How much profit should you put on a job? Who knows the answer? Your CPA? Your competitor? David Copperfield? Everyone has an answer. But what is the best one, and how do you get there?
A reader from a good, stable market wrote and asked me about profit. What is a reasonable profit? As it turns out, he was really more concerned with markup, which is often confused with gross profit margin. Both terms are important when determining profit.
First of all, there is only one true expert on how much you need to mark up your costs to make your business successful: you. You can get some good guidance but only internally generated costs checked and analyzed by you show what the real numbers are. Let’s make a very good New Year’s resolution to pay close attention to measuring and analyzing our job-cost numbers. Only when you check your actual costs against your estimated costs do you know your true production cost.
Here’s the caveat: If you aren’t comfortable taking the risk of being in business or you believe you can’t pay yourself what you’re worth, go to work for a good company, make what you are worth, junk the risk, reintroduce yourself to your family and live happily ever after.
If you’re still with me, let’s determine how we mark up the cost of goods sold or estimate to make the profit we want. I believe 7 to 10 percent of sales volume is a reasonable target for a net profit. If your company is doing $1 million in sales, after paying all the bills, including your own salary (for what you are worth), 401k and bonuses, I want to see you have $70,000 to $100,000 left as real net profit.
Start at the bottom (line, that is) with net profit and add the full cost—commonly called general administrative and overhead, or GA&O—of operating your company. This should be independent of all construction costs associated with jobs. GA&O is rent, insurance, non-jobsite utilities, office equipment and salaries (including burden). You should include your salary, as the big cheese, here. The total of all these costs, including the net profit, is what you will need after you have paid for all the construction costs and the goods sold. This is your needed gross profit. Successful, full-service remodelers I know around the country use a general benchmark minimum needed gross profit margin of 31 to 33 percent of sales.
In simple terms, when you complete all the construction activities of a job and all the bills are paid, the gross profit is what is left. When you complete the estimating process, you know the production cost of the project. What do you need to sell it for to preserve that intended 10 percent net profit? We can compute the markup percentage by the following formula: Markup = Gross Profit Margin ÷ (1 - Gross Profit Margin).
Based on what we know the needed gross profit should be for a successful, full-service remodeler, the equation would be: Markup = 0.33 ÷ (1 - 0.33) = 0.33 ÷ 0.67 = 0.50, or 50 percent for a markup. If your costs are $10,000, then your markup needs to be 50 percent of that, or $5,000.
You are the only true expert on figuring this markup because only your proven construction costs verified by your job-cost analysis tell the real-world story. Your gut may believe the markup is too high but if you figure your costs correctly, it is correct. You can wish it lower, but you can’t deposit wishes in your bank account.
If you use good numbers and manage your company well, you probably will save some money. When you do, that old net profit goes up. In other words, if you are making 10 percent net profit on sales and you can save $5,000, it’s like getting a $50,000 job that you don’t have to build; you just collect the profit. That’s not too shabby, while you’re here...