Leading Luxury Builders To Great ness
CASE STUDY
PROFIT MARGIN VS. MARKUP: LEARN THE DIFFERENCE AND HOW TO AVOID THE PITFALLS
UNDERSTANDING THE DIFFERENCE IS CRITICAL. INTRODUCTION
Builders are often confused when it comes to margin and markup. The two terms reflect profit differently. Financial experts estimates that at least three-quarters of installation contractors don?t know how to estimate the markup they?ll need to cover job costs plus overhead and still turn their projected profit margins.
75% OF CONTRACTORS DON'T KNOW HOW TO PROPERLY ESTIM ATE THE M ARKUP.
It?s important to know the difference between margin and mark-up in your accounting, pricing, and contract format. To better understand margin and markup, and how to properly calculate them, let?s define each as well as use examples to show each function in your business.
Margin is a percent value, indicating how much of every dollar in sales is a business profit and available to cover general overhead. Markup is a percent value that shows the relationship of your sales price to your costs and has no real purpose in construction. A markup measures how much more you sell your items for than the amount you pay for them. It is not recommended to use markup terms in pricing discussions.
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LET'S TALK TERM INOLOGY. To understand how money is functioning in your business, it is also important to have a clear understanding of some additional finance terms. These terms-- and the money that they represent-help in determining your margin and markup, and aid in a further understanding of the profits in your company, as well as how to talk about your pricing in contracts and with your clients. The following t erms are key in figuring out your margin and markup: Revenue: The total income you collect on a contract. Revenue is the top line of your income statement and reflects earnings before deductions. Cost of Goods Sold (COGS): All expenses that go into any project; all labor and materials that can be directly related to a project in whole or in part. Gross profit : The revenue that remains after all Cost of Goods Sold are paid. Grossprofit = Revenue ? COGS Gross Profit Margin: The gross revenue you make as a percentage of your revenue or the percentage of the revenue that you make, which covers COGS. Grossprofit margin = GrossProfit/Revenue A key strategy is to make certain that all expenses that are related to, or required for a project, are included as a COGS. This includes project administration costs, general liability insurance premiums, principal?s hours related to the project, etc. Expenses consist of any non job related cost that is incurred in order to keep your business functioning. Overhead is commonly used to describe these expenses, and the overhead of a business should be factored into the calculation of your margin. Net Profit measures how much of every dollar in sales you keep after paying both COGS and overhead expenses. Net profit = Gross Profit-Overhead Expenses Net Profit Margin measures how much net income is generated as a percentage of revenue. Net profit margin = Net Profit/Revenue
THE TOP 3 PITFALLS TO AVOID W HEN BIDDING If you have trouble estimating the necessary markup to cover job costs and still turn a profit, you're not alone. A lot of contractors don?t know how to properly estimate the markup they?ll need to cover job costs plus overhead and still turn their projected profit margins. Understanding the difference between margin and markup is critical for contractors and business owners. That knowledge can strengthen your bidding process and result in more profit and less risk. 3 Bidding Mist akes That Are Killing Your Profit Margin Pit fall #1: Profit Is Caught Up in Ret ainage If you build in a 10% profit margin and your general contractor is withholding 10% retainage, stop kidding yourself. Waiting to pull a profit from retainage leaves you at a huge risk of a cash flow shortage until the job is completed and your retainage is paid out, which can take a long time. Pit fall #2: Not Account ing for Overhead Expenses or t he Cost of Capit al Whether you use a factoring company, bank line of credit, SBA loan, merchant cash advance, or mobilization funding, the cost of outside funds must be built into the project costs of your job (or depending on the type of capital, into the overhead calculations), rather than digging into the project?s profit margin. Pit fall #3: Lowballing a Bid t o Land a Dream Job Thinking of submitting an artificially low bid in order to land the big job later?Don't. If anything goes wrong, that ambitious new project could mean financial ruin for your company, late paychecks for your employees, delayed payments to your vendors and sleepless nights for you, the business owner.
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HOW TO CALCULATE YOUR GROSS PROFIT M ARGIN To calculate gross profit margin, start with your gross profit: Revenue ? COGS= Gross Profit Then, find the percentage of the revenue that is gross profit by using the following formula: Gross Profit Margin % = GrossProfit/Gross Revenue x 100 FOR EXAMPLE: Your contract to build a custom home is $2,000,000. All labor and materials for the project (COGS) equals $1,700,000. (PRO-TIP: Be sure t o charge ret ail rat es for any in-house labor services) STEP 1. Find your gross profit, or the difference between the revenue ($2,000,000) and the COGS ($1,700,000). $2,000,000 ? $1,700,000 = $300,000 gross profit STEP 2. To find the gross profit margin, divide gross profit by the revenue. $300,000 / $2,000,000 x 100 = 15% Gross Profit Margin CONCLUSION: The Gross Profit Margin is 15%. That means you keep 15% of your total revenue. You spent the other 85% on all labor and materials. You may even make more if you supplied in-house labor at sub-contractor rates.
INTERESTED IN LEARNING ABOUT CLB'S ACCOUNTING AND FINANCE SOLUTION? Certified Luxury Builders' accounting and finance team can help you increase productivity, raise profitability, and stay compliant.
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HOW TO CALCULATE YOUR M ARKUP Like a margin, you find your markup by starting with your gross profit: Revenue ? COGS= Gross Profit Then, find the percentage of the COGS that is gross profit with the following formula: Markup = Gross Profit/COGSx 100 FOR EXAMPLE: Using the custom home example from above, your contract price is $2,000,000. Your COGS is $1,700,000. STEP 1. Find the gross profit. $2,000,000 ? $1,700,000 = $300,000 gross profit STEP 2. To write the markup as a percentage, divide the gross profit by the COGS. $300,000/ $1,700,000 x 100 = 17.65 % markup CONCLUSION: The markup is 17.65%. That means you priced the contract for 17.65% more than the COGS.
INTERESTED IN LEARNING ABOUT CLB'S ACCOUNTING AND FINANCE SOLUTION? Certified Luxury Builders' accounting and finance team can help you increase productivity, raise profitability, and stay compliant.
LEARN M ORE
IS YOUR LACK OF UNDERSTANDING M ARGIN VS. M ARKUP AFFECTING YOUR PROFITABILITY?
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