A Typical Contractor's Mistake: Not Calculating the True Cost of an Hour's Work

Greetings! I'm Vladimir Vyborny, founder of formspace.design. Today, I want to talk about one of the most common and, in my opinion, fatal mistakes I made early in my career and that I see many contractors make, especially in the service sector: the inability or unwillingness to calculate the true cost of an hour of their work. Apparent profit often turns into losses if all expenses are not considered. I'll explain how I came to this understanding and why it's so important.

Why Ignoring Costs Leads to Collapse?

When I first started my "Dom i Sad" (Home and Garden) business in the 2000s, I, like many, thought it was enough to calculate employee salaries, material costs, and add a small markup. This was a typical mistake that led to a situation where, at the end of the year, despite a large number of projects, the actual profit was significantly lower than expected, and sometimes non-existent. We worked a lot but earned little because we didn't account for "hidden" costs. For example, paying a team 20000 UAH for a project and spending 15000 UAH on materials, I might have thought that 5000 UAH was my profit. But where did the expenses for fuel, equipment depreciation, warehouse rent, taxes, marketing, and my own time go?

This approach is a direct path to burnout and business closure. Without understanding the true hourly cost, you cannot adequately assess project profitability, set competitive yet profitable prices, and, most importantly, understand where you are losing money. These are not just numbers in a report; they are the foundation of your financial stability and growth.

Components of the True Hourly Cost: What to Consider?

To calculate the true hourly cost, you need to include much more than just direct expenses. Here's what I've learned from 25 years of experience:

1. Direct Costs:

   • Employee Salaries: Not just the base salary, but all bonuses, premiums, and vacation pay. If your employee works 160 hours a month and receives 30000 UAH, their direct hourly cost is already 187.5 UAH.
   • Payroll Taxes: These are mandatory deductions that increase the true cost of an employee.
   • Materials and Consumables: Those that go directly into the project and are not included as a separate line item in the estimate (e.g., small fasteners, gloves, angle grinder discs).

2. Indirect (Overhead) Costs: These are expenses without which the business cannot function, but which are not directly tied to a specific project.

   • Office/Warehouse Rent: Even if it's your own garage, you must account for its depreciation or alternative rental cost.
   • Utilities: Electricity, water, heating.
   • Equipment and Vehicle Depreciation: My cars, lawnmowers, tools – all of them wear out. I always set aside funds for their repair and replacement. This is perhaps one of the most underestimated items. Imagine a chainsaw costing 20000 UAH that lasts 2 years with intensive use. This means that 833 UAH (20000/24) each month must be included in the hourly cost.
   • Accounting and Legal Services: Services of external specialists or the salary of an in-house accountant/lawyer.
   • Marketing and Sales: Advertising, website promotion, social media management, even time spent negotiating with clients. These are the expenses that attract new orders. I discussed in more detail how the lack of a systematic approach to this cost me clients in the article How the absence of CRM cost me clients in "Dom i Sad".
   • Administrative Expenses: Phone, internet, stationery, bank fees.
   • Contingency Expenses: I always allocate 10-15% for unforeseen circumstances: a broken tool, a delayed delivery, having to redo part of the work. It's better to have a buffer than to operate at a loss later.

3. Your Salary as Owner/Manager: You should not work for free. Your time has a cost, and it should be paid, just like the time of any other employee.

Calculation Methodology: Step-by-Step Plan

Let's break down how this can be calculated using the example of a small landscape company with one owner and two employees:

1. Determine all monthly fixed and variable expenses.

   • Employee salaries (2 people at 30000 UAH each + taxes ≈ 70000 UAH)
   • Your salary (e.g., 40000 UAH)
   • Warehouse/office rent (10000 UAH)
   • Vehicle and equipment depreciation (15000 UAH)
   • Fuel (10000 UAH)
   • Marketing (5000 UAH)
   • Accounting (3000 UAH)
   • Other administrative (2000 UAH)
   • Total monthly expenses: 70000 + 40000 + 10000 + 15000 + 10000 + 5000 + 3000 + 2000 = 155000 UAH.

2. Calculate the total number of productive working hours per month.

   • Let's say each of the 3 people works 176 hours per month. Total hours = 3 * 176 = 528 hours.
   • But not all hours are productive. Some are spent on indirect tasks, downtime, training. Let's say the truly productive, billable hours are 450.

3. Divide the total expenses by the number of hours to get the base hourly cost.

   • 155000 UAH / 450 hours ≈ 344 UAH/hour. This is your cost per hour.

4. Add your desired profit to this.

   • If you want a 25% profit, then 344 UAH * 1.25 = 430 UAH/hour. This will be your minimum selling price per hour of work.

If you see that the market price for similar work is 350-400 UAH/hour, and your calculated price is 430 UAH/hour, it's time to reflect. Either you offer unique value, or your costs are too high, or the market is simply operating at a loss without realizing it. I learned to make such calculations back in the 90s when I was involved in business planning at 'Alkar-Invest,' and that experience is invaluable.

Common Calculation Mistakes and How to Avoid Them

During calculations, many make typical mistakes that distort the real picture:

• Not accounting for equipment/employee downtime: This is especially relevant in landscape design, where there is seasonality and dependence on weather. In winter months, the volume of work decreases, but fixed costs (rent, some salaries) remain. These need to be distributed throughout the year or across active months.
• Forgetting about inflation and supplier price increases: Prices don't stand still. Calculations made a year ago might be irrelevant today. I recommend reviewing all calculations at least once a year or when significant market changes occur.
• Ignoring small but constant expenses: A ream of paper, a printer cartridge, tea/coffee for clients – all these seem minor, but over a year, they can add up to a significant amount. Even 1000-2000 UAH per month should not be neglected.
• Not separating personal and company finances: This is perhaps the most common mistake among small business owners. Money you take from the cash register for personal needs should be recorded as your salary or dividends, not just 'taken.' Otherwise, you won't see the true picture of the company's profit.
• Focusing solely on competitor prices: Your competitors might have made the same calculation mistakes or operate under different conditions. Always rely on your own figures, and use competitor prices as a guide for positioning, but not as the basis for your pricing.

How to Plan in formspace.design

My experience in business, where I myself faced the problem of accounting and automation, led me to create formspace.design. While formspace.design is not a full-fledged CRM or management accounting system in the classical sense, it lays an important foundation for accurate planning by allowing you to structure a project and assess its complexity even before detailed hourly cost calculations begin.

In Module 1.x (Planning/Zones/Objects), you can meticulously break down a plot into elements: zones (e.g., 100 m² of lawn, 50 m² of paving, 20 m² of flowerbed) and objects (gazebo, bench, fountain). For each such element, you can define the scope of work and materials, which will form the basis for further calculation of labor costs and expenses. For example, 1 m² of paving requires X hours of work and Y kg of tiles. This is not the final calculation, but it is a structured approach to data collection that I used in my practice. Modules 2.1 AI-concept and 3.1 Design by photo allow for quick generation and visualization of various landscape options, which helps in the early stages to assess their complexity and potential labor intensity. This allows you to filter out overly expensive or resource-intensive ideas, saving time on in-depth calculations, and also helps to form an understanding of future costs. My goal in creating formspace.design was to provide a tool that helps to see "behind the scenes" of beautiful pictures and understand the real costs that lie behind them. My philosophy for creating accounting systems, based on 25 years of my own figures, is reflected in the article How I design an accounting module based on 25 years of my own figures.

FAQ

How often should the hourly cost be recalculated?

I recommend reviewing your calculations at least once a year to account for inflation, changes in material and service prices, and changes in your expense structure. In case of significant changes, such as the purchase of new expensive equipment, changes in staff, or a sharp increase in fuel prices, recalculation should be done immediately. Flexibility in this matter is key to sustainability.

What if my calculated hourly rate is higher than the market rate?

Don't panic. Perhaps you offer higher quality services, use more expensive but reliable materials, or have unique expertise that justifies a higher price. First, review your costs – perhaps there's something that can be optimized without sacrificing quality. If not, then it might be worth focusing on positioning your offering as premium or higher quality to justify the higher cost. Sometimes the market simply undervalues the true cost of work.

Can averaged values be used for some expenses?

Yes, for some secondary expenses, such as stationery, minor office repairs, or tea/coffee for clients, averaged values based on data from previous periods can be used. However, for key items such as salaries, depreciation of expensive equipment, fuel, and main materials, always use the most accurate and up-to-date data. Otherwise, the overall error could be too large and distort the real picture.

How to account for seasonality in the landscape business?

Accounting for seasonality is critical. I recommend distributing fixed costs (rent, some administrative salaries) evenly over 12 months. Variable costs and the main part of project-related salaries should be distributed over the active working months. During the off-season, you can focus on maintenance, training, planning, and client acquisition, but these activities must also be included in the overall cost structure to avoid falling into the red.

Should I include my salary in the hourly cost?

Absolutely, you should. You are a key employee and manager of your business. Your salary, like that of any other specialist, should be included either in direct costs (if you work directly on projects) or in administrative expenses (if your primary role is management). If you don't include your salary, you are effectively working for free, which leads to burnout and loss of motivation.

What about taxes?

Taxes are an integral part of running a business and must be accounted for. Payroll taxes for employees, company profit taxes, and VAT (if your company is a payer) – all these mandatory payments must be factored into the hourly cost or the overall project estimate. These are not "additional" expenses, but a mandatory component of your financial model that the state requires from you. Not accounting for them means operating at a loss.

What are "hidden" costs?

"Hidden" costs are those expenses that are not always obvious but constantly arise during work. This can include time spent searching for and negotiating with new suppliers, solving unforeseen client problems, minor rework, training employees on new technologies, as well as the wear and tear of small tools and equipment that are not depreciated separately. I always allocate 10-15% for unforeseen expenses in each project to cover such "hidden" aspects and avoid surprises that can eat up all the profit.

Stop working at a loss based on incomplete data. Understanding the true cost of your hourly work – it's not just bureaucracy; it's a fundamental element of a sustainable and profitable business. Start calculating, and you will see how your financial picture and confidence in each new project will change.