If it were only that simple to put into practice. In reality, it may be very difficult today to obtain enough additional work at a 35% contribution margin to increase volume by 43% ($342,857 divided by $800,000). If you cannot reduce your overhead to achieve break-even, you may have to reduce your pricing to get the extra work.
To keep things simple in the illustration above, let's assume that the $800,000 is already signed on and represents your company's backlog of work. If you were to reduce your pricing by 10% on only the new bids, you would divide the $120,000 of remaining overhead (the "Loss" not covered by the $800,000 backlog) by the Contribution to Overhead to be realized on such additional new work. Be aware that when dropping pricing by 10% to win the additional work, the variable cost percentage increases: what was a 35% contribution would become a 27.8% contribution with a 10% cut in fees. So your break-even volume would have to be $1,231,655 (a scenario not illustrated in the table).
If you do not follow this increase in variable cost percentage, try this: Simply calculate what it would be on the in-house $800,000 if you dropped pricing by 10% to $720,000. You would have the same $520,000 in variable costs but yield only $200,000 in Contribution to Overhead which, when divided by $720,000 is 27.8%, rather than the 35% contribution you would derive from the $800,000 in sales secured at normal pricing.
You'll notice that the new break-even volume of $1,231,655 is even more than the $1,142,857. Now, instead of a 43% increase in volume, this example calls for a 54% increase. At least with a 10% cut in fees, you can reasonably expect to get a lot more work and hopefully achieve profitability. For any work you get over and above the $1,231,655 BEP, 27.8% of it is pure profit. The real key is to operate above your true BEP. For those who aren't sure what that is, achieving profitability is an ever-elusive goal, especially in difficult times.
While the old adage "we'll make up for it in volume" is often used as a punch line, the underlying business calculations are quite sound. The trick is to know your true BEP and to ensure that your contribution to overhead is significant enough to haul in the additional work without totally disrupting your business model and cost structure.
This is also a good time to address an item that may be buried in company overhead - discretionary expenses. If you are accruing "overhead" of say, $20,000 in personal benefits, extras or niceties, and you have a 20% Contribution to Overhead rate, it means that your BEP is $100,000 more than it should be. The same holds true for someone you treat as overhead who is overpaid (as difficult as that might be to accept).
This doesn't mean that you cannot continue to carry such discretionary expenses. But to the extent that they exceed your competitors, you need to be careful not to lose bids because you are trying to cover overhead that may be excessive in the new world order.
Remember, as stated above, you are looking for your "true" and "real" overhead costs. As shown in the table's last column, if you were to eliminate $30,000 from each of your two fixed overhead line items, it's amazing to see how significantly your BEP drops.
Every business has its own unique circumstances, sensitivities and margins. I have used hypothetical margins here for illustration. While I expect your breakdown to be different, the concepts will not change.
Many contractors have multiple divisions or cost centers, which means that you are juggling more than one set of numbers. But the analysis is the same. You do not have to possess all the answers internally, but you do need to come to grips with these relatively simple concepts - even if it means shaking-up your controller or getting outside support.
Sal Falzone is a partner in the Boston area accounting and business advisory firm Rucci, Bardaro & Barrett PC. Through the firm's Construction Business Practice Group, he offers business, financial and strategic planning advice to companies in transition. For specific questions about the variables that go into successful project bidding, contact Mr. Falzone at (781) 321-6065 or email@example.com.