Margins, Markup and Making More Money!
Essential pricing strategies for specialty contractors
I just spoke at a national convention of specialty contractors. I left shocked at the number of business owners who don’t know how to price their work. My guess is that more than 75 percent of all contractors don’t know the right markup to use for overhead and profit. They just bid to get the work at whatever the customer will pay. These contractors continue to charge too little for the work they do and ruin it for the business owners who know how to run and manage their companies like professionals.
I just spoke at a national convention of specialty contractors. I left shocked at the number of business owners who don’t know how to price their work. My guess is tha tmore than 75 percent of all contractors don’t know the right makrup to use for overhead and profit. They just bid to get the work at whatever the customer will pay. These contractors continue to charge too little for the work they do and ruin it for the business owners who know how to run and manage their companies like professionals.
These contractors leave a lot of money on the table every year. They don’t know the difference between markup and margin or how much to add to their bids to break even or make a profit at the end of the year. The difference between markup and margin is a simple concept to grasp and will make you more money than you are currently making, if you learn these definitions and follow these steps.
Markup Percentage = Percentage of money added to direct costs to cover overhead and profit.
Margin Percentage = Difference between direct costs and sales price divided by the sales price.
Job Bid Example No. 1 Percent of Sales
Direct Job Cost $1,000 77 percent
Markup at 30% $ 300 23 percent (Margin)
Job Sales Price $1,300 100 percent
Markup Percent = Markup/Cost = $300/$1,000 = 30 percent
Margin Percent = Markup/Sales = $300/$1,300 = 23 percent
In the example above you are not making 30 percent. You are only making 23 percent on your sales. To earn 30 percent margin on your sales, you would have to mark up your cost 42.8 percent. To determine your selling price and make the overhead and profit margin you want, you must divide your direct costs by the Margin Conversion Rate (MCR).
Sales Price = Direct Job Costs/MCR
Using the example above, to make 30 percent margin on the job, convert 30 percent margin using the MCR formula:
MCR = 1.0 – Margin Percent (i.e., 1.0 – .30 = .70)
To make the overhead and profit margin you want, determine the final sales price by dividing your direct job costs by the MCR as follows:
Sales Price = Cost/MCR (i.e., $1,000/.70 = $1,428)
Job Bid Example No. 2 Percent Of Sales
Direct Job Cost $1,000 70 Percent
Mark-Up at 42.8% $ 428 30 Percent (Margin)
Job Sales Price $1,428 100 Percent
In example No. 2, the margin is 30 percent. These two examples show that you could be losing lots of money if you are selling your jobs using markup vs. the margin method. Next, you’ll need to know how to determine the margin you need to hit your overhead and profit goals.
Determine Your Overhead
The annual fixed indirect cost of running your company is called overhead—overhead consists of every cost needed to keep your doors open for the entire year with or without any work under construction. It includes your office or warehouse expenses, phones, utilities, office supplies, postage, computers, website, office equipment, office staff, administration costs, bookkeeping, sales, marketing, advertising, estimating, accounting, legal, banking, company insurance and closed job expenses. And don’t forget to also include the regular salary and vehicle expenses of the owner or president who manages the company.
Notice what is not included in your annual overhead cost: field labor, field labor insurance, field labor benefits, field trucks, field equipment, gas and maintenance for field vehicles, job insurance, job supervision and project management. These field costs are a part of your total job cost since they are not needed unless you have jobs to build.
An exception that should be included in your overhead is the non-billable portions of your project management, field supervision, field labor and field vehicles you pay for while they are not working on a job. For example, if you have to keep paying a superintendent during the winter months, you’ll need to add that portion of his salary to your overhead. And if you can’t bill out for your vehicles every day, you’ll need to include the downtime days in your overhead cost.
Determine Your Break-Even Point
When all your jobs for the year bring in enough money to cover all of your direct job costs plus enough to cover your annual overhead costs, you break even, making no profit. To make a profit, you must add your overhead costs plus a profit margin to your bids. Your overhead margin is easy to calculate. It is the total sum of your annual overhead costs divided by the sales you anticipate for the year.
Overhead Margin = Annual Overhead Expenses/Annual Sales
To calculate the overhead margin to use on your bids to break even, you’ll have to estimate the annual sales you’ll be able to collect for the entire year. In example No. 3, below, there are three different levels of annual sales estimated: $1 million, $2 million and $3 million. For each sales level you estimate, you’ll have a different overhead margin that needs to be added to your bids to break-even.
Break-Even Analysis Example No. 3
Annual Overhead Expenses $ 500,000 $ 500,000 $ 500,000
Estimated Annual Sales $1,000,000 $2,000,000 $3,000,000
Overhead Margin to Break Even 50 percent 25 percent 16.66 percent
Job Bid to Break-Even Example No. 4
Direct Job Cost $1,000 $1,000 $1,000
Margin Conversion Rate
MCR = 1.0 – Margin Percent .50 .75 .8333
Job Sales Price (Cost/MCR) $2,000 $1,333 $1,200
Determine Your Profit
Profit is the amount of money you want to make at the end of the year based on the risk you take and the return you want for being a business owner. I recommend contractors have an annual minimum net profit target of 20 percent return on their annual overhead (ROOH). Determine your annual overhead expenses and then multiply by 20 percent to determine your annual minimum net profit goal (pre-tax). Then, for the hard part: Try your best to again estimate the annual sales you’ll generate over the next year as shown below in example #5.
Minimum Profit Example No. 5
Estimated Annual Sales $1,000,000 $2,000,000 $3,000,000
Annual Overhead $500,000 $500,000 $500,000
Annual Profit Target (20% ROOH) $100,000 $100,000 $100,000
Total Overhead and Profit $600,000 $600,000 $600,000
Overhead and Profit Margin 60 percent 30 percent 20 percent
Annual Job Costs $400,000 $1,400,000 $2,400,000
Margin Conversion Rate .40 .70 .80
In the previous example, to earn a minimum of $100,000 for the year, divide your estimated job costs by the MCR to determine your final selling prices.
Job Bid – Overhead Plus Minimum Profit Example No. 6
Direct Job Cost $1,000 $1,000 $1,000
Margin Conversion Rate
MCR = 1.0 – Margin Percent .40 .70 .80
Job Sales Price (Cost/MCR) $2,500 $1,428 $1,250
Set Higher Profit Goals
An annual net profit return on overhead goal of 20 percent is too low for the risk most contractors take. I recommend you consider a higher profit target of at least 40 percent return on your annual overhead. Again, first determine your annual overhead expenses and then estimate your annual sales projected. Next, multiply your annual overhead by 40 percent to determine a higher net profit goal for the year as shown in the example below.
Higher Profit Example No. 7
Estimated Annual Sales $1,000,000 $2,000,000 $3,000,000
Annual Overhead $500,000 $500,000 $500,000
Annual Profit Target (40% ROOH) $200,000 $200,000 $200,000
Total Overhead and Profit $700,000 $700,000 $700,000
Overhead and Profit Margin 70 percent 35 percent 23 percent
Annual Job Costs $300,000 $1,400,000 $2,400,000
Margin Conversion Rate
MCR= 1.0 – Margin Percent .30 .65 .77
In the example above, to earn a minimum of $200,000 overhead and profit for the year, divide your total estimated job costs by the MCR to determine your final selling prices as shown in No. 8 below.
Job Bid – Overhead Plus Higher Profit Example No. 8
Direct Job Cost $1,000 $1,000 $1,000
Margin Conversion Rate
MCR = 1.0 – Margin Percent .30 .65 .77
Sales Price (Cost/MCR) $3,333 $1,538 $1,298
Estimating Jobs to Make a Profit
To determine your final selling price on jobs you bid, use a job estimating template to determine your break-even sales price, your minimum profit sales price and your higher sales price.
Job Estimating Template Example No. 9
Projected Annual Budget
Annual Estimated Sales $2,000,000
Annual Company Overhead $500,000
Break-even MCR (example 4) .75
Minimum Profit MCR (example 5) .70
Higher Profit MCR (example 7) .65
Bid Recap 1,000 Square Feet
Labor $ 2,000
Equipment $400
Materials $2,000
Subcontractors $200
General Conditions $400
Total Job Cost $5,000
Final Sales Price MCR Sales Price Cost/SF
Break-even MCR .75 $6,666 $6.66/SF
Minimum Profit MCR .70 $7,142 $7.14/SF
Higher Profit MCR .65 $7,692 $7.69/SF
Converting Annual Targets to Weekly Goals
It would be great to know how much work you need to perform every week to hit your annual goals. Using the example above, you need to cover at least $500,000 of annual overhead to break even. If you can work productively for fifty weeks per year, you need to make at least $10,000 more than your job costs a week to pay for your annual overhead. In most parts of the country, contractors average only forty productive weeks per year. If you only can work for forty weeks a year, you need to make at least $12,500 more than your job costs a week to pay for your annual overhead.
Convert Targets to Weekly and Daily Goals Example No. 10
Break-Even Overhead $500,000/Year
Productive Weeks x 40 Weeks
Overhead Recovery Needed $12,500/Week
Break-Even Overhead = $2,500/Day
Minimum Profit Goal $100,000/Year
Annual Overhead and Profit $600,000/Year
Productive Weeks x 40 Weeks
Overhead and Profit Needed $15,000/Week
Minimum OH & P = $3,000/Day
Higher Profit Goal $200,000/Year
Annual Overhead and Profit $700,000/Year
Productive Weeks x 40 Weeks
Overhead and Profit Needed $17,500/Week
Higher OH and P = $3,500/Day
Taking Overhead and Profit to the Crew Level
Let’s say your company has three regular crews each consisting of five men with trucks. Your crew cost might look like this:
Typical Crew Cost – 40 Weeks/Year Example No. 11
Labor – 5 Men at $30/Hour $150/Hour
Down Time at 10 percent $15/Hour
Truck $15/Hour
Small Tools & Equipment $10/Hour
Miscellaneous Supplies $10/Hour
Total Crew Cost $200/Hour
3 Crews x 3
Total 3 Crews Cost $600/Hour
Total 3 Crews Cost $4,800/Day
To determine how much you need to bill each day, forty weeks per year, add the following costs to your crew daily rates shown above in the above example:
Break-Even Overhead $2,500/Day ($104/Hour/Crew)
Minimum Overhead & Profit $3,000/Day ($125/Hour/Crew)
Higher Overhead & Profit $3,500/Day ($145/Hour/Crew)
To break even in the example above, each of the three crews will have to be billed out $200/hour to cover their cost, plus $104/hour to cover the company overhead = $304/hour, plus what you want to earn for profit. If you want to make the higher profit amount, your crew billing rate is $200 + $145 = $345/hour.
Understanding what it takes to make the money you want is not a simple task. It takes time and concentration to figure out your numbers. And then it takes discipline to actually ask and get the proper amounts you need to make a profit at the end of the year. Take the time to get to know how to make a profit, and then you might actually make it become a reality!
OUR DIGITAL PARTNERS
