You are on page 1of 3

CALCULATING CONTRACTORS MARKUP

You think a 25% "markup" is fair (I think it is low, but more on that later) and that that is the number you will use to "markup" the jobs you sell. So far, you have done everything right, but there is danger just around the corner. The most common error is the confusion between "markup" and "margin". "Margin" is your monetary gross profit expressed as a percentage, in this case 25%. "Markup" is is the mathematical tool used to get you the 25% gross profit or "margin". There is an easy way to do this. To realize a gross profit "margin" of 25%, multiply the total direct cost of your job by 1.33 (this is your "markup"). A job whose direct costs total $1,000.00 must sell for $1,333.00 for that 25% gross profit "margin" to be realized. Your monetary gross profit will be $333.00. Remember that your "indirect expenses" will be paid out of your gross profit (also known as your "margin". Mathematical proof: gross profit divided by selling price equals margin or in this case 333/1333=24.9%. The biggest mistake most new Contractors make is to multiply their "direct costs" by their intended "margin" and add it back to their "direct costs" to arrive at a selling price. In the above example that would be $1.000.00 times .25 (or 25%) equals $250.00 added back to $1,000.00 equals a selling price of $1,250.00. Now let's go back to the mathematical proof: gross profit divided by selling price equals margin or in this case 250/1250=20.0% But wait, you budgeted and committed to spending $25,000.00 over a years time and decided to operate at a 25% margin! If you calculate your selling price in this manner we have just proven that you are quickly going in the hole. Most new Contractors do not realize until it is too late that they have spent more than they have earned. Unless they have deep enough pockets to afford them the time to learn from their mistakes, we have proven they are doomed to failure. You can't plan for a 25% gross margin and mistakenly earn a 20% gross margin for long. Too many Contractors sit and wonder "where did the money go?" at the end of the year. Many never figure out the math, they just vow to sell more and work harder which just hastens the inevitable. Now lets go back to our assumptions. You understand the math. You have budgeted and committed to spending $25,000.00 on indirect expenses in the next year. You have decided to work on a 25% margin using a 1.33 markup. You are a great estimator and never make mistakes or encounter unforseen circumstances. You will pay yourself an hourly wage (direct expense) for pounding nails and will not "take anything out of the business" other than the money you earn hourly. How much do you have to sell to "break even" and pay the bills? To calculate your "break even point", use the following formula: total indirect costs divided by gross margin equals sales volume needed to break even. In our example, $25,000/.25(25%)=$100,000.00. In other words, you will have to sell $100,000.00 worth of business at a 25% gross margin just to pay the bills to which you have committed. You will have earned a living pounding nails (remember you are paying yourself by the hour ... a direct expense) but at the end of the year, your business will have earned nothing. But neither will you be in the hole. The good news is, for every dollar you sell over $100,000.00, the business earns $.25 in net profit before taxes! Now that you know your "break even point", you can plan to make a profit. If you sell $150,000.00 in

volume at a 25% gross margin and stay within your $25,000.00 "indirect expense" budget, your business will earn a $12,500.00 net profit before taxes. This is the cash you need to grow your business. It provides additional "working capital", perhaps cash for a small salary for all the long evening and weekend hours out selling, the realization of a return on investment, etc. Over many years, positive cash flow gives a business value. When you decide to retire some day, someone will be willing to buy your profitable business. Back to the margin percentage. You specify a 25% markup. By any industry standards today, the residential remodeling business requires at the very least a 40% gross margin (1.67 markup) with many believing that 50% (2.0 markup) is necessary. Some specialty Contractors use substantially higher markups. Once you wrap your mind around the need for higher markups, youo need to learn how to sell your jobs at those kinds of prices. Believe me, it can, and is being done. You must seperate yourself from the competition in your presentations to customers and you must sell value and benefits. Selling is an art in and of itself and deserves to be addressed separately. I always told my customers "The bitterness of poor quality lingers long after the sweetness of a cheap price is forgotten". There are quality buyers out there and you need to go out and find them. Many years ago I learned a lot from Walter Stoeppelwerth at HomeTech located in Bethesda, MD. His Company publishes outstanding industry related books. In addition, he travels the country putting on seminars on the building and remodeling business. If you have the chance to attend one of his seminars, don't miss it. You can view the website at www.hometechonline.com. I enjoy imparting this information and used to teach classes on cost accounting, business management, and selling to my peers in my local HomeBuilders Association.

THE MISTAKE OF MARKUP


If a builder wants to make a 20% margin (also called gross profit) to cover overhead and profit, he has to mark up his hard costs by 25%. This little twist of math manages to confuse many people and has probably lead to the bankruptcy of more than a few small contractors who thought they could mark up their jobs by 20% for a 20% gross profit. The math, shown below is simple. To achieve a 20% margin (for overhead and profit), you need to mark up your costs by 25% (see box below). SAMPLE JOB MARKUP Job Costs price 12,500 $10,000+ 25% markup: 2,500Total

Markup Price = Margin2,500 12,500 = 20% The chart below shows how much a contractor has to mark up his hard costs in order to make a certain margin. Margin, or gross profit, is used to pay for a companys overhead and to provide a net profit at the end of the year.

MARKUP VS. MARGIN Markup 15% 20% 25% 30% 35 40% 50% 100% Margin (Gross Profit) 13.0% 16.7% 20.0% 23.0% 25.9% 28.6% 33.0% 50.0%

Note: To achieve the margin in the second column, a contractor must mark up its hard costs by the number in the first column.