Margins, Mark-Up & Making Make More Money!
by George Hedley

I just spoke at a national convention of specialty contractors. I left shocked at the number of business owners who don’t know how to price their work. My guess is that over seventy-five percent of all contractors don’t know the right mark-up to use for overhead and profit. They just bid to get the work at whatever the customer will pay. These contractors continue to charge too litle for the work they do and ruin it for the business owners who know how to run and manage their companies like professionals.

These contractors leave a lot of money on the table every year. They don’t know the difference between markup 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 are cyurrently making, if you follow these steps.

   Mark-Up %  = Percentage of money added to direct 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 Cos            t                       $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%. You are only making 23% on your sales. To earn 30% margin on your sales, you would have to markup your cost 42.8%. Let me show you how to calculate the margin needed to make what you want. To determine your selling price and make the overhead and profit margin you want, you must DIVIDE your direct costs by the ‘Margin Conversion Rate’ (MCR).

            Sales Price = Direct Job Costs / MCR

Using the example above, to make 30% margin on the job (not mark-up), convert 30% 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 sales price by dividing your direct job costs by the MCR as follows:

            Sales Price  = Cost / MCR   = $1,000 / .70  =  $1,428 

Job Bid (Example #2)                                           % Of Sales
Direct Job Cos            t                       $1,000               70%
            Mark-Up         @ 42.8%         $   428               30% (Margin)
            Job Sales Price                        $1,428             100%
           
In example # 2, margin is 30%. If you are selling your jobs using markup versus the margin method, you could be losing lots of money. Next, let’s figure out how to determine the margin you need to hit your overhead and profit goals.

Determine your Overhead
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.

Notice what is NOT included in your annual overhead cost: field labor, field labor insurance, field labor benefits, field trucks, field equipment, gas and maintenance for field vehicles, job insurance, job supervision, and project management. These field costs are a part of your total job cost as they are not needed unless you have jobs to build.

An exception needing to be included in your overhead is the non-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 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 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: $1,000,000, $2,000,000 and $3,000,000. 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%

Job Bid - To Break-Even (Example # 4)
   Direct Job Cost                                $      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

Determine Your Profit
The profit you want to earn is just that. It is the amount of money you want to make at the end of the year based on the risk you take and the return you want for being a business owner. I recommend contractors have an annual minimum net profit target return of 20% on their annual overhead (ROOH). Determine your annual overhead expenses and then multiply by 20% to determine your annual minimum net profit goal (pre-tax). Then for the hard part. Try your best to again estimate your annual sales you’ll generate over the next year as shown in example #5.

Minimum Profit (Example #5)
   Estimated Annual Sales                   $1,000,000      $2,000,000      $3,000,000
   Annual Overhead                             $   500,000      $   500,000      $   500,000
   Annual Profit Target 20% ROOH  $   100,000      $   100,000      $   100,000
   Total Overhead & Profit                  $   600,000      $   600,000      $   600,000
   Overhead & Profit Margin                     60%                  30%                 20%
   Annual Job Costs                             $   400,000      $1,400,000      $2,400,000     
   Margin Conversion Rate
MCR= 1.0 - Margin%                        .40                   .70                    .80

In the example #5 above, to calculate your final selling price on jobs to earn a minimum of $100,000 for the year, divide your estimated job costs by the MCR to determine your final selling prices.

Job Bid - Overhead Plus Minimum Profit (Example #6)     
   Direct Job Cost                                $      1,000       $    1,000         $      1,000
   Margin Conversion Rate
MCR = 1.0 - Margin%                       .40                 .70                    .80
   Job Sales Price    (Cost / MCR)       $      2,500       $    1,428         $      1,250

Set Higher Profit Goals
An annual net profit return on overhead goal (ROOH) of 20% is too low for the risk most contractors take. I recommend you consider a higher profit target of at least 40% return on your annual overhead. Again, first determine your annual overhead expenses and then estimate your annual sales projected. Next multiply your annual overhead by 40% to determine a higher net profit goal for the year as shown in example #7.

Higher Profit (Example #7)
  Estimated Annual Sales                    $1,000,000      $2,000,000      $3,000,000
  Annual Overhead                              $   500,000      $   500,000      $   500,000
  Annual Profit Target  40% ROOH  $   200,000      $   200,000      $   200,000
  Total Overhead & Profit                   $   700,000      $   700,000      $   700,000
  Overhead & Profit Margin                      70%                  35%                 23%
  Annual Job Costs                              $   300,000      $1,400,000      $2,400,000     
  Margin Conversion Rate
MCR= 1.0 - Margin%                        .30                   .65                    .77

In the example above, to calculate your final selling price so you will earn a minimum of $200,000 overhead and profit for the year, divide your total estimated job costs by the MCR to determine your final selling prices as shown in example #8 below.

Job Bid - Overhead Plus Higher Profit (Example #8)          
        Direct Job Cost                           $      1,000       $    1,000         $      1,000
        Margin Conversion Rate
MCR = 1.0 - Margin%                       .30                 .65                    .23
        Sales Price  (Cost / MCR)           $      3,333       $    1,538         $      4,347

Estimating Jobs To Make A Profit
To determine you final selling price on jobs you bid, use a job estimating template to determine your breakeven sales price, your minimum profit sales price, and your higher sales price.

   Job Estimating Template (Example #9)

     Projected Annual Budget
Annual Estimated Sales                      $2,000,000
Annual Company Overhead               $   500,000
Break-Even MCR        (example 4)                .75      
Minimum Profit MCR (example 5)                 .70      
Higher Profit MCR     (example 7)               .65

     Bid RECAP                                  1,000 Square Feet
            Labor                                                   $ 2,000                       
Equipment                                           $    400
Materials                                             $ 2,000
Subcontractors                                    $    200
General Conditions                             $    400
Total Job Cost                                     $ 5,000

        Final Sales Price                      MCR  Sales Price        Cost / SF
@ Break-Even MCR              .75       $ 6,666            $ 6.66 / SF                  
@ Minimum Profit MCR        .70       $ 7,142            $ 7.14 / SF
@ Higher Profit MCR                        .65       $ 7,692            $ 7.69 / SF

Converting Annual Targets To Weekly Goals
Next, it would be great to know how much work you need to perform every week to hit your annual goals. Using example 9 above, you need to cover at least $500,000 of annual overhead to break-even. If you can work productively for 50 weeks per year, you need to make at least $10,000 more than your job costs a week to pay for your annual overhead. In most parts of the country, an average of only forty productive weeks per year is the average for contractors. If you only can work for 40 weeks a year, you need to make at least $12,500 more than your job costs a week to pay for your annual overhead.

     Convert Targets To Weekly & Daily Goals (Example # 10)

Break-Even Overhead          = $500,000 / Year
            Productive Weeks                   X           40 Weeks
            Overhead Recovery Needed  = $  12,500 / Week
            Break-Even Overhead                        = $    2,500 / Day

            Minimum Profit Goal           = $100,000 / Year
            Annual Overhead & Profit     = $600,000 / Year
            Productive Weeks                   X           40 Weeks
            Overhead & Profit Needed    = $  15,000 / Week
            Minimum OH & P                  = $    3,000 / Day

            Higher Profit Goal                = $200,000 / Year
            Annual Overhead & Profit     = $700,000 / Year
            Productive Weeks                   X           40 Weeks
            Overhead & Profit Needed    = $  17,500 / Week
            Higher OH & P                       = $    3,500 / Day

Taking Overhead and Profit to the Crew Level
Let’s say your company has three regular crews each comprised of 5 men with trucks. Your crew cost might look like this:
           
     Typical Crew Cost – 40 Weeks / Year (Example #11)
            Labor – 5 Men @ $30/Hour   $   150 / Hour
            Down Time @ 10%                $     15 / Hour                         
            Truck                                       $     15 / Hour
            Small Tools & Equipment       $     10 / Hour
            Miscellaneous Supplies           $     10 / Hour
            Total Crew Cost                      $   200 / Hour
            3 Crews                                   x       3
            Total 3 Crews Cost                 $   600 / Hour
            Total 3 Crews Cost                 $4,800 / Day

To determine how much you need to bill each day, forty weeks per year, ADD the following costs to your crew daily rates shown above in example 11:
           
            Break-Even Overhead                        $2,500 / Day   ($104 / Hour / Crew)
            Minimum Overhead & Profit  $3,000 / Day   ($125/ Hour / Crew)
            Higher Overhead & Profit      $3,500 / Day   ($145/ Hour / Crew)

To break-even in the example above, each of the three crews will have to be billed out $200 / hour to cover their cost plus $104 / hour to cover your company overhead = $304 / hour, plus what you want to earn for profit. If you want to make the higher profit amount, your crew billing rate is $200 + $145 = $345 / hour.

Understanding what it takes to make the money you want is not a simple task. It takes time and concentration to figure out your numbers. And then it takes discipline to actually ask and get the proper amounts you need to make a profit at the end of the year. Take the time to get to know how to make a profit and then you might actually make it become a reality!



ABOUT THE AUTHOR

George Hedley is the best-selling author of “Get Your Business to Work!” As an entrepreneur, popular speaker and business coach, he helps business owners build profitable companies. E-mail: gh@hardhatpresentations.com to request your free copy of “$ure $trategies To $urvive A $lowdown!” or sign up for his free monthly e-newsletter. To hire George, attend his “Profit-Builder Circle” academy or be a part of an “Executive Roundtable Group” call 800-851-8553 or visit www.hardhatpresentations.com.

 

George Hedley  HARDHAT Presentations
(800) 851-8553  
Email: gh@hardhatpresentations.com     website: www.hardhatpresentations.com

 

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