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BUSINESS By James R. Huston Six Most Common Methods of Estimating BUSINESS MANMANAGEMENT An Analysis of the Barron's Dictionary of Business Terms defines cost estimating as,"deter- mining the total costs of labor, materials, capital and professional fees required for a proposed product."I would add that it is "the science" of determining those costs. It also defines benchmarking as,"(a) standard unit for the basis of comparison;universal unit that is identified with suf- ficient detail so that other similar classifications can be compared as being above, below, or comparable to the benchmark standard." Both are sci- entific processes built upon measuring things accurately and consistently. The primary goal of cost estimating is to estimate your costs for a service or project accurately. Direct costs (materials and sales tax, field labor and burden,equipment and subcontractor costs) are fairly easy to cal- culate and include in your pricing. General and administrative (G&A) overhead costs,often referred to as indirect costs,normally cause the most confusion.This is also the primary area where the six methods of cost estimating differ.Factoring,the single overhead recovery system (SORS), the dual overhead recovery system (DORS) and the multiple overhead recovery system (MORS),all use percentages multiplied by one or more direct cost elements to calculate and allocate G&A overhead to services or jobs being priced.The fifth method,market-driven unit pricing, simply has you pluck common unit prices from the market.The sixth method is the G&A overhead per hour method. Upon review of the six methods of estimating commonly used today, we can draw two conclusions.First,calculating G&A overhead costs to allo- cate and put into a price by means of multiplying one or more direct costs by percentages is an automatic mathematical mistake — a false mathemat- ical assumption.Second,there is no correlation between the amount of gross profit margin (GPM) —G&A overhead plus net profit margin —that you desire to see on your financial statement at the end of the year and the amount of GPM that you should put on an individual job or service being priced.Calculating and allocating G&A overhead to your pricing creates numerous inconsistencies and inaccuracies.You will, in turn, under-price some jobs/services while over-pricing others.And in a competitive mar- ket,guess which ones your company will win — the ones you under-price? This is why I use the G&A overhead per hour method to calculate and allocate G&A costs to my pricing.Of the six methods,it is the most accurate and consistent [see sidebar].Its merits can be proven and demon- strated scientifically quite readily.It is also the simplest of the six methods for calculating accurate costs. Cost estimating and benchmarking are both sciences.As such,the mer- its (or demerits) of a cost estimating system must be open to scientific verification. Five of the six estimating methods do not pass the test.Your company deserves to have the most accurate (most scientific) pricing sys- tem available.The economic uncertainty that you and your company are currently facing locally, nationally and globally demands that you have such a system.Such a system will not only allow you to price your work accurately, it will allow you to benchmark your pricing as well as that of your competition.Companies that price their work accurately and con- sistently will outperform their competition,even in tough economic times. 22 Arbor Age / July/August 2012 6 Ones that can't price their work this way won't. In fact, they might not even be around when the economy gets better. James R. Huston is president of J.R. Huston Consulting, Inc., a Colorado- based firm that specializes in construction and services management consulting to the Green Industry.Huston is a member of the American Society of Professional Estimators and he is one of only two Certified Professional Landscape Estimators in the world.This article is excerpted from his book,"A Critical Analysis of the MORS Estimating System."For more information,call 800-451-5588,e-mail jhuston@jrhuston.biz, or visit www.jrhuston.biz. The Field-labor Hour Recovery or the G&A Overhead and Net Profit Per Hour Method Although not foolproof, the Overhead and Profit per Hour pricing method provides a considerable number of advantages over the other five methods. An overview of this method is as follows: I. Production of the finished product and/or providing the service • Materials (at re-wholesale cost) • Labor (labor hours multiplied by crew average wage or specific labor rate) • Equipment (equipment hours in job multiplied by a predetermined cost per hour) • Subcontractors (same) II. General conditions • Materials (same) • Labor (same) • Equipment (same) • Subcontractors (same) III. Margins and markups A. Tax on materials (if applicable) B. Labor burden on labor C. G&A overhead recovery (total number of field-labor hours in sections I & II above multiplied by company G&A overhead cost per field-labor hour (OPH): _______ (No. Hours) x _________ (OPH) = $_____________ D. Net profit (a straight percentage markup on total of all costs for the job; or, if desired, company/division average profit per hour (PPH) multiplied by total number of field-labor hours in sections I & II above): ________ (No. Hours) x _________ (PPH) = $____________ or A net profit margin applied to the total of all costs for the job E. Contingency factor (if applicable) For more details regarding the six most common methods of estimating, see "A Critical Analysis of the MORS Estimating System" by James R. Huston. www.arborage.com