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