Unbillable Hours Cost Contractors Money

I've recently discovered a new trick for improving the bottom line of construction companies: focus on unbillable hours. They turn out to be a key indicator of financial performance.

Unbillable hours are all field hours that weren't or aren't billable. Management and supervisor hours are not unbillable hours. They are overhead hours. Unbillable hours are associated with your field workers. A billable hour is an hour that is covered by the project's estimate. For example, if you estimated that a project will take 1,000 man-hours then you have 1,000 billable hours. If you happen to bring the project in at 900 hours you still had 1,000 billable hours. If you brought the project in at 1,100 hours, you still have 1,000 billable hours.

Determining your unbillable hours for the year is pretty simple when sticking with the offered definition. Pull out of your payroll system the total hours turned in by your field workers. Sum up the hours covered by the estimates associated with the projects you worked this year. If you have project carrying over from last year, subtract the hours used as of 12/31 from the budgeted hours. The remainder is the number of billable hours that project contributes to this year's total of paid for hours. Subtract the estimated hours from the paid
for hours. The result is your unbillable hours.

As you will discover unbillable hours are costing you a lot of money. Money that you probably have not accounted for in your budget.

Unbillable hours are tricky little beasts. They show up in your direct costs. They throw off your production numbers. They almost always end up being significantly higher than assumed. They cause a lot of chaos that is buried deep in the finances of your business. They are also going to occur.

You are unlikely to completely eliminate unbillable hours unless your estimates are overly conservative. As your estimating goal should be to predict the needed man-hours spot on you shouldn't be using conservative estimating factors. The only way to properly eliminate unbillable hours is to: be deadly accurate with your take-offs and productivity factors, manage the field exceedingly well and make sure you get paid fairly for change orders.

The reason unbillable man-hours are such a useful indicator of performance is that they reveal how well your job costing, estimating and production management systems are working. Obviously if you can perfect those three areas of your business you are going to make a lot of money and have a great opportunity to vanquish your competition who is highly unlikely to have those three areas working properly in their business (in 15 years I've only met one company that did).

Let's dive into the details of how you should be accounting for unbillable hours. To begin with you need to account for them in your annual budget.

You may remember I recommend building budgets on man-hours not on arbitrary revenue targets. I specifically recommend building your annual budgets on the man-hours you will be able to bill for in the upcoming year.

Allocating Overhead via Man-hours

Figure out how many billable hours you have generated each of the last three years. Divide each year's hours into the year's revenue. You have two trends to consider. Will you sell more or less billable hours than last year? Choose a target. Now decide what price you are likely to receive per hour. Take a look at your three year trend. Multiply that price per hour against your chosen target of hours. The result is your budgeted revenue for the year.

Next look at your total unbillable hours from the current year. What can you do to lower that number? How much lower is realistic to project for? Choose that target and write it down. Next look at your direct costs for the past year and figure out how much lower they would have been if you could have prevented the excessive unbillable hours?

Using your burdened wage rate subtract the associated cost from your recorded direct costs. Divide the adjusted number by your sales to arrive at your adjusted percent of direct cost (i.e. Gross Margin). Assume the upcoming year's direct costs will come in at that same ratio after adjusting for expected margin increases or decreases due to changing competition and the health of the projected construction market. Lock in your projected direct costs and that leaves you with your budgeted gross profit.

Figure out what next year's overhead will be and there you have it: your budget.

Your budget accounts for projected unbillable hours. You know the cost per unbillable hour so if you end up trending higher or lower than your budgeted unbillable hours you can project its impact on your bottom line.

One of the by-products of unbillable time is the lost opportunity cost. If your crews are swamped with work and some of that work is unbillable the cost to your business is actually much higher than the burdened wage rate. It is the amount equal to your average revenue per billable hour. Painful.

Your takeaway should be to start paying much closer attention to unbillable hours. Make them visible. Track them. React to them. Figure out how to minimize them. Reap the rewards.ยท