A fundamental review of the bidding process

By Randy Bonnecaze

When bidding on a job, your ultimate goal is to submit an offer that maximizes your company's potential profit while achieving the coveted status of "lowest bid." You no doubt savor the moment when these two criteria, which may at times seem mutually exclusive, come together.

To bid competitively, you need to understand all of the costs involved so you can strategically recoup these expenses, as well as produce a solid profit margin. Thus, it doesn't hurt to review the fundamentals of this process occasionally to ensure your next bid will be a winner.

Fixed, direct costs. Most contractors are fairly successful at identifying costs that directly relate to a job, including those for materials and labor. A general contractor, for instance, will call for bids from subcontractors and material suppliers to get a fixed price for external labor and materials needed for a specific project element.

Using these quotes, the general contractor is then able to formulate an estimate to include in his or her financial assessment of the job and subsequent bid.

If you're a subcontractor, or a general contractor with an internal labor force, you can estimate direct labor costs by calculating the number of hours and trade-level skill required to complete the project. To get a reasonable estimate, take the standard hourly rate, which includes a burden rate for benefits, and multiply it by the projected hours. As long as you understand the scope of the work and realistically assess the total hour commitment, this calculation will be relatively simple to perform.

Indirect costs. Indirect costs pertain to construction activities, but are not easily identifiable with a single contract. Factoring them into a bid can present a challenge. These costs include expenses for project managers and estimators, vehicles used in construction, communication equipment, office trailers, shop and yard expenses, and owned equipment.

Normally, indirect costs are allocated either in total or in separate pools based on a relevant allocation base, such as direct labor hours or direct labor dollars. The allocation base is typically a rate based on a comprehensive plan for the year.

For example, the indirect cost budget for the year could be divided by estimated total direct labor hours for the year to calculate an indirect cost rate per direct labor hour. This cost rate can be applied to the direct labor hours in the bid to estimate the indirect costs that should be included.

General and administrative costs. "Home office" expenses, such as advertising, office supplies, accounting, professional fees and office utilities, are necessary to manage and grow your business. These costs should be recovered from the gross profit margin.

Once you pinpoint your home office overhead annual costs, which are typically fixed, apply the percentage of those costs to projected revenues for the year. Keep in mind that your gross profit percentage has to be large enough to cover these costs and to provide for the levels of net income you determine are acceptable for your business.

Equipment expenses. Owned equipment is another indirect cost that some contractors fail to apply to their job bids. This is often because they have fully paid off the equipment and don't see any current cash outflows associated with it.

But if you're not allocating an expense for your equipment, you may not be recovering costs for items such as depreciation, repairs, property taxes, storage and insurance. You need to include all of these in a bid.

There are many ways to allocate equipment expenses to a job. Many contractors assign equipment a usage rate, which you can determine by calculating the annual cost of operating a piece of equipment and dividing that number by the expected annual hourly use.

Then, multiply this rate by the number of hours you expect to use the equipment and allocate that expense to the project bid.

Some contractors fail to revise their equipment usage rates when adverse conditions, such as increased insurance or maintenance costs, warrant it. Do not make this mistake, as it could substantially undercut your profitability.

Profit margin calculations. Once you have all of these costs broken out and included in your contract bid, it's time to calculate the profit margin. The average gross profit for contractors varies. If you want an 18% profit, take the total cost calculated and divide it by 82% to gain the total contract price you should bid.

The formula for success. To succeed in today's construction industry, your price structure must remain competitive. Only by solidly understanding each prospective job's costs can you accurately and strategically determine what the project is truly worth and bid accordingly.

Editor's Note: Randy J. Bonnecaze is a Certified Public Accountant (CPA) with Hannis T. Bourgeois LLP, Baton Rouge.