What is a Reasonable Profit in Heavy Construction?

Here’s how to back out from your answer to the question ‘How much do you want to earn as net, bottom-line profit?’

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Here’s an excerpt of an interesting example of how to evaluate heavy-construction margins (from BusinessEcon.org) compared to residential construction. The numbers are five years old and hypothetical, but the concepts are sound.

Consider a small bridge builder doing $70 million per year in government work.

The owners of this company want about $850,000 in after-tax profit. Assuming the tax rate is around 39%, the gross profit (net profit and taxes) will need to be $1,394,000.

This business has a front office staff of 12: an officer manager, controller, finance director, two engineers, an accountant, two support staff and four project estimators/buyers. Costs for the front office are a tad over $1,900,000.

So total margin needed to cover net profit, income taxes and front office is $3,294,000. This is 4.71% of total revenue.

Compared to light construction, like home building, for example, indirect costs are a greater percentage of contract revenues. Expertise of the project managers, site engineers, surveyors and quality control is much more expensive than in home building. Risks are significantly greater, so the indirect costs are significantly greater. Equipment alone will dominate indirect costs.

The offset to this is that often the accounting mechanism is different here in that the government requires a cost allocation model that must be followed whereby indirect costs are assigned to the project using some formula. In effect, the definition for direct costs of construction is different in government contract work than in private residential construction. Here direct costs include an indirect cost allocation line.

Since most of the indirect costs are assigned via formulas to jobs, the indirect section of the financial report will actually become a small number as a percentage of revenue. Basically, direct costs of construction rise as a ratio of revenue as the construction venue goes from residential to complicated highly engineered structures. 

For large public-works contractors, project margins are in the 9% to 12% range.

Read the entire profit analysis at BusinessEcon.org