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Markup, margin, and overhead aren’t simple concepts. Yet, they’re often overlooked by business owners. You can understand the basics quickly, but it can take months (even years) to master a business model and pricing plan that works for you.

A small mistake can have a huge impact on your business. Read carefully as we break it down as simply as possible. Put a sound plan into action before pricing out and completing a quote for your next job.

What is overhead, markup, and profit margins for contractors?

All of these terms are slightly different from one another. Yet, each has a different impact on your business. So here’s a breakdown in a way that matters for construction business owners:

Overhead

Overhead is the fixed indirect cost of running your business over the course of the year. This includes everything you need to “keep the lights on” for your business to operate. Overhead does not generate revenue. It’s purely expenses or background costs of running a business.

Overhead helps you understand how much money your business spends on expenses for every dollar made in revenue (or sales).

The breakdown is different for every single business. It’s important to know what types of overhead you pay for so you can calculate overhead accurately.

There are three types of overhead costs:

  1. Fixed. Monthly costs that don’t fluctuate, like rent and annual salaries.
  2. Variable. Monthly costs that do fluctuate because they’re associated with business growth and activity, like vehicle maintenance and gas.
  3. Semi-variable. Monthly costs that are always present but fluctuate in cost. In construction this can include hourly wages of subcontractors and employees, materials, and permits for example.

Categorize your overhead expenses by completing a few monthly expense reports before moving forward. Always use a consistent time frame and stick with it when calculating overhead.

Your overhead should be baked into your pricing.

Start. by taking a job. revenue projection based on direct job costs and cost of goods sold (not including markup).

Then, multiply your overhead rate by that number total to see how much you should charge your client to account for overhead in your final price.

Pro Tip: Overhead is one of the easiest-to-control factors that impacts your profit margin or bottom line. It’s the number that you can play around with, adjust, and shrink.

For example, finding cheaper rent, a less expensive phone bill, or reduce how many administrative salaries you pay to. lower the cost of overhead.

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How to calculate overhead for a construction business

  1. Start by adding up all your overhead costs for a specific time period (one month is ideal).
  2. Figure out your sales or revenue sum for that same period of time.
  3. Now, calculate your overhead rate. Divide your overhead cost by your sales for the same time period. This will give you a decimal, or your overhead rate.
  4. Multiply this decimal point by 100 to get your overhead percentage to see how much of your revenue on average you spend on overhead.

When you calculate your overhead rate, you’ll learn how much your business spends on overhead for every dollar it makes.

For example, you spent $15,000 in one month on overhead expenses like:

You completed four jobs that month and took in a revenue of $40,000.
Calculate your overhead: 15,000/40,000 = 0.375 (37.5%)

That means that for every sales dollar you make, you allocate or spend $0.357 cents on overhead.

To figure out how much money you spend on overhead for a job, multiply your overhead rate by the revenue you made on that job.

If you made $5,000 in revenue from one job, then you must allocate $1,875 to overhead to keep your business stable and running.

Pro tip: Remember that part of your revenue or sales number should be higher than the actual job at cost. This is because your sales number should be marked up from what the. job actually cost you.

You might charge your customer $5,000 when the job only cost you $3,500 for labor and materials. You mark up that cost to account for profit and overhead!

Markup

Markup is how much more money you charge for a product or service after cost to help ensure a stable profit.

Overhead expenses are different because they are necessary costs you must pay to keep your business operational. Markup helps you make additional profit which can be allocated to your net margins and business growth.

Markup can be measured as a dollar amount or a percentage. It should have your overhead ratio baked in.

The calculation for markup is your Gross Profit (which includes overhead percentage and profit percentage) divided by the Job Cost (or Cost of Goods Sold – COGS), multiplied by 100.

Markup =

Gross Profit [Job Cost ($) + Overhead (%) + Profit (%)]
______________________________________  x 100
[Job Cost]

Profit margin

Profit margin is the net amount of money your business has made after subtracting all your expenses. In order to price a job to ensure a healthy profit margin, you need to mark the cost of the job up.

To figure out what your business’ profit margin number is, you need to:

  1. Subtract overhead, materials, payroll, and all your other expenses from your revenue.
  2. Divide this number by your revenue to get a decimal.
  3. Multiply this number by 100 to see the percentage value of your profit margin.

On average, construction businesses make anywhere from 15 to 45 percent gross margin. The net profit all depends on how efficient the business is in terms of overhead expenses in relation revenue coming in. This all depends on pricing structure, business model, and finance efficiency.

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How profit margin, markup and overhead work together

A common mistake people make is that they don’t consider all these factors together. Usually overhead isn’t included in markup, for example. Or, entrepreneurs think that markup will immediately indicate net profit.

Both options aren’t necessarily true. Why? Because all three concepts are closely related. So, for example, markup needs to be high enough to absorb:

  • The cost of overhead
  • Expense overages
  • Leave enough over for net profit

For example, if you markup your services 25% (and don’t account for profit margin), and your overhead costs you 26% of all revenue, then it’s clear that you’ll be in the red. You won’t make enough profit to cover overhead, plus expense overages.

This is partly why markup and profit margin are considered two different values.

Accounting for profit margins in your construction business

Your goal is to make money––otherwise you wouldn’t be an entrepreneur.

The key concept for you to understand when calculating how profitable your construction job will be is to remember that your markup does not necessarily indicate job profitability.

Remember:

Profit margin is the difference between your sales and your costs (materials, payroll, utilities, price adjustments) after a job.

Markup is the difference in price between your costs and what you charge a client to help maintain or boost your profits.

Overhead is how much it costs you to run your business back end.

Use your profit margin to inform your markup, and your overhead to inform your markup. This can help to keep your pricing in check.

For example, if you set a goal to have a profit margin of30%, then work backwards to know how much you need to make from each job (on top of material costs) to reach that goal (roughly 40%).

You can charge 20% markup on your materials and labor to cover your direct job costs.

Realistically speaking, your profit margin will be lower than the amount made on markup. The amount you make will go towards some of the indirect costs, business investments, and other overhead costs of running your business. The leftover sum will be your net profit.

Take this example:

Job at Cost
MarkupProfit MarginSale Price/RevenueGross Profit (attributed towards Overhead)Net Profit
$40020%16.6% ($66.40)$480$80$13.60

Final tips for success

If you’re not sure where to start, don’t sweat it. Calculating the profit margin on a construction job can be tricky.

If you want to get started right away, then consider pricing out your desired profit per day and work backwards from there.

For example, start with a realistic number to net daily or weekly. Tack it on to your job cost, calculate the sum, and then do the math to figure out how much the net profit percentage is in relation to the other costs.

Ask yourself if this number can be applied across the board; if the new price or profit percentage seems fair to the customer; and if it can keep you competitive.

Sometimes, this simply takes trial and error to figure out what final profit margin works for your business goals and projections.

If you need help with this and want to ensure that you’re running a profitable business, consider working with an accountant. Their expertise can push you in the right direction and help you make wise decisions moving forward.

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