Markup for a Construction Business

Remodeling/New Home Construction/ Specialty/Commercial

By Michael Stone

markup

Markup for a Construction Business

o you know the number one reason construction businesses fail? They dont charge enough for the work or service they provide. It makes sense to charge a price high enough to cover your job costs, pay your overhead and make a profit, but not everyone knows how to determine that price. The easiest way is by using a markup a factor that, multiplied by the job costs estimated for each job, produces a sales price sufficient to cover your job costs, pay your overhead and make a profit. The markup factor for your business will be different than the markup factor for someone elses business because your business has different overhead expenses and profit needs than another business.

I can hear the cries of anguish from many of you, even as I write. Nobody can charge that much, youll never get the work.

Is there a quick and simple method to help you determine your markup factor? Yes. Lets take a look.

Markup for a Remodeling Company

Lets say youve done the research for your company and concluded that with no employees or subcontractors, you can expect to sell, build and get paid for a volume of $150,000 in your first year (or next year). Now, maybe thats too low thats okay. This is an example only; use your own numbers because the math is the same. Its the process of determining your markup that were covering here. Lets assume you want to make a minimum net profit of at least 8 percent. Most remodeling contractors would be happy to make 8 percent (many would be happy with any profit at all). And after calculating your overhead (all non-job related expenses such as advertising, office expenses owners salary, fuel for vehicles, etc.), you project your overhead will be $41,250 for the first year, or 27.5 percent of your volume.

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Markup for a Construction Business

So this is what you are projecting for your companys first year: Dollar volume built $150,000 Overhead expenses (27.5%) $41,250 Net profit (8.0%) $12,000 Heres how youll compute your markup: Add overhead expenses and net profit: $41,250 Overhead $12,000 Profit $53,250 Total Overhead and Profit (O&P) Subtract O&P from the projected dollar volume, and that will tell us the total job costs: $150,000 Projected Volume - $53,250 Total O&P $96,750 Total Job Costs Your projected job costs for your first year in business are $96,750. In other words, thats the amount you expect to spend the first year to build the jobs youve projected youll sell. With those projections, use this formula to compute your markup: Total Projected Volume Job Costs = Markup $150,000 $96,750 = 1.55 Your markup factor is 1.55. How do you use it? To arrive at the correct sales price for each job that you do, first estimate the actual job costs for that particular job. Then multiply the estimated job costs by your markup of 1.55. The result is a sales price that will allow you to pay all of your job costs, all of your overhead expenses and make your projected 8 percent profit. Its that simple.

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Markup for a Construction Business

A quick check using the following formula will tell you if youre using the right markup. Markup 1.55 x x Job Costs $96,750 = = Total Volume Built $149,963

Thats close enough to the $150,000 projected dollar volume to show that this markup is correct. I can hear the cries of anguish from many of you, even as I write. Nobody can charge that much, youll never get the work. If that thought is going through your head, youre going to have a tough time surviving in this business. This is a hypothetical problem for a hypothetical company, but what would you cut to lower your markup? You might say that you could cut the overhead expenses. If so, youll probably start with your salary first. The truth is that the 27.5 percent overhead figure we calculated is a lot closer to reality than the arbitrary 10, 15 or 20 percent that too many contractors think is correct. So if you are going to incur the overhead, and if you want to make a profit, how else will you do it if you dont charge that price? The math is correct. And an 8% profit is more than reasonable for the time, effort and risk that will go into the jobs your company will build. Trust your math! If the math dictates a 1.55 markup but you choose to cut your sales price, youll still have to pay your expenses. They wont just go away.

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Markup for a Construction Business

Markup for New Home Construction

With new home construction, its easier to project our job costs than it is to project our dollar volume. So, with a different set of figures, well calculate our markup with a different formula. Lets say youve estimated your overhead to be $87,750. Youve decided to build four homes this year. You will build two at a cost of $115,000 each (no land expense) and two at a cost of $138,000 each. Your goal is to make a $55,000 net profit. What should our markup be to arrive at the sales price for these homes? Take the figures you projected and add them together to get the total volume built: Job Costs $506,000 ($115,000 x 2) + ($138,000 x 2) Overhead Expenses (13.5%) $87,750 Profit (8.0%) $55,000 Total Volume $648,750 Total Volume built Job Costs = Markup $648,750 $506,000 = 1.2821 (round to 1.29) Check your figures by using our formula: Markup x Job Costs = Total Volume Built 1.29 x $506,000 = $652,740 Looking at the numbers brings us to some very interesting points. First, as your total dollar volume built increases, your percentage of overhead expenses is proportionally smaller. The dollar amount increases, but the percentage of overhead to total volume decreases. When the total dollar volume built was $150,000 for our remodeling company, the overhead was 27.5 percent of that amount. With a total volume of $648,750, our overhead is 13.5 percent of our total dollar volume built. And, as you can see, your markup also goes down proportionally as well.

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Markup for a Construction Business

Now, heres some advice. If your business is going to do both new home construction and remodeling, you must keep separate books, one for new homes and one for remodeling. This is mandatory. If you lump everything into one set of books, youll never There are two reasons be able to figure out where to assign expenses. And if specialty contractors may have you cant figure out where the expense should go, you lower overhead expenses. wont be able to compute an accurate markup for the different types of job. This is one of the main reasons that I dont recommend trying to do both remodeling and new construction work at the same time. Contractors are notorious for not keeping accurate books few, if any, will take the time or expense to keep two separate sets of books. But its really critical that you do.

Specialty Contractors
Some of you may be surprised to learn that the percentage for overhead expenses in the specialty building trades normally wont fluctuate more than plus or minus four percent from the overhead of a general contractor. Theres a commonly held belief that specialty contracting is somehow different, and so the overhead numbers must also be different; for most people that means much, much lower. Not true. If youre a specialty contractor, take the time to develop a list of your overhead expenses. Its a good exercise that should also give you more confidence in establishing a sales price for your work. There are two reasons specialty contractors may have lower overhead expenses: First, specialty contractors normally dont have the sales and advertising expense that general contractors have. Thats assuming, of course, that theyve done a good job of letting the general contractors who can use their services know that theyre in business. If theyve done that, then word-of-mouth advertising resulting from their work will get them referrals and repeat work from general contractors on a regular basis. Thats also assuming that the specialty contractor chooses to work primarily with general contractors, as opposed to soliciting and doing work for the general public.

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Markup for a Construction Business

Working only for general contractors and reducing their advertising allows specialty contractors to lower their overhead expense by 6 to 12 percent. But if they do some or all of their work for the public, theyll have the same advertising expense as a general contractor. Second, specialty contractors may have lower overhead because they do a smaller volume of business (or their job size is smaller, however you want to put it). Their overall cost of doing business is less, in terms of dollar volume and percentage of expense. Some specialty contractors have an average job size of only $550 to $1,200. With smaller job size and lower overhead, specialty contractors normally have a markup thats lower than remodeling contractors doing the same volume of work, but higher than contractors doing new home construction or commercial work. As a specialty contractor, once you have your overhead costs nailed down, you can develop your markup using the same calculation as a remodeling contractor and use that markup to determine the sales price of your jobs.

Commercial Work
Contrary to what most commercial contractors will tell you, you should use the same approach in establishing your sales price for commercial work as for remodeling, new home construction or specialty work. The math doesnt change. Commercial work normally has a much higher dollar volume in any given year than other areas of construction, so your markup is often lower than residential construction.

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Markup for a Construction Business

Make It Happen
Doing the math and making sure all the numbers are where they should be isnt enough. You must also make it all happen. Thats the difference between those who make it in this business, and those who dont. Less than one contractor in 10 will take the time to both develop They dont know if your these numbers and then use them. Thats because price is too high or not. If they of the biggest myth in construction the belief did, they wouldnt have called that you must be competitive.

you in the first place.

You do not have to be COMPETITIVE, but that is certainly an option. What you have to be, what you must be, is PROFITABLE. If you are not profitable, you and your business are going to go away. Period. End of conversation. Now, in construction, being competitive is code for having the lowest price. There is a belief that no one will want you to remodel their kitchen, build their home, repair their electrical service or construct their office building unless you have the lowest price. That belief ignores the fact that in todays market, there are a lot of little things that matter more than price. Some of those little things are returning phone calls, dressing properly, keeping your hair trimmed and shoes shined, arriving for your appointments on time, and providing solid answers to the customers questions. Big things matter too. They include following through on what you say, starting and finishing jobs on time, communicating clearly and frequently with your customer and keeping jobs clean from start to finish. Your customers rank price seventh or eighth in their list of considerations when they select the company that will do their remodeling work, new home, or specialty service work. That has been shown by a number of different studies, including one by the National Association of Home Builders.

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Markup for a Construction Business

So, the next time you start worrying about your price being too high or that you must be competitive, remember it is in your head, not your customers. They dont know if your price is too high or not. If they did, they wouldnt have called you in the first place. They would have done the job themselves. Polish up your sales skills, stay on top of the intangibles and forget about being price competitive. Let the other guy be competitive and go broke. Set your markup where it should be, focus your attention and efforts on being profitable and do the intangibles needed to make you and your company successful. Michael Stone, author of two construction business management books, Markup and Profit; A Contractors Guide and Profitable Sales, A Contractors Guide has more than four decades of experience in the building and remodeling industry. He provides Coaching and Consulting services for construction companies throughout the U.S., as well as products and other services to assist contractors with their business management needs. He can be reached by e-mail at michael@markupandprofit.com, by phone at 1-888-944-0044, on the Web at www.markupandprofit.com or at his new web site, www.myconstructionbiz.com.

March 2009