Knowing how to calculate markup is essential for general contractors because it can ensure company longevity
General contractor markup is the amount, usually shown as a percentage, that a contractor charges above their direct costs. It is your construction profit margin, or the amount left over after paying all hard and soft costs. You'll want to build markup into the job’s cost to ensure your company’s longevity, even in downtimes.
Charge too much, and you risk losing the bid on a job. Charge too little, and you have no room for error when paying all of your expenses.
The average pre-tax net profit is between 1.4 and 2.4 percent for general contractors, according to the Construction Financial Management Association. The average pre-tax net profit for subcontractors is between 2.2 to 3.5 percent. To compensate for the risk, this is barely enough for most contractors to survive.
Contractor markup is the percentage added to your direct costs to cover profit and overhead. Markup for residential contractors considers all costs, including labor, materials, fees and permits, insurance, and more. The higher the markup, the more revenue your company makes.
Several factors determine actual contractor markup and can include the time of the year, downtime, licenses and certifications, reputation, specialized equipment, competition, and the availability of materials.
Markup and profit margin are tools used by contractors to measure productivity and determine your bottom line. However, it’s best not to use them interchangeably, and it’s essential to know the difference between the two.
While both markup and profit margin deal with net profit, contractors will calculate each one for different purposes.
Contractor markup includes all direct, indirect, fixed, or variable costs spent while on a job. It includes labor, administrative fees, transportation, overhead, and profit. This is how you’ll calculate how much to charge for your work to earn a desired net profit.
Gross profit margin is how you’ll determine what you’ll make on a particular job, but you calculate it differently than markup. You subtract your cost of goods sold (COGs) from the total cost of your project. For example, if your company reports a 30 percent profit margin, it means you had a net income of $0.30 for every dollar generated.
Markup is the difference between what you charge for the work and its cost to get the job done. The formula looks like this:
Markup =Gross Profit [Job Cost ($) + Overhead (%) + Profit (%)] x 100 [Job Cost]
Your cost (COGS): $200,000
Your gross margin: 25%
Your markup: 33.33%
Revenue: $266,666.67
Gross profit: $66,666.67
Generally, there are three direct and indirect costs for contractors:
Direct costs: Materials, labor, subcontractor equipment
Indirect costs: Transportation, payroll, insurance
Overhead: Office expenses, such as accounting, taxes, marketing capital costs
Calculate markup on your direct costs to cover both your indirect costs and overhead and provide a net profit. Be sure to identify all indirect costs and overhead and determine the monthly cost, so you don’t underestimate a job.
But it is different for each contractor, and there is no industry standard for calculating markup. Just like there is no industry standard for indirect costs or overhead.
Use this basic markup table to ensure you make the profit you need to maintain daily operations:
For 15% profit, your markup on costs should be 17.65%
For 20% profit, your markup on costs should be 25%
For 30% profit, your markup on costs should be 42.85%
For 40% profit, your markup should be 66.67%
Three main factors go into calculating markup:
Overhead consists of “indirect soft costs” like general office expenses, rent, utilities, accounting fees, taxes, marketing, and advertising, and more—all the ongoing costs related to running your business not linked to an actual job.
Determining markup on overhead is just as important as for all other costs associated with your business as it helps you budget and ensures a profit.
Contractors have to mark up the materials they purchase for each job to cover the cost of purchasing, sourcing, storing, and delivering the materials to the construction site. Markups vary from one contractor to the next and possibly from one project to the next.
But as a general guide, the typical markup on materials will be between 7.5 and 10%. However, some contractors will mark up materials as much as 20 percent, according to the Corporate Finance Institute.
There is no industry standard for labor markup or a set hourly rate. Areas with high costs and complex regulations, like New England and California, will likely see higher labor markups than the Midwest. With hourly labor, it’s important to set expectations and milestones (for the worker as well as for the client), as each hour over the budgeted work will diminish profits.
That said, people often miscalculate labor. The time a project takes and the labor rate in a particular area can vastly change your bottom line.
While it’s true you may lose out on work if your markup is too high, you risk the opposite—a substantial loss in profits—if you don’t mark them up enough.
Other factors that determine markup for contractors include:
Size of the project
Degree of safety or hazard
Permit fees, reinspection fees, and cost of meeting ever-changing building codes
Location and duration of the project
Type of equipment or materials necessary for the job
Communicating with customers is essential to building trust and confidence in your work. But your customers won’t want to pay any more than necessary to get the job done to both your high standards and their expectations.
Many contractors shy away from showing customers their markup on the estimate and instead show only final costs. If you have your customers’ trust, that’s all that may be necessary. But if you have no prior relationship, your customers may ask for more.
Generally, you can’t negotiate markup, but there are ways you can haggle some costs that will give your customers the confidence they need to approve the project.
Offer less expensive materials: This can be as simple as swapping wall siding, choosing a less expensive tile product, or switching from granite countertops to a less expensive solid surface material.
Suggest a partial DIY: If it’s a remodel, your customer might want to take on some of the work to save money.
Sell your leftover material: Once the job is complete, sell any leftover materials at a reduced rate and give the money to the customer.
While you may be hesitant to show your markup, if your customer insists, be ready to explain the indirect and direct costs that go into keeping your business up and running.
Everyone understands you need to make a profit, and as long as you can justify your markup, you can’t go wrong. It’s also a good idea to create even payments at distinct milestones during the project, so you’re not facing a renegotiation for the entire cost at the end of the job. Ideally, the last milestone only impacts your profit and not your cost.
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