When I 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 over 75% of all contractors don’t know the right mark-up 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 mark-up and margin is a simple concept to grasp and will make you more money than you are currently making, if you follow these steps.
- Mark-Up % = Percentage of money added to direct costs to cover overhead and profit.
- Margin % = Difference between direct costs and sales price divided by the sales price.
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% margin on the job (not mark-up), convert 30% margin using the ‘Margin Conversion Rate’ (MCR) formula:
- MCR = 1.0 – Margin %
- MCR = 1.0 – 0.30 = 0.70
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 = $1,000 /0.70 = $1,428
Next, let’s figure out how to determine the margin you need to hit your overhead and profit goals.
Determine Your Overhead
It all starts with what it costs you to keep your business open. The annual fixed indirect cost of running your company is called overhead. Overhead comprises 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. Don’t forget to include in overhead a regular salary plus vehicle expenses for 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 as they are not needed unless you have jobs to build.
An exception needing to 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.
Determine Your Break-Even
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 even without a 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.
Determine Your Profit
The profit you want to earn is just that. It 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 return of 20% on their annual overhead (ROOH). Determine your annual overhead expenses and then multiply by 20% to determine your annual minimum net profit goal (pre-tax). Then for the hard part: try your best to again estimate your annual sales you’ll generate over the next year.
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. If you can work productively for 50 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, an average of only 40 productive weeks per year is the average for contractors. If you only can work for 40 weeks a year, you need to make at least $12,500 more than your job costs a week to pay for your annual overhead.
George Hedley, CSP, CPBC, helps contractors grow and profit as a professional business coach, popular speaker and peer group leader. He is the author of “Get Your Construction Business to Always Make a Profit!” and “Hardhat BIZSCHOOL Online University,” available on his website. Visit www.hardhatbizschool.com for more information.