Understanding profit margin is vital to the long-term growth and success of your construction company
Construction is one of the largest industries in the world. In 2019, the value added by the construction industry was 4.1% of the U.S. gross domestic product (GDP), according to Statista.
Yet in 2020, the average profit margin for general contractors was between 1.4 and 2.4%, according to the Construction Financial Management Association. For subcontractors, the profit margin ranged from 2.2 to 3.5%. This makes construction profit margins some of the lowest of any industry.
For all the risks and fiscal responsibilities contractors take on, these low margins make it challenging to maintain, much less grow, your business.
There are three main types of profit margin.
Gross profit margin: Gross margin is the percentage of net sales. It conveys a company's net sales minus the cost of goods (COGs).
Net profit margin: This measures the profit your company generates per dollar of revenue gained from a completed project. It is an important indicator of your company’s overall financial health.
Operating profit margin: The operating margin shows the amount of revenue your company earns once you’ve covered all fixed and variable costs, except for interest and taxes.
On every job, you want to be sure to cover all direct and indirect costs, as well as make a profit. (That includes paying yourself out of your overhead, not your profit).
Although there is no “normal” profit margin for all construction companies, generally, you will want to show an average net profit of 10% profit and 10% overhead.
This “10 and 10” rule is considered the industry standard but can differ from one company to another. Combined, that means your gross profit or margin would be 20%.
But if you want to see your actual 20% margin, you will want to mark up your hard costs by 30%.
Here’s why: Let’s say your job costs are $10,000, you’d follow the below equation:
Your markup is 20% or $2,000
Total billable = $12,000
If you figure your margin using this formula:
Markup / total costs = margin
Then, $2,000 / $12,000 = 16% margin
But, with the highly volatile fluctuations in everything from dimensional lumber to fuel costs, we suggest that if you mark up your hard costs by 30%, it’s a whole new ballgame:
Your job costs are $10,000
Your markup is 30% or $3,000
Total billable: $13,000
Using the same formula: Markup / total costs = margin
$3,000 / $13,000 = 23% margin
So, when you mark up your project by 30%, you yield a 23% margin—11.5% profit and 11.5% overhead.
But because there are so many factors that go into determining the overall profit for your business, your actual profit margin may be lower or higher.
Many contractors use profit margin and markup interchangeably when estimating construction projects. Both are typically shown as a percentage, but you calculate them differently.
Markup is a percentage added to your direct job costs to cover your overhead and profit.
Margin is the actual sales price minus job costs and overhead.
In construction, many factors go into determining your profit margin. Location, type, and size of the project, as well as material costs, labor costs, and more can all affect how much money you have left over once the job is complete.
To improve your profit margin, it’s best to understand the costs associated with completing a project. This includes both job costs and overhead—basically everything directly needed to get the job done. This might include labor, materials, equipment, supplies, fuel, and permits.
With volatile pricing, it is totally acceptable to qualify a quote to say that it is based on current cost of materials and—if there is a shortage/price spike—that the customer will pay the difference/increase.
Your net profit, direct costs (COGs), and sales volume all factor into your profit margin. You can increase your net margins with solid project management of all direct costs and overhead. Strengthen it further by offering more services, encouraging customers to add more items to their orders, or raising your prices, which increases total revenue.
If you work closely with certain vendors, you can boost your profit margins by taking full advantage of these relationships to cut overall costs. Long-standing relationships build trust and might even save you money on materials and equipment.
Ask for cash discounts and, if the vendor accepts credit cards same as cash, use credit cards that provide cash back, points, or other benefits. If you spend $40,000 with a vendor and get 1% in credit card benefits, that is $4,000.
Overhead is all the ongoing business expenses that keep your business running but do not generate revenue. Often called “soft costs,” these indirect costs could be anything from selling and marketing expenses to administrative costs.
Understanding your overhead costs can help you save money, streamline your business operations, and get a better price for your services.
Common examples of overhead may include:
Labor payroll and insurance, such as worker’s compensation
Equipment
Supplies and materials
Travel
Legal or administrative costs
Office expenses
Advertising and marketing
One way to know if your company is profitable is to look at your profit margin, which considers your operating, gross, and net profit as a percentage of your total revenues.
Your company’s profit margin will vary depending on several factors, including labor, location, length of time to complete the job and more. You can calculate it by dividing the net income (revenue - costs) by the revenue and then multiplying this figure by 100. That gives you a profit margin percentage.
Use this formula to determine your company’s profit margin over time:
Net income (gross income - expenses) / revenue x 100
In the first quarter of 2020, more than 50% of all U.S. contractors expected to see increases in profit throughout the year. Due to the coronavirus pandemic, industry confidence fell but is continuing to rebound into the first quarter of 2021, according to a report by the Associated Builders and Contractors.
To boost your company’s profit margin so that it stays profitable long into the future, you’ll want to build up how much revenue remains as profit instead of becoming bogged down by business costs and expenses.
Use these tips to help increase your profit margin:
On-the-job accidents can be costly to your bottom line. Going over safety procedures and addressing the common causes of accidents (and how to prevent them) with your employees can save you both time and money.
While there are many ways to market your business, you should at least have a grasp of the following basics:
Word of mouth advertising: Past customers will be your greatest marketing weapon. Focus on 100% customer satisfaction to increase your chances of referrals.
Testimonials: As your project is in its final phase, actively engage your client to provide a written endorsement and have them take a picture with you in front of the project. Do this for every project—the longer you wait after the project, the less likely they will agree to endorse/take a photo with you.
Company website: Having a company website with photos and customer stories can generate business and increase profits.
Email newsletters: Send email newsletters showing up-to-date work you’ve completed and upcoming discounts or promotions.
Social media: Post a slideshow of before and after photos on Facebook, Instagram, and Pinterest.
Networking events: Whether in-person or virtual, networking can lead to new opportunities and introduce you to prospective customers.
If you're not seeing the profit margins you’d like, you might consider setting new goals for your business. These might include new ways to improve productivity and efficiency, updating safety measures, and improving customer satisfaction by asking for feedback and staying in touch.
Increase your exposure to prospective local customers by creating your pro business profile on Angi. Manage your online reputation, build credibility, and showcase your work to prove you are the best company for the job.
Profit margin is a measurement of your company’s success. It provides insight into how you’ve managed the cost of doing business over the past year or weathered an unstable economy. This is helpful to understanding if you gained or lost ground compared to previous years.
Finding ways to boost your profit margin can future-proof your business. Angi can help. Sign up for a pro account on Angi to reach homeowners who are ready to book construction projects today.
