Rates, margin and GST

Every time in this book has been multiplied by a rate: A$95 an hour for labour, A$110 for the brake, A$180 for the laser. Those rates are not wages. They are what an hour of each resource must recover for the business to cover all its costs: the person’s wage and on-costs, the hours that cannot be charged to any job, the machine’s depreciation and running costs, and a share of the rent, management, estimating and everything else that keeps the shop open. A quote built on rates that are too low loses money however carefully its times are counted. On top of cost comes the margin, and on top of the price comes GST, each of which has its own common errors.

This chapter builds a labour rate from its parts, outlines how machine rates are built, sets out the difference between margin and markup, and states EN-700’s prices with and without GST. The running case finds that a quote meant to carry a 20% margin had been priced with a 20% markup, giving away about A$14.70 per enclosure at 50 off.

Building a labour rate

This is an illustration, not a statement of any award or wage. A fitter is paid A$38 an hour. On-costs, superannuation, leave, workers’ compensation insurance and payroll tax where it applies, add about 30%, bringing the cost of each hour paid to about A$49.40. Not every paid hour can be charged to a job: training, cleaning, maintenance, waiting for material and meetings take time. If 80% of paid hours are productive, each productive hour costs 49.40 ÷ 0.80 = about A$61.75.

The shop’s overheads, the costs it carries whatever work it has, rent, power, management, estimating, insurance, vehicles, the office, must also be recovered. If they amount, in this illustration, to about A$33.25 per productive labour hour across the business, the rate needed to recover everything is about A$95 per productive hour.

Figure 1How EN-700's A$95 labour rate is built

1. WageA$38.00 per productive hour · 40%
2. On-costs at 30%A$11.40 per productive hour · 12%
3. Unproductive time, 80% productiveA$12.35 per productive hour · 13%
4. Overheads per productive hourA$33.25 per productive hour · 35%

The wage is only 40% of the rate. A shop that prices labour near its wage rate, because “that is what the job costs”, is pricing well under half of what each hour really costs it.

Where the overhead figure comes from

The overhead per productive hour is the business’s annual overheads divided by its annual productive hours. This is an illustration. If the shop’s overheads, everything not directly charged to jobs, total about A$399,000 a year, and its people and machines together deliver about 12,000 productive labour hours a year, the overhead per productive hour is 399,000 ÷ 12,000 = A$33.25. Both figures come from the accounts and the timesheets of the past year, adjusted for what is expected in the next. A shop that grows its productive hours, by winning more work or improving productivity, spreads the same overheads more thinly and can lower its rates; one whose hours fall must raise them or lose money. That is why rates and workload are connected, and why a quiet period is dangerous: the overheads keep arriving while the hours that recover them do not.

Overheads on material too

Chapter 2 added an 8% on-cost to material for ordering, receiving and handling. That on-cost recovers overheads that relate to material rather than to labour. A shop must decide which overheads it recovers through material and which through hourly rates, and must not recover the same overhead twice. If the store’s wages are included in the overhead per productive hour above, they should not also be in the material on-cost. The split is a policy choice made once, written down, and applied consistently to every quote.

Machine rates

A machine’s rate recovers what it costs to own and run it, per productive hour: its depreciation or finance cost, maintenance, consumables such as laser gas and optics, power, the floor space it occupies, and its operator’s time where an operator is needed, together with a share of overheads. The productive hours are what matter: a laser that cuts 1,500 hours a year must recover its annual cost over those hours, not over the hours the shop is open. A machine that is under-used has a high true rate; one that runs two shifts has a lower one. EN-700’s illustrative rates, A$180 an hour for the laser and A$110 for the brake with its operator, are typical in their relationship, the laser costing more per hour, though a real shop’s figures come from its own accounts.

Rates must be current

Rates go stale. Wages rise, insurance renews, rent increases, and a machine that was new and lightly used becomes older and busier. A shop that sets its rates once and forgets them slowly prices itself into losses or out of work. Rates should be reviewed at least annually, against the shop’s actual costs and actual productive hours, and whenever a major cost changes, such as a new machine or a move to new premises. Each quote should record the date of the rates it used, so that a quote revived months later for a repeat order is not priced on rates that have since risen. EN-700’s estimating sheet carries the rate table’s date in its header, and the review of Chapter 9 checks it against the current table before the quote goes out. A shop that has just reviewed its rates may find that some of its regular customers’ prices no longer recover its costs, which is uncomfortable to discover and much better discovered in a review than in the year’s accounts.

Margin and markup

Once the cost is known, the price adds a margin for profit and for risks not otherwise priced. Two terms are used, and they are not the same:

• Markup is the profit as a percentage of cost: price = cost × (1 + markup).
• Margin is the profit as a percentage of price: price = cost ÷ (1 − margin).

A 20% markup on a cost of A$100 gives a price of A$120, a profit of A$20, which is 16.7% of the price. A 20% margin on the same cost gives a price of A$125, a profit of A$25, which is 20% of the price.

Figure 2Price from cost by margin and by markup

price = cost ÷ (1 − margin); price = cost × (1 + markup)

cost

A$294.04 per enclosure, including risk

margin

Profit as a share of price

markup

Profit as a share of cost

1. 20% margin: 294.04 ÷ 0.80 = A$367.56
2. 20% markup: 294.04 × 1.20 = A$352.85, a margin of only 16.7%
3. To give a 20% margin by markup, the markup must be 25%

The error: a markup taken for a margin

This is an illustration. The shop’s owner had set a target of a 20% margin on fabricated work, meaning profit equal to a fifth of the price. The estimator’s spreadsheet applied a 20% markup to cost, believing it to be the same thing. EN-700’s cost at 50 off, including the risk allowance, is about A$294.04; with a 20% margin the price is about A$367.56, and with a 20% markup about A$352.85.

The difference is about A$14.70 per enclosure, about A$735 on 50, and the quote’s real margin was 16.7%, not 20%. Across a year’s quotes, the same spreadsheet would have under-priced every job by the same proportion. The review caught it when the owner checked one quote’s profit as a percentage of its price and found 16.7%.

Figure 3EN-700 price per enclosure at 50 off, ex GST

Cost including riskA$294.04

20% markup, as first pricedA$352.85

20% margin, as intendedA$367.56

The fix was to label the spreadsheet’s field “margin on price” and to compute the price by dividing by one minus the margin, with a check cell showing the resulting profit as a percentage of price. The words margin and markup should never be used loosely in a shop, because they lead to exactly this error, and a target stated in one and applied in the other is wrong on every quote it touches.

How much margin

The margin a shop can earn depends on its market, its competitors, the job’s risk, the customer’s relationship and how busy the shop is. A job with high risk, a new product, tight tolerances, a hard delivery date, may justify a higher margin; a repeat job with known costs and a long-standing customer may be priced at a lower one. A margin is not a fixed rule to apply mechanically, but the shop should know its target and its minimum, and should know, for every quote it sends, what margin it is actually offering. A quote priced below the shop’s minimum margin to win a job should be a deliberate decision, not an accident of arithmetic.

Pricing when the shop is quiet

When a shop has idle capacity, it may price a job below its full cost to keep people and machines working. The reasoning is that the overheads are paid anyway, so any price above the job’s variable costs, the material, bought-in items, subcontracted coating and the time that would otherwise not be paid for, contributes something towards them. This is an illustration. EN-700’s material with on-cost, bought-in items and coating total about A$161.21 per enclosure at 50 off; at the full price of A$367.56, each enclosure contributes about A$206.35 to labour, overheads and profit.

Pricing for contribution can be sensible for a short, deliberate period. It is dangerous as a habit, because a shop full of contribution-priced work has no room for full-priced work and does not recover its overheads, and because customers remember a low price and expect it again. A quote priced below full cost should be marked as such, with the reason and an end date, and reviewed against the shop’s overall recovery.

Payment terms and discounts

Payment terms are part of the price. Waiting 60 days for payment instead of 30 ties up the job’s cost for an extra month, which costs the shop interest or overdraft, and a long-terms customer is effectively receiving a small discount. Early-payment discounts reduce the margin directly: a 2% discount on a 20% margin job gives away a tenth of the profit. The quote should state its payment terms, and any discount should be priced as a reduction in margin, knowingly.

GST

Most Australian businesses with a turnover above the registration threshold are registered for GST and charge 10% on their taxable sales, as the Australian Taxation Office explains. For a business customer that is registered for GST, the GST on a purchase is generally claimable as a credit, so business-to-business quotes are commonly stated excluding GST, with the GST shown separately and the total including it. The quote must make clear which figure is which.

This is an illustration. EN-700’s prices, excluding GST, with GST at 10% and the totals including GST, are:

• 20 off: A$403.66 per enclosure, GST A$40.37, total A$444.02.
• 50 off: A$367.56, GST A$36.76, total A$404.31.
• 200 off: A$348.04, GST A$34.80, total A$382.84.

A quote to a consumer, rather than a business, is subject to the Australian Consumer Law’s requirements for displaying prices, which the ACCC administers and which generally require the total price, including GST, to be shown prominently. A shop that quotes to both kinds of customer should be careful which form it uses. The GST treatment of a particular sale, such as an export, should be confirmed with the ATO or a registered tax agent; this book does not give tax advice.

Rounding the price

The calculated price is rarely the price sent. Shops round to a sensible figure, A$367.56 to A$368.00, say, and some round to a “price point”. Rounding should be done once, at the end, on the price per enclosure, and the rounded figure used for the total; rounding each line separately and then adding can shift the total by more than intended. The quote’s spreadsheet should keep the unrounded figures for the record.

Exercise: the target margin at 20 off

EN-700’s cost at 20 off, including risk, is about A$322.93. What price gives a 20% margin, what is the GST and the GST-inclusive total, and what markup would give the same price? If the customer asks for the 50-off price of A$367.56 at 20 off, what margin would the shop then earn?

Worked answer. The price for a 20% margin is 322.93 ÷ 0.80 = about A$403.66 per enclosure, GST about A$40.37, total about A$444.02. The same price as a markup on cost is 403.66 ÷ 322.93 − 1 = 25%.

At A$367.56, the profit would be 367.56 − 322.93 = A$44.63 per enclosure, a margin of 44.63 ÷ 367.56 = about 12.1%, well below the 20% target. The shop could accept that deliberately, for a customer likely to order 200 later, or explain that the 20-off price reflects its set-ups and offer a 50-off batch instead. Either is a business decision; the arithmetic simply shows what each choice gives up.