A Simple Guide To Construction Markup - Discover How To Track Your Profits
Written by Bridget Cooper
Many construction companies have struggled to come up with an ideal construction markup for a project. Even worse, most of them confuse markup with margin. Doing so makes them underprice or overprice their projects, which leads to financial losses or loss of potential clients.
This detailed general contractor markup guide helps address issues around the topic, like defining markup, addressing the difference between margin and markup, and determining the average markup on a construction project.
Let’s start by defining a markup.
What is a Construction Markup?
In the construction industry, a general contractor markup is an additional cost to the total construction cost, either in percentage or dollar amount. The constructor often adds it to cover overhead expenses and other unexpected expenses and includes a desired profit margin once they complete the project.
However, many general contractors use construction margin and markup interchangeably to refer to one thing. It’s wrong, as the two terms refer to different things. Let’s examine the two to find the key differences.
What is Margin and Markup in Construction?
The construction margin is the percentage of the remaining revenue after deducting direct and indirect project costs. The net profit margin often measures the profitability of a project by factoring all the costs related to a project.
Here is a simple formula to calculate construction margins:
Net Profit Margin % = (Total Revenue - Total Expenses) / Total Revenue x 100
In this case, the total revenue is the total amount a contractor charges for the entire project. Total expenses include direct and indirect costs. The direct job costs, also called hard costs, include labor, material, equipment rental, and other costs directly related to the project. By deducting just your direct costs, you're left with the gross profit margin.
Indirect job costs, also called soft costs, include insurance, salaries for non-field workers, office rent, and other charges not directly related to construction. Deducting these costs from the sales price gives you a net profit.
Let’s consider an example project with the following details:
**Total revenue: $ 100,000
Total expenses: $ 70,000
This is how you calculate the construction margin:
(100,000 - 70,000)/ 100,000 x 100
30,000/ 100,000 x 100
0.3 x 100
30%**
The total margin for the entire project is 30%.
The construction margin is helpful to managers and owners, as they use these numbers to determine the project's profitability. It’s the best way for a construction business to track financial performances and determine how to structure their bids. Unfortunately, many general contractors ignore indirect costs and are left with gross margin which they confuse with net profits. Doing so risks their profits since the overhead expenses can eat into their profits quickly. You must understand the relationship between overhead and profit if you are to make any profits from a construction project.
To avoid confusion and ensure they don't fall for the gross profit margin, it's best for general contractors to include hard and soft costs together under the total cost column, instead of separating them.
A general contractor markup, on the other hand, is the percentage you add to the project’s direct costs to cover unforeseen expenses, overheads, and desired profit margin. In this case, you already know the direct expenses and estimated overheads for the entire project. You also have an ideal figure for your desired profits, which you add to the total project cost.
Direct costs include materials, equipment rental, and other related expenses. Overhead expenses include employee salaries, insurance, office rent, administrative fees, and other office expenses. It’s the cost of running a construction project.
You wish to earn the desired profit margin after completing the project. It usually determines the final sales price of the project. Simply put, it determines how much you’ll charge the project owner for the project.
Here is a simple formula for calculating a general contractor markup.
Markup % = (Selling Price - Direct Costs) / Direct Costs x 100
Let’s use another example to explain the formula:
**Selling Price: $200,000
Direct Costs: $160,000
(200,000 - 160,000)/ 160,000 x 100
40,000/ 160,000 x 100
0.25 x 100
25%**
In this case, your markup would be 25% of the contract price.
Now that we know about construction margin and markup let’s look at the average markup you can set for a construction project.
What is the Average Markup on Construction?
Setting an average markup for construction is complex as no industry standard rates exist. General contractors tend to calculate markup percentage rates based on the project complexity, time frame, and the market in which they operate. Simply put, there is no one-size-fits-all solution to setting up the average markup.
You have to factor in many things, including the nature of the project, to calculate markup percentage. Is it a complete construction or remodeling? You must also consider geographical location, as some regions have higher rates than others. Competition from other contractors is also crucial when you calculate markup percentage, as it sets the tone for project bidding, with project owners preferring affordable bids.
It does sound complex when we put it like that.
Luckily, there are crucial details to help you formulate a better general contractor markup to keep your business profitable and still win construction bids. The details help you understand the project’s cost better so that you can come up with an ideal markup.
Let’s analyze them.
Understand your Overhead Costs
Overhead costs include direct and indirect expenses. Direct costs are tangible expenses that are directly attributable to the construction project. Think of them as the ‘muscles’ of the project. Each one of them is very crucial to the project. They include:
Material Costs
A construction project requires materials like steel, concrete, lumber, bricks, tiles, pipes, plumbing fixtures, electrical components, flooring, paints, and other building materials.
Again, the type of materials required depends on the project. A complete construction project would require more materials than a renovation project. The overall budget to cover material expenses comes down to how many materials your project needs.
Understanding the project's complexity by studying the plans helps you determine the amount of materials needed. Contact local suppliers for a quotation for these materials to have an accurate cost figure. It’s always best to adjust the budget to account for unforeseeable challenges like price hikes for specific materials.
Labor Costs
Workers directly involved in the construction project require remuneration in terms of wages and benefits. Such construction workers include operating engineers handling heavy pieces of machinery, site laborers, foremen, and supervisors.
Labor costs account for around 30% of the total project’s budget, making it a crucial determinant when setting up a general contractor markup.
Equipment Expenses
Every construction, whether small or large, requires specific equipment to complete. Large-scale construction projects require equipment like excavators, cranes, and generators. Small projects like remodeling and renovation require tools like a circular saw, orbital sander, cordless drill, etc.
While a general contractor might own some of the equipment and tools, they’re often forced to rent others, like cranes and bulldozers, for larger projects. Leasing certain construction equipment is an affordable option than buying new ones.
There is also the cost of maintaining and repairing the equipment to keep them in good shape and functional throughout the project. You should budget for fuel costs as the equipment runs on diesel or biodiesel.
Subcontractor Costs
Although a construction company promises to meet the project’s demands, it’s common for companies to subcontract part of the project. Factor in whether you subcontract and how much you’ll incur doing so. Start by assessing the amount of work you’ll subcontract. A quotation from a subcontractor helps you determine the overall job cost.
Depending on the project’s size, it’s common for a construction project to subcontract plumbing, electrical, roofing, excavation, and landscaping.
Waste Disposal Cost
Construction waste like demolition debris, excel materials, broken glasses, paint cans, and other waste requires proper disposal, which costs money. You’d need to hire cleaning and garbage disposal companies as they’re licensed to carry out such tasks.
Let’s look at the indirect costs.
Administrative Expenses
Costs like licensing, office supplies, salaries for office staff, and renting an office space all make up the administrative costs. Administrative expenses like licensing have a lengthy period, with many lasting two years before renewal. However, office supplies, rent, and staff salaries recur frequently. You must also factor in additional expenses like accounting when you hire an accountant to balance your books, create invoices, and bank reconciliation. Legal fees involve hiring a lawyer to negotiate a contract on your behalf.
Site Overhead Costs
These expenses include inspection, permits, temporary utilities, and security. They’re usually common in large-scale construction projects, like huge structures, roads, and extensive facilities like sports stadiums.
Marketing and Advertisement
Proper marketing and advertisement campaigns help a construction company attract better clients. With the current digital age, utilizing social media marketing seems to attract more clients. Such campaigns receive better exposure since many people are using social media platforms. It’s also easy to track essential marketing metrics like conversion, engagement, and interest from potential clients.
After analyzing job cost, it’s time to come up with an ideal profit margin.
Set Up a Desired Profit Margin
Brainstorm how much you wish to earn from the project as a net profit margin after deducting overheads. Although there is no industry standard figure for the margin, many companies account for figures between 2% and 10%.
To come up with an appropriate figure, you can use the break-even analysis. The analysis factors in all the expenses to come up with a selling price that doesn’t include making a profit or losses. Compare the relationship between the selling price, costs, and volume to determine how a change in each affects your net profit margins. This refers to understanding the relationship between overhead and profit. Too much expense reduces your profit percentage, and you risk losing money once you complete the project.
Once you break even, you should use the value engineering approach by optimizing the project’s design and plans without compromising the quality or functionality. It involves identifying alternative equipment, processes, and materials that are cost-effective and would still complete the project while maintaining desired standards.
It’s always best to have a reasonably higher profit margin to protect the company from unforeseeable expenses that might impact your profit.
Final Thoughts
A contractor markup is crucial as it determines the selling price of the project. You must factor in the project’s total cost and the desired profit margin to come up with an ideal general contractor markup. The markup figure should also be reasonable and not too high or too low, or you risk losing clients or making losses.