You’ve been there before. You are discussing the budget of a potential project with a prospect. You get that uneasy feeling in your gut that the prospect’s budget might not be enough for the project, but you’re a little unsure. You don’t want to miss out on closing the deal, but you also don’t want to lose money by making a commitment at such a preliminary stage of the sales process.

This is where having a fast, accurate way of checking your prospective customer’s budget will save you time and money in the long run.

Instead of pricing the work, calculating the cost of the materials, labor, subcontractors, and equipment, you should reverse engineer the prospect’s budget for the time it takes to do the project.

DO NOT PRICE THE WORK. CHECK THE CONSTRUCTION ESTIMATE.

Remember, you are not pricing the project at this stage of the sales process. You are simply verifying the budget. You will calculate the price of the project once you have determined the scope of work and all the details associated with it. But first you have to determine if the estimated budget is enough to cover the costs and provide you with the margin your business needs to make a profit.

REVERSE ENGINEER THE NUMBERS

Let’s start with the margin, work our way back to the costs, and check the construction estimate.

The example below comes from a conversation I had with one of my coaching clients:

The contractor asked the prospect for the budget of a potential kitchen remodel project. The prospect told the contractor her budget was $40,000 for this kitchen project and that she would provide the appliances, fixtures, and tile materials. The contractor’s initial gut reaction was that this budget was too small, but he wasn’t sure how to communicate what the budget should be. I told the contractor, “Let’s determine what we do know, and check this budget to see if it will work.”

We started with the following formula:

PRICE = COSTS × MARKUP FACTOR (see Pricing Method #2 in this article for more about this formula.)

We know the budget, or price, is $40,000.

We know the markup factor for this construction business is 1.30, or a markup of 30%. (We previously determined the markup for this business by analyzing its profit and loss statements and developing a pricing strategy.)

Step 1 – Start with what you know

We can now write the formula above like this:

$40,000 = COSTS × 1.3

Step 2 – Solve for COSTS

If you remember the rules from algebra class, then we can solve for COSTS by dividing both sides of the formula by 1.3 and writing the formula like this:

COSTS = $40,000 ÷ 1.3

Now we can determine COSTS.

COSTS = $30,769.23

The difference between the price of $40,000 and $30,769.23 is your GROSS PROFIT. This means that if your costs for this project equal $30,769.23 and you sell these COSTS for $40,000, you will have this gross profit:

GROSS PROFIT = PRICE − COSTS = $40,000 − $30,769.23 = $9,230.77

And your margin is:

MARGIN = GROSS PROFIT ÷ PRICE × 100% = 23%

When you start with your price and divide by your markup factor, you are essentially taking your profit first and determining if the remaining budget is enough to buy the COSTS of the project. (This method of reverse engineering your business is the subject of my new book, Profit First for Contractors, due out in November 2018.)

Step 3 – Estimate your COSTS of materials and subs

Now that we know the budget for the COSTS, we can start to subtract the estimated costs of the subcontractors and materials.

At this point in the process, you do not need to calculate the cost of the subcontractors and materials. You need to merely estimate them. Remember, this is not a quote. This is an estimate. An estimate is a guess based on your experience. That’s it.

Here’s a table showing the estimated costs the contractor came up with based on his experience and an initial conversation with the prospect:

Step 4 – Estimate the labor

I asked the contractor, “How long will it take to complete the project?”

He said, “Probably about four weeks overall for a couple of guys.”

I replied, “So would you estimate it would take two guys two weeks if they could work straight through?”

He answered, “Yeah, that sounds about right.  It’s two weeks of work for two guys over about four weeks time.”

I said, “Great. That’s 160 man hours—two guys working 40 hours per week for two weeks.”

Now we can estimate the labor costs for this project.

The wage for this level of production work is $35 per hour for this business.

Labor costs = $35 per hour × 160 man hours = $5,600.

Step 5 – Determine the estimated budget price

In this example, the “Total Estimated Costs w/out Labor” of $32,450 exceeds the ”Budget Costs” of $30,769.23. Therefore, we know that the $40,000 budget is not realistic.

If the “Total Estimated Costs w/out Labor” were less than the “Budget Costs,” then you would divide the “Total Estimated Costs w/out Labor” by the hourly wage to determine the number of man hours available to do the work.

This is not the case for this project. We need to determine the correct budget based on what we know.

We know the estimated labor cost is $5,600. We know the estimated cost without labor is $32,450. We also know that because this customer is already trying to “save money” by buying some materials and fixtures, this will cause additional delays and coordination. The contractor decided to add a 10% difficulty factor to the estimated costs of the job to account for this.

Therefore, the total estimated costs are:

TOTAL ESTIMATED COSTS = ($5,600 + $32,450) × 1.1 difficulty factor = $41,855

This is the cost of the project.  This is not the price. We need to add the markup for this project.

The budget price for this project is:

“Checked” BUDGET PRICE = $41,855 × 1.3 = $54,500

Remember, this does not include the appliances, fixtures, and tile.  This budget is only for the items listed above, and much of that was just a guess. There will be more when the contractor digs into the details.

GETTING REAL WITH YOUR CUSTOMERS

Based on this information, which took about five minutes to produce, the contractor now knows what to tell the prospect. The $40,000 budget is not enough for the work she wants done. The budget for this project should be about $55,000, and she should probably plan on spending about $70,000 once the appliances, fixtures and tile are included.

The prospect’s budget does not fit the estimate. This contractor will either sell the prospect on the appropriate budget, or he will walk away. He does not have to waste any more time running numbers. He knows everything he needs to know.

SUMMARY

You cannot guess your way to profitability. You must calculate it. Once you have established a budget with your potential customer, then you need to ensure that your estimate is accurate for the preliminary scope of work.

Reverse engineering your costs from the budget is a fast, accurate way to determine what your estimate should be. Once you have checked your construction estimate with realistic numbers and determined that the prospect has the budget, then you can move forward with developing the scope of work and preparing a proposal.

But preparing a proposal for a project is work. Professionals get paid for work. Charge your prospects for a proposal. That’s when they become customers—when they actually buy something from you.

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Thanks for taking the time to read this article. I really appreciate you and value your time. Please leave a comment below if you have any questions about how to avoid the line-item pricing trap.

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Follow me on YouTube, Instagram @shawnvandyke, LinkedIn, Facebook, or shawnvandyke.com to learn more about how to streamline your construction business.  My new book, Profit First for Contractors, will be released later this year. Follow the @ProfitFirstContractor account on Instagram for more information about the release of the book.