When pricing is based on erroneous estimates, a company could lose orders due to overpricing or capture unprofitable sales due to underpricing. In both scenarios, the competition benefits, and you're the one who will eventually close your business. Since we are not in the business of aiding the competition, we need to take a good look at our costing model.

Cost estimating needs to be a clearly defined process; by following the proper steps, we will achieve accurate estimates. So what are those necessary steps?

Let's document a procedure that allows you to identify the number of labor hours available for sale. But, first, can you guess how many billable hours are available from the average employee in one year?

Your estimate here: _________

Now put that costing hat on, open up your cost estimator notebook, and we’ll fine-tune that estimate!

Billable Labor Hours Worksheet

Let's say you have an employee who is paid 40 hours a week, receives three weeks of vacation, 10 paid holidays, eight paid sick days, and, because you are one of the most benevolent employers in town, he also receives bereavement pay and a few days off for good behavior (no overtime in this example). You're about to see how a sizable portion of payroll and benefits are paid for hours not worked.

Total Hours Paid: 52 weeks x 40 hours = 2,080 hours (100%)

To calculate the nonworked hours:

Total Nonworked Hours: -320  (-15%)
Recalculated Total Available Hours:    1,760 hours   (85%) 

You've just discovered that you pay your employee 100% of the time while he is available only 85% of the time. 

But, wait -- there is one final step in your labor hours calculation. At best you are in the position to bill 1,760 hours to your clients, but this is rarely achievable. What other factors come into play? These vary depending on the type of business and include nonbillable hours committed to administrative tasks, clean up, tardiness, etc. For example, manufacturers face machine inefficiencies and downtime that are nonbillable.  If you estimate that these items consume three hours per week, then:

Additional Unbillable Hours: 52 weeks x 3 hours =  -156 hours  (-8%)
Total Billable/Chargeable Hours:  1,604 hours   (77%)

It is important for business owners to bring in enough new business to keep employees productive every hour they are available. If you work <em>in</em> the business rather than <em>on</em> the business, then you can be sure there will be times when there is not enough work for your employees (the billable % will further decrease). But you will continue to pay them. Hiring anything less than highly qualified individuals, not having well-trained and competent employees, and working with outdated or inefficient systems and procedures will cause you to hire additional employees to offset these added inefficiencies. This further adds to your costs, and it erodes your profitability.

Part 2: We’ll look at an employee's true hourly cost.