I just spoke at a national convention of specialty contractors. I left shocked at the number of business owners or estimators who don’t know how to price their work. My guess is that over 75 percent of all installation contractors don’t know the right mark-up to use to cover all of their annual overhead expenses plus make the net profit they want. The typical standard bidding style is to price work low enough to beat their competitors at whatever customers will pay. Not knowing what it takes to cover your actual job costs, overhead and profit keeps contractors busy doing work for too little a price.
Contractors who don’t charge enough for the work they do ruin it for the business owners who know how to run and manage their companies like professionals. These “guesstimate” contractors leave a lot of money on the table every year charging too little. I call it “stupid low” when contractors bid jobs to get them at a cheap price to get work and keep their crews busy. They don’t know or calculate their real costs of doing work on a regular basis. They use an industry standard square foot, lineal foot or some other ballpark pricing method to calculate their bids.
Most contractors also don’t know the difference between mark-up 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 currently are, if you follow these steps when pricing your next jobs.
Mark-Up % = Percentage of money added to direct job costs to cover overhead and profit.
Margin % = Difference between direct costs and sales price divided by the sales price.
Job Bid (Example 1) % Of Sales
Direct Job Cost $1,000 77%
Mark-Up @ 30% $ 300 23% (Margin)
Job Sales Price $1,300 100%
Mark-Up % =
Mark-Up Cost = $300 $1,000 = 30%
Margin % =
Mark-Up Sales = $300 $1,300 = 23%
In the example above you are not making 30 percent. You are only making 23 percent on your sales. To earn 30 percent margin on your sales, you would have to markup your costs 42.8 percent.
Let me show you how to calculate the margin needed to make the overhead and profit you want. To determine your job sales price, you must divide your direct job costs by the “margin conversion rate” (MCR).
Job Sales Price = Direct Job Costs MCR
Using the example above, to make 30 percent margin on the job (not mark-up), convert 30 percent margin using the “margin conversion rate” (MCR) formula:
MCR = 1.0 - Margin%
MCR = 1.0 - .30 = .70
To make the overhead and profit margin you want, determine the final job sales price by dividing your direct job costs by the MCR as follows:
Job Sales Price = Direct Job Costs MCR = $1,000 .70 = $1,428
Job Bid (Example 2) % Of Sales
Direct Job Costs $1,000 70%
Mark-Up @ 42.8% $428 30% (Margin)
Job Sales Price $1,428 100%
In Example 2, margin is 30 percent. If you are selling your jobs using mark-up versus the margin method, you could be losing lots of money.
Determine your overhead
Next, let’s figure out how to determine the margin you need to hit your overall overhead and profit goals. 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.
Operating Fixed Expenses Annual
Administrative Salaries & Benefits
- President / Owner (Non Job Charged) $100,000
- Estimator / Sales $65,000
- Non- Job Billable Project Manager $20,000
- Office Staff (Non Job Charged) $60,000
- Labor Burden For Overhead Only! $45,000
Vehicles (Non Job Charged) $18,000
Office, Rent & Utilities $36,000
Office Supplies & Equipment $20,000
Telephone, Communications & Postage $18,000
Internet, Website & Computers $12,000
Estimating & Bid Expenses $10,000
Sales, Marketing & Promotion $36,000
Office Insurance (Non Job Charged) $15,000
Interest & Banking $3,000
Professional, Legal & Accounting $12,000
Service, Closed Job & Warranty $20,000
Total Annual Overhead $500,000
Notice what is not included in your annual overhead cost: field labor, field labor worker’s compensation insurance, field labor benefits, field trucks, field equipment, gas and maintenance for field vehicles, job insurance, job supervision, and project management. These field costs should be included in your total job costs as they are not needed unless you have jobs to build.
An exception needing to be included in your overhead is the non-job billable portions of your project management, field supervision, field labor and field vehicles you pay for while they are not working on a job. For example, if you have to keep paying a superintendent during the winter months, you’ll need to add that portion of his salary to your overhead. And if you can’t bill out for your vehicles every day, you’ll need to include the downtime days in your overhead cost.
Determine your break-even
When all your construction 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, 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.
Overhead Margin = Annual Overhead Expenses Annual Sales
To calculate your break-even overhead margin to use on your bids to break-even, you’ll have to estimate the annual sales you’ll be able to collect for the entire year. In Example 3 below, you have estimated three different levels of annual sales: $1 million, $2 million and $3 million. For each sales level you estimate, you’ll have a different Overhead Margin needed to add to your bids to allow you to break even.
Break-Even Analysis (Example 3)
Annual Overhead Expenses $500,000 $500,000 $500,000
Estimated Annual Sales $1,000,000 $2,000,000 $3,000,000
Overhead Margin To Break-Even 50% 25% 16.66%
Break-Even Job Bid (Example 4)
Direct Job Costs $1,000 $1,000 $1,000
Margin Conversion Rate
MCR = 1.0 - Margin% .50 .75 .8333
Job Sales Price (Cost MCR) $2,000 $1,333 $1,200
In Part 2 of this series, we will explore how to calculate your profit and develop a profitable job estimate. In the meantime, learn these important factors and calculate your annual overhead and break-even for your company.
George Hedley is the best-selling author of Get Your Business to Work!, available at his online bookstore. As an entrepreneur, popular speaker and business coach, he helps business owners build profitable companies. Email him at gh@HardHatPresentations.com to request your free copy of “Everything Contractors Know About Making A Profit!” or sign up for his free monthly e-newsletter. To hire George, attend a “Profit-Builder Circle” boot camp or be a part of an ongoing coaching and mentoring program, call 800-851-8553 or visit www.HardhatPresentations.com.