Average Variable Expenses
Unlike fixed expenses, which occur no matter what, variable expenses occur only when you’re building or remodeling something. If you do more work, you incur more variable expenses, including:
Construction loan interest
For calculating your break-even volume, take an average of these expenses from whatever time frame best represents reality. If you normally average 10 jobs per year but saw a slowdown last year, take the earlier average.
What about supervision? Last month, I put supervision in the category of “construction indirect” expenses — costs that are necessary to get the job done but not actually part of the labor and material installed in the job. Unless you’re subcontracting your supervision, you can’t hire a portion of a person, and if you’re using lead carpenters, only a portion of their salary or wages is supervisory. Don’t confuse this with how you bill the time to clients: For budgeting, it’s an issue of your overhead cost for the period. To be safe, if you expect your lead carpenters to spend half their time banging nails, then for purposes of budgeting include that half of their wages and burden as a fixed operating expense and the other half as supervision, a variable expense.
The first step in determining your break-even point is to calculate your average project’s “contribution margin” — the average chunk of change that each completed project contributes toward covering your fixed expenses for the period.
Contribution margins will be unique for each person reading this. Your contribution margin depends on the type of job you do, your selling price, and your gross-profit margin. It’s calculated on the basis of an average project.
In the example above, which represents a remodeling company, the fixed costs for the year are $141,240, or $11,770 per month — just shy of 30 percent of annual sales. The average project is an $80,000 job that contributes $25,256 toward keeping the doors open. The gross-profit margin is 40 percent, though the contribution margin is much less — only 31.6 percent. That’s because we also have to pay several cost categories out of the gross profit for each job. The salesperson needs to be paid, we need to allocate some money toward supervision, and we have to account for the warranty and job-site costs we know we will incur.
The average contribution margin for each job is its average gross profit (the selling price minus direct job costs) minus average variable costs like sales commissions and construction loan interest. Dividing your total fixed overhead by the average contribution margin will yield your break-even volume — the number of average projects you need to complete and collect for during the period.
In this case, we simply divide the fixed annual expenses of $141,240 by the average job contribution of $25,256 and come up with an annual break-even volume of 5.6, or conservatively, six projects for the year — one every two months. Remember that you have to complete and collect for those six average projects, not just sell them. Assuming that nothing else in our overhead model changes, you could also interpret this result as meaning that you need one $40,000 project per month or two $240,000 ones per year — and so on.