Estimating labour costs is a critical part of planning a project. In fact, it can be the difference between a successful project and a failed one.
Whether your service business is in architecture, design, consulting, or any other industry, underestimating project costs can result in cost overruns, eroded profit margins, overworked staff and unhappy clients. Labour is often your biggest cost, so it’s one of the most important parts of any project estimate to get right.
Since you’re dealing with employee time, fluctuating productivity levels and various project uncertainties, it’s difficult to estimate labour costs precisely. However, spending the time up front to be as accurate as possible will help you to stay on budget and hit your profitability goals.
We’ve outlined three tips to help you estimate your labour costs so you can increase accuracy with each project you work on.
These tips are featured in our free guide: Cost Estimating for Projects. Download the full version to get more estimating tips, expert recommendations and more.
1. Look at historical job data
Reviewing past projects is one of the best ways to estimate future work. It enables you to see how well you were able to deliver work according to previous estimations, evaluate employee productivity and assess overall job performance.
Review data from previous similar jobs to understand the following:
Estimated vs. actual costs
Understand how your actual recorded time and costs compare with your estimated values, and evaluate how any variance might be avoided for your next job.
Write-off represents the amount of billable time recorded on a job that you were not able to charge to your customer (billable WIP minus invoiced amount). Ideally, you’re not writing off any costs, and you’re charging your clients for all of the work you put into the project. Analysing write-offs can provide insight into why you’ve underestimated projects in the past and consider how to adjust estimates for the future. Ask yourself questions such as:
- Do we need to provide more training for our team?
- Do we need to price these services differently?
- Do we need to consider not offering this service at all because we’re not able to offer it economically?
Recoverability is the opposite of a write-off – it represents the amount of billable time you invoice to a client. Ideally, recoverability should be at 100% for each project. Recoverability can be an indication of employee performance and their ability to complete work according to projections.
Profit margin is the difference between your invoiced and actual costs (invoiced amount minus actual costs). While it’s certainly important to understand how profitable your jobs are, profit margin isn’t the best indicator of a job being estimated accurately. A job can have a high write-off rate, yet still be profitable. Profitability on jobs can also be subjective based on how businesses represent their labour costs.
“It’s quite important to be reviewing and analysing different services you’ve offered in the past and look at the percentage of write-offs you’ve had. When you’re re-quoting in the future, you want to apply learnings from past projects and adjust based on how you’ve delivered versus what you’ve promised.”
2. Ensure your staff base rates are accurate
Staff base rates reflect how much it costs to employ a staff member for one hour of work. When you’re estimating, it’s important that the rate you use to calculate labour reflects the true cost employing each staff member, not just their hourly wage.
Indirect costs associated with employing staff (also known as labour burden) can have a significant impact on the overall cost to deliver a job and job profitability. To determine the true cost of employing a staff member, add allowances for holiday pay, superannuation, sick leave and other types of overhead to their salary.
There’s no one ‘right’ way to calculate staff base rate – what you choose to include in your employees’ base rate will depend on the type of indirect costs you incur related to your employees (such as benefits, office space and travel) and region-specific costs, such as taxes and contributions. As a general guide, use the formula below to calculate staff base rate for your employees:
3. Get the right people involved
When calculating labour for a cost estimate, it’s important that you understand the specific tasks that are required, how much time you need to allocate to each task, and how much it costs your business to deliver each hour of work.
Many different people with varied expertise are typically involved in delivering one project – such as business development or account managers, project managers, specialists who are hands-on in the project, and the director or business owner.
When you’re building out your estimate, include people from all stages of the project lifecycle to make sure you fully understand details, risks and dependencies that could impact labour costs.
Improve project cost estimation with our free guide
There’s a lot that goes into creating an accurate cost estimate – from defining project scope, to using the right technology, and more. Plus, it’s important to figure out which estimating practices work best for your business.
We’ve put together a free guide to help you define and standardise your estimating approach so you can cover all the critical steps and increase accuracy with every project.