Last week we discussed adjusting your markup based on the length of a job. In the example used, the writer estimated job costs using a $64/hour labor rate. That $64/hour would be either their fully burdened labor rate or their charge rate; I doubt it’s the actual rate paid to employees.
It reminded me of a question we received last summer that we haven’t addressed yet:
In regards to employee labor rates when doing estimates. Are you figuring the labor rate based on what the actual employee burden cost is and then x your markup? Or are you using a labor rate that is industry standard x your markup? In other words, if my total employee burden cost is $26 hr, would it look like $26 hr x 4 hrs = $104 x 1.5 markup? Or using the same $26 hr rate would you use the standard here of $30 – $40 hr x 4 hrs x markup? As you can see, the results can be $1,000’s different on a job depending on which way you figure it.
The answer: it depends on what you assumed when you calculated your markup. Using the wrong labor rate, or using someone else’s markup when you don’t know their assumptions, is one of the biggest mistakes we see and, as the question points out, the difference can be thousands of dollars.
A few definitions:
- A fully burdened labor rate is your full cost of an hour’s worth of work. It includes all payroll taxes and any other costs related to labor. Vacation pay, health insurance, and any other benefits or expenses related to employment are included.
- A charge rate is used in Time and Material contracts. It would include all labor-related costs just like the fully burdened labor rate, but it normally also includes a chunk for other overhead expenses and often profit.
That’s a quick and dirty definition of the different labor rates; an accountant would go into more detail, but you get the idea.
Here’s the issue. When you calculate your markup, you start with last year’s P&L and adjust your overhead to estimate what you’ll need next year.
If you keep all labor-related expenses in your overhead when you calculate your markup and then estimate jobs using a fully burdened labor rate, you’re adding overhead to your sales price twice; once in your labor rate, again in your markup. If you estimate jobs using a charge rate, it’s even more extreme. Your price will be much higher than it needs to be because you’re recovering overhead and maybe even some profit in both your job costs and in your markup.
This mistake can also go the other way: if you deduct labor-related expenses from your overhead when you calculate your markup, then estimate your jobs using a $15/hour rate because that’s what you pay employees, you’re underpricing and losing money.
So, when you quote a job, you can use the rate you pay your employees, or your fully burdened labor rate, or your charge rate. The rate you should use depends on what you included in overhead when you calculated your markup.
There isn’t a right or wrong way to do this, it really doesn’t matter. What matters is that you’re consistent; whatever assumptions you make when calculating your markup need to be considered when estimating your job costs. The goal is to have all your payroll taxes and benefits accounted for when you quote the job, but only once. If you aren’t consistent, you’re doing it wrong.
It’s dangerous to compare your markup to someone else’s, because you don’t know their assumptions. If they have a markup of 1.5 and estimate labor at $50/hour, and you use their markup while estimating labor at $15/hour, you’re probably headed for trouble.
When I say that the markup for a typical remodeling company is usually at least 1.50, I’m assuming a fully burdened labor rate. If you estimate jobs using the actual rate paid to employees, you’ll probably need a higher markup. You need to calculate your numbers based on your situation. If you don’t know how to calculate your markup, it’s one of many things covered in our book, Markup and Profit Revisited.
One more thing. If you’re doing time and material work and use a charge rate for invoices, don’t use someone else’s charge rate, or try to track down the going rate for your town. That’s the same as using someone else’s markup; it can get you in trouble. There is no industry standard. You need to look at your labor expenses and your overhead and profit needs, then calculate your own charge rate.
We’ve talked about markup for two weeks in a row. Next week, I promise, there won’t be any math.
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations as needed.
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Hi Mr Stone,
Do you know if subcontractor general liability, umbrella and workers compensation are part of the hourly labor rate? Would the GC also mark up for GL, umbrella and WC on top of these rates? I am the owner and I have subcontractors including this billing as well as the GC including this. I feel like this is double dipping on the direct cost of the labor. Also, I believe general liability and umbrellas are not per hour costs, therefore these would not be billable per hour of extra work.
This is one more example of why cost-plus and time and material projects are a mistake. You’re getting down into the fine details of how the subs and the general calculated their labor rates, when your general contractor should have quoted you a firm fixed price for the entire project. It would have saved everyone a lot of trouble.
GL and umbrellas are handled differently by different states, different companies. Sometimes it’s volume related, sometimes it’s hourly.
Are you happy with the work your contractor did? Is the job completed as it was designed? Pay the bill.
Where do you include the cost of your office to run payroll? Or if you have a payroll service where does that cost get included? Is it in the fully burdened labor rate or is that part of O/P or part of the markup?
The cost of your office, or a payroll service, would be included in your overhead so it’s part of your markup.
That is included in the full labor burden
I don’t hear much about Owner/Operators and information on charging in situations where the business is owned by one person and that same person does all the work, minus using subs sometimes. I normally add up the cost of materials and add a 10% markup to that amount, then calculate labor hours and charge $125 an hour. I add the material cost and the labor cost together and then add 25-30% markup to the total of material and labor cost. The $125 an hour is my salary taking into consideration taxes as a single person LLC. And the markup at the end would be the business’s expenses and profit. Does that sound okay? Some people think my prices are too high and others are fine with them its hit or miss. I’ve been in business for a steady 4 years and am still trying to iron things out to make them work.
J.W., I apologize for not responding earlier. Your calculation sounds complicated, it doesn’t need to be. We address this type of situation in the book Markup & Profit Revisited, you need to read it. My guess is that you’re pricing is too low.
Good evening Mr Stone,
I know nothing about running a contracting business. I’m a homeowner in the midwest doing a complete gut remodel on a home with a small addition. My contractor does open book billing, charges 30% markup, and charges $70/hr labor rate for himself and proportionately less for the lower skilled workers on the job. Does this sound reasonable?
I don’t know your contractor’s numbers, but my guess is you got a bargain. Bargains aren’t always a good deal.
Great article buy I am still a bit lost. I have always just charged straight labor rate and never had to calculate a mark up. I am in the process of doing an RFQ for a company that is asking me for a “Standard Markup” How would I figure this?
Andrea, are you the business owner, and if so, how do you cover your overhead and profit if you don’t markup your labor rates?
There is no “standard markup”. You’ll need to look at your business numbers (overhead and profit needs) and calculate the markup that your business needs. I’d strongly suggest reading Markup & Profit, A Contractor’s Guide Revisited.
Finally, why are you doing business with someone who wants to know all your numbers? It’s none of their business, that’s proprietary information. There is no way they’ll let you succeed, their goal is to get the cheapest work done possible. Walk away. Take a look at this article, or others on our website that talk about that.
Good article; thanks. I was working with our pricing shop on a project, and provided them with a FBLR for each of the performers on the job – but only included fringe, overhead, and G&A. I did not include fee/profit since I always considered that something ABOVE the FBLR. Turns out our pricing shop assumed FBLR INCLUDED profit. Which created some confusion until we sorted out our assumptions. I still maintain that the FBLR term should only include actual costs associated with labor to maintain consistency. Profit can have a pretty broad range depending on the job, price model, and contract, so it doesn’t make sense to have that as a standard part of FBLR.
But should the term be FBLR+Fee? Or is there another term that is more generally accepted?
As of now, when working up an estimate for a project, I use my employee’s hourly rate plus some payroll expenses that I can easily apply/track to project costs (Employer SS, Employer Medicaid, State unemployment and Federal unemployment). Let’s say that I pay one of my employees $25/hour. When the payroll expenses are added in his hourly rate increases to $28/hour. That is the rate I use on my estimates as all of the other employee-associated expenses such as vacation time, holiday pay, bonuses and payroll expenses associated with those costs are included in indirect overhead (along with vehicle expenses, office expenses, insurance, etc..) which is covered by my markup. So, the labor rate of $28/hour is treated as any other line item on my estimate in that at the end of my estimate a fixed markup is applied to all of my direct jobsite costs. Of course my employee costs me far more than $28/hour when all of the other expenses (true labor burden) are added to it but those are covered by my markup. I could included workers comp in my employee’s labor rate instead of as a general indirect overhead expense but it’s a bit complicated to track that from an accounting point of view (unless I switch over to QuickBooks Workers comp insurance that is a pay as you go type of policy but I imagine even that would get complicated at audit from a book keepers perspective…thus, to keep it simple I leave workers comp as a general overhead expense). I believe this is a correct way of doing it…as long as all of my costs are calculated for either in the labor rate or in the markup factor it is correct. As long as I’m not doing both which would make my prices way to high or forgetting to included payroll expenses in the mark up factor which would make my prices way to low. Any thoughts?
Worker’s comp is not general overhead. It’s a direct expense that should be in your cost of goods sold. Any cost that’s attributed to direct labor, is a direct expense and belongs in COGS. Example: Direct labor, direct labor payroll tax, union benefits, job consumables, subcontractor expense, fuel for direct work, worker’s comp insurance are all direct expenses and belong in COGS.
For the most part I agree with you but what about when I have my employee’s organize the garage, work on vehicles, etc. None of that goes to direct jobsite expenses. I still have to pay comp on non-jobsite labor.