A Contractor’s Need to Know: Fixed vs. Variable Costs

Bart Adams, CPA, Shareholder - Auditing & Accounting   email | bio
July 2010
 
As Tom Frisby of the Frisby Group, consultants to the construction industry, says, "Construction is about three things: selling the work, producing the work, and counting the beans."

Today, contractors are probably wondering, do any of these three components still apply since the chances of acquiring work are slim when there are 20 bidders for each project, and the work often goes to the lowest bidder?  With no work to be had, there is nothing to produce and consequently, no beans to count.

This scenario will eventually turn; however, it may not in 2010. So until then, contractors should avoid acquiring work that makes their situation worse.  What does it mean to avoid acquiring work that makes the situation worse?  Simply put, avoid acquiring work that does not cover the variable costs of a project.  Variable costs are costs from a job that a contractor would not otherwise have if the contractor was not working on that project. 

The following is an illustration of this principle.  A contractor wins a bid allowing it to keep some employees (fixed costs), hire additional employees (variable costs) and procure materials and subcontracts (variable costs).  However, the gross profit on the contract turns out to be a loss greater than the fixed costs.  In this example fixed costs are $10,000 and variable costs are $90,000, which total $100,000.

If the contract is $80,000, the contractor would fail to cover its fixed costs as well as $10,000 in variable costs, making its situation worse by $10,000.  The contractor could have saved $10,000 by not doing the work.

Eventually, contractors as a whole will get back to the basics of selling the work, producing the work, and counting the beans.  But in today's economy, knowing the variable and fixed beans will help contractors identify the right work to sell and produce, which just may be a contractor's meal ticket to survival.

If you have any questions, please contact Bart Adams.