not source from a company I trusted after the remodel). In time, I concluded that I did not need to price a job one way if I was going to produce some or all of it in-house and another way when I was going to out-source some or all of it. As a result, for many, many years, I priced everything as though I was going to out-source everything, no matter how much we produced in-house, and there was no negative or unintended consequence for doing so.
My selling price of a job was slightly higher if I was going to out-source everything (based on my states sales tax structure, sales tax is only charged on materials, not labor, so when I process something in-house, I only paid sales tax on the material portion, but when I out-sourced it, I paid sales tax on the entire cost), but that slight difference did not make any change in our estimates to closed sales ratio at the time I was testing this theory, so I simply started charging everyone as though everything would be outsourced, even if we were doing all or most of the work in-house. It did not change what I paid in Sales Tax, but I was simply calculating my selling price as though I was out-sourcing everything, so I was covered in case I needed to outsource everything. I seldom knew at the time of an Estimate what I would be making verses out-sourcing, so my theory was assume the highest cost, and pocket the difference when I need to make it in-house.
The advantages to this system were many, but the most obvious one that comes to mind was the pain and suffering with the manning up and manning down with every cycle of the economy, or just local feast and famine cycles went away (As well as most of the HR stuff I really don’t like doing). The same crew did the work if we sold $45,000.00 of cabinetry in a month that did the work if we sold $120,000.00 in a month. On the low end of the sales scale, we did as much in house as possible, on the high end of the sales scale we outsourced everything; the cabinet carcass components, doors, drawer fronts, drawer boxes, trim, molding and finishing of all those parts as well. We simply assembled, delivered and installed the cabinetry.
A second and very clear advantage of out-sourcing was knowing my absolute cost. Anytime we made things in-house, my costs varied from hour-to-hour, day-to-day, week-to-week, month-to-month, employee-to-employee, project-to-project, etc.-to-etc. We could run ten time studies, drop the longest and shortest time, find the mean/average time, publish it, and if we determined a process should take 4 hours, somebody would figure out a way to make it take 10. Even my best team members process times varied between Monday, Wednesday and Friday. No matter how good our internal systems and processes were, costs varied on all our products and processes. When I purchased something, my cost was an absolute that I could deal with effectively. When I knew my absolute costs, it was not hard to determine my selling price, and feel good about that selling price.
If you have not read an earlier version of this series, just know that it has gone through multiple revisions, the latest being in the second quarter of 2022, and the past 12 months have been a season of unprecedented inflation. Many will blame the inflation on various causes, but whatever the cause, it is a real and present danger to the survival of many a small business in America, and most likely in other nations as well. BUT, if your estimating system is well designed, then it will accommodate the translation from cost to selling price, so as the things that make up the cost of your product rise, you are able to quickly and equitably account for those increased costs, and adjust your selling price by exactly what it needs to be adjusted by (and when inflation subsides at some point in the future, you will be able to do the converse). If your estimating system does not do this, it may be time to adopt a new system, and there is no better time to change estimating systems than when prices are fluctuating anyway.
So to wrap this up, the true litmus test of your Estimating System is based on the time it takes you to go to sleep after your head hits the pillow each night. When we know our costs, and have a simple system of marking those costs up for all the necessary components that make up a selling price, we can rest assured that each and every project will be profitable, and sound sleep will come naturally each night.
Today we covered “The end depends upon the beginning.” That wraps up this series on Effective Estimating. If a more comprehensive look at all these things and more is something you think would be beneficial to you and your company, taking the full Custom Cabinet Estimator course may fill in any gaps.
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May the Lord bless the work of your hands, heart and mind.
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