The Math Behind the Last Number

In “The Billing Rate is the Last Number” I built a billing rate for a sole proprietor. I showed that you start with the after tax pay that you need to fund your chosen lifestyle. Then you begin adding additional costs; taxes, retirement, insurance, general overhead, etc and a rate falls out the far end. Importantly the rate is the total number at the end, not the one you start with.

The cost layout that I described previously works when you’re one person, and it works because when you’re one person your wage and your profit are the same pile of money. Add a second person and the game changes. Now there’s a wage that isn’t yours, an overhead that isn’t a guess, and a profit that has to come from somewhere other than your own paycheck.

Hiding inside the methodology from my previous article are two numbers that will be familiar to everyone who has read the majority of my work. GP/Day and DLER. And neither of these ratios changes shape when the company grows.

Your business has to produce a certain amount of gross profit defined as the money left after the cost of the work itself has been covered. The money that pays overhead and ideally leaves behind some net profit. This is not an hourly idea but a yearly one, and the calendar year is what turns it into a number that can guide your business. Take the gross profit the company has to clear in a year per your company budget and divide it by the days you have to clear it in. What comes out is gross profit per day, the pace the business has to hold to achieve your budgeted goal.

At my company, the target is around a million dollars of gross profit against a full calendar year, or $2,740 a day. On average we run about four jobs at a time, so each one has to carry roughly $685 a day of that pace to keep us whole. That’s our number, built from our overhead and our crew. Yours will land somewhere else, possibly more possibly less. This isn’t just a number, it is a rate of production. Like feet of wall framed in a day.

The pace tells you how much gross profit you need, but it doesn’t tell you how to price an hour of labor to get it. For that you need to know what each dollar of labor has to return because in a company that builds and manages its own work, labor is the constraint. And the constraint is what caps how much gross profit you can earn. Yes you can scale gross profit by selling more trade partner work or fancier tile, but I would rather stake my success on my in house labor that on the hope that a client will choose $100/sqft tile over an off the rack subway tile.

The formula I use is direct wages (no benefits or payroll taxes included), plus your operating expenses, plus the profit you’re aiming at, all divided by your direct wages. Run our budget through it and it lands near 3.5. For every dollar I pay a carpenter to swing a hammer, the company needs about three and a half dollars of gross profit to come back.

This is where the rate falls out, because a ratio is a multiplier. Take a lead carpenter’s paid wage at $40 an hour multiplied by the ratio. $40 x 3.5 = $140. Our published time-and-materials rate is $137 an hour. This is not a coincidence and it’s not a number I looked up in a book, the rate is the wage times the DLER.

The two numbers give you a lens through which to view your projects. GP/day is the perfect metric for when your project in question matches the COGS profile of your average project. DLER is the check against a high labor or high risk project. One is measured against time, one against labor, and they’re two views of the gross profit target the business has to make. I use both but I run GP/Day first to see if the project can be structured to track the average. When it can’t I look closely at the estimated labor and increase the margin according to the risk the project poses to my labor output.

The long hand cost calculation was sufficient for one person. But when your risk starts to scale as fast as your company you need a better set of metrics even if those metrics are also buried inside the long hand calculation.