QUESTION:
Paul, I'm confused about how to determine what our pool(s) and base(s) should be for our proposal writing. We are a full service video production and post production company, and we have both commercial and non-commercial rates for many types of services. These rates vary greatly depending on what we do, how we do it, how long we do it, and even for whom we do it.
Our pricing policy is written down but there are always special agreements and our non-commercial rates are generally lower. All of our direct and indirect costs are built into our rates.
How do I determine what our labor costs are? What could I possibly use as a base? I've considered using an hours work as a base. I could possibly determine roughly how many hours of work are involved in a project and go from there. Will using commercial rates as a basis for government pricing work for us? What do you think?
RESPONSE:
Wow! You've got a lot of questions on your mind don't you? Well let's begin with an important concept: There is a difference in gathering, recording, and tracking cost and how you choose to price your product/service. I recommend tracking your cost regardless of the type of business you are in. It is just good business sense to know what it actually cost to do any job or produce any product. That being said lets use the basic concept of tracking your cost.
1) Labor you can have your entire staff track their actual time spent on specific projects (Direct Labor) versus administrative effort such as Overhead or G&A (General and Administrative).
2) Non Labor Direct Costs Other direct costs such as subcontractors, video equipment, supplies, rental equipment, etc. can be tracked direct to the project. Remember, we are looking to track Actual Costs not Billed or Commercial Rates.
If you use your own equipment for many projects you can develop a rate based on usage, such as costs per hour/day/etc. You would estimate the number of usage hours expected for projects over a specific time period (usually one year) and divide the equipment costs by those hours to get a per hour/day/etc. rate. This rate can be adjusted (up or down) as you get more accurate information on usage expected, if there is a significant or material change.
Alternatively, you could consider just identifying the costs as part of Overhead and allocating it back to projects using a relevant base such as usage. I dont think in your case that Direct Labor Dollars would produce a fair allocation of equipment usage. At least not as reasonable as usage might.
3) Direct Administrative Support - You can have a Direct Labor Category called Direct Administrative Support where significant effort on a project is tracked and charged direct to the project.
4) Fringe Benefits and Payroll Taxes (FB's) Where applicable you may want to identify the FB's for your Direct and Indirect staff.
5) Indirect Administrative Support - You can also have Indirect Administrative support (Overhead) for those general ongoing activities your administrative staff engage in to support all activities of the company. These would be activities that are not easily identified to one specific project or that administratively would be less cost efficient to track separately.
A reasonable base for this activity could be Direct Hours worked versus Direct Dollars. This is because the level of admin support is probably not impacted as much by the salaries on consultant contracts they support as much as the hours that are put into the project by direct staff and consultants.
6) G&A The remaining costs, all of your other General and Administrative costs can be tracked and accumulated under G&A accounts. These would include Officers wages and benefits (except that part of their time that would be charged either direct or considered overhead), accounting and finance costs, outside legal and consulting fees for indirect activity (such as my costs), corporate related rent, depreciation, supplies, etc.
You can review the chart of accounts received at the workshop to determine what types of cost could go in the G&A pool. Remember, this is only a guide. You could then use the base TCI (Total Cost Input) to distribute the G&A costs back to all of your projects. As a class attendee you may recall that TCI means Total Costs except for G&A Costs. Very good..!
7) Fee (Profit) Now here is where the difference in pricing comes in. Once you project your Direct costs for a project then add your Indirect costs based on the rates developed from 5 and 6 above, then you determine what fee/profit you will add to that total costs.
Now in your case you will have different rates for varied clients and products offered. Since you have what is known as Market or Catalog Commercial rates, you can price your product based on these commercial rates. The difference in your commercial rates is based more on what the Market Will Bear and that is also what you use in negotiations with your various clients.
As you can see, it is the Fee/Profit that makes most of the difference in the pricing and not as much the actual costs. At least not for the same service or product. Also, the price difference in the types of services you offer is based on the amount of Direct Labor and Other Direct Costs (loaded with related indirect costs) identified to the service.
So you are really looking at two aspects of pricing for your business: Level of effort to do the service and level of fee/profit that can be applied to the service based on market/catalog rates or your firms goals such as lower fee/profit for foundations or non-profits.
But again, your costs base will be consistently applied and your accounting system can track the actual costs (Direct and Indirect) as they are incurred.
Here it is again - Tracking your costs is separate from setting your final price(s). However, you use your costs as a base of reference for determining your final price(s) or to track the profitability of a service offered.
Lets look at an example:
Price Based on Costs Projected For A Project
|
Cost Category |
Hours |
Rate |
Amount |
|
Direct Labor - Level 1 (Includes travel) |
20 |
$20.00 |
$400.00 |
|
Direct Labor - Level 2 |
10 |
$18.00 |
$180.00 |
|
Direct Labor - Level 3 |
8 |
$15.00 |
$120.00 |
|
Total Direct Labor |
38 |
|
$700 |
|
Subcontracts |
|
|
|
|
Direct Material: |
|
|
|
|
Equipment Rental |
|
|
$150.00 |
|
Equipment Use Charge |
5 |
$20.00 |
$100.00 |
|
Other Direct Costs: |
|
|
|
|
Video tapes, etc. |
|
|
$50.00 |
|
Total Direct Costs |
|
|
$1300.00 |
|
Fringes on Direct Labor |
|
30% |
$210.00 |
|
Overhead on Direct Labor |
|
20% |
$140.00 |
|
Total Base for G&A |
|
|
$1650 |
|
G&A (Total Cost Input) |
|
12% |
$198.00 |
|
Total Cost for Project |
|
|
$1848.00 |
|
Fee/Profit (This is added based on what you negotiate to get your final price) |
|
20% |
$369.60 |
|
Total |
Price |
|
$2217.60 |
The above costs are based on Actual Direct Labor Rates Paid To Employees. It also is based on Actual Direct Costs expected to be expended on the project. The Equipment Use Charge is based on an Hourly Rate Developed by taking the actual and projected costs of the equipment; including depreciation, maintenance, etc. and dividing by the Total Projected Hours the equipment will be used over a relevant range, in this case one year. This resulted in an hourly rate of $20.00. It can be further divided into parts of an hour down to the minute. Remember, this is one way we would determine what our true costs are for any particular project.
On to Commercial Pricing: What we actually use as Market or Catalog Prices when pricing this project can be different as follows:
|
Price based on Market Rate |
Hours |
Market Rate |
Amount |
|
Direct Labor - Level 1 |
20 |
80.00 |
$1600.00 |
|
Direct Labor - Level 2 |
10 |
$50.00 |
$500.00 |
|
Direct Labor - Level 3 |
8 |
$35.00 |
$280.00 |
|
Total Direct Labor |
|
|
$2380.00 |
|
Subcontracts: |
|
|
$300.00 |
|
Direct Materials: |
|
|
|
|
Equipment Rental |
|
$250.00 |
$250.00 |
|
Equipment Use Charge |
5 |
$30 |
$150.00 |
|
Other Direct Costs: |
|
|
|
|
Video Tapes, etc. |
|
$75.00 |
$75.00 |
|
Total Price |
|
|
$3155.00 |
The above represents our Price based on Market Based Commercial Rates for our Direct Labor and Direct Costs. These commercial rates are fully burdened with Direct Costs, Indirect Costs, and Fee/Profit.
As you can see in the above case the Total Price using Market Rates is higher than the price using Projected Costs that apply a 20% Fee/Profit Objective. Actually, based on Market Rates, there is a 71% Fee/Profit on this effort calculated as follows: $3,155 (Market Price) less $1,848 (Total Cost from detaile cost projections in non-market price example above) = $1,307 Fee/Profit. $1,307 (Fee/Profit) divided by $1,848 (Total Cost from above) = 70.73%
The result could have easily been the opposite with a Market/Catalog Price being Less than the Price Based on Cost. It happens all the time. Wouldn't you like to know this? I think yes!
Now remember, the cost is the same in both situations and can be tracked in your accounting system.