Last updated on May 25th, 2022
All you have to do to run a successful construction business is turn a profit, right?
Well, that’s easier said than done, especially when you consider the many challenges confronting construction firms today. Inflation, soaring fuel prices, and unreliable supply chains are just a few of the bigger challenges that can impact profitability and ultimately success. Still, there are three key numbers that you should know, review, and update during the course of a project to help boost financial success: total costs, markup, and profits. Let’s take a closer look…
Total Costs
While it may be tempting to lowball bids in an effort to win business, it’s also a risky proposition. According to the 2022 Association of General Contractors (AGC) national survey, 84% of respondents’ costs are higher than anticipated. To be competitive and choose the right projects to bid on, it’s important to understand what it will cost to actually do the work and budget accordingly (or even charge more, which is what 62% of AGC survey respondents indicate they are doing).
To start, define each task or activity you’ll need to complete and then put a price on it. Be sure to include the price reflects labor, materials, and overhead. When you add those costs together, you’ll get the true cost of a job (that’s why this process is sometimes called job costing). By taking this approach, you can also easily identify and track project scope changes that impact costs.
Be aware of indirect costs, which typically apply across all of your jobs and include things like construction equipment, workers’ compensation insurance, and payroll service fees.
Finally, there’s overhead. In general, this includes rent/mortgage, office equipment, and supplies, licenses and fees, taxes, utilities, general insurance, and salaries.
It’s important to define all costs upfront and then track them regularly throughout each project’s duration. Unexpected costs and work come up on most projects. By adding them to your costs immediately and letting your client know about changes in scope and price, you help manage client expectations while making sure your costs are covered. Regularly meet with project managers and accounting staff to track costs and swiftly course-correct when needed.
Markup Percentage
Breaking even on a job pays the bills but nothing else. To succeed, you need to make above and beyond the cost of the project. By applying a markup percentage to the total cost, you can generate additional revenue to cover other additional costs or serve as a profit.
For example, let’s say your total cost estimate for a job is $10,000. You decide to mark it up by 20% or $2,000. You’ll charge your client $12,000. If you’ve kept your costs on track, your profit will equal the markup amount of $2,000. It’s important to note that realizing the full $2,000 in profits requires you to be sure all direct and indirect costs are reflected in the estimate; otherwise, a portion of the revenue will go towards those other costs.
To protect your revenue, you should carefully review contracts for language that limits markups on change orders. Project owners often include this language so contractors do not lowball a bid and later make up any shortfall by overcharging on change orders. Unfortunately, contracts that limit markup percentages can also prevent you from covering your costs, much less retaining revenue. At the very least, avoid contracts that limit you to cost or cost plus 10%.
Sales/Profit Margin
Net profit is the amount of sales revenue left after you’ve paid all applicable costs. For example, a 40% profit margin means 40 cents of every dollar in sales is profit. To calculate profit, use this formula: (Net Income / Revenue) × 100. In general, you should strive to earn a net profit of at least 8% — more is even better.
You should review profit margins regularly as it measures your ability to maintain and build a strong bottom line. You can use this knowledge to create a realistic profit margin goal, and then use your markup percentage to reach that goal.
Calculating total costs, markup percentage, and sales/profit margin is essential to defining and measuring construction company success.
Always start using good data that’s regularly gathered, clearly displayed, and accurately analyzed. If you need help with your finances or processes, RBT CPAs is here to help. Contact our experts today!