PRICING THE JOB: MARK-UP, OVERHEAD & PROFIT

IN THIS ARTICLE
Calculating Overhead & Profit
The Mistake of Markup                 View all Bidding articles

Once a contractor has come up with his estimate of hard costs to complete the job, he will mark up his costs to determine the bid price. The hard costs – the money paid out for labor and materials — is marked up to cover overhead and profit.

Overhead. Overhead includes all the “soft” costs incurred by being in business that are not associated with a specific job – for example, trucks, tools, and equipment; office expenses, bookkeeping and accounting; advertising, training, legal, insurance, and other costs of being in business. If a contractor does not charge enough to cover his overhead, he won’t be in business long.

Profit. The other component of markup is net profit, often referred to simply as “profit.” Net profit is amount left for the owner after paying all hard and soft costs to complete the job (gross profit  net profit plus overhead). If the company owner works part-time of the job, his labor cost while swinging a hammer is treated as a hard cost of that job. If he works in the office and pays himself a salary, his office pay would be counted as overhead. If the job is profitable, the owners would earn profits in addition to any wages paid to them by their company.

CALCULATING OVERHEAD AND PROFIT
Every company calculates overhead and profit a little differently. For example, some companies consider labor burden (employee benefits and taxes) as a direct job cost, some consider it overhead. Some companies mark up materials, labor, and subs. Some just mark up labor. Some assign overhead based on the time it takes to do a job, rather than the cost of the job.  Some assign a line-item expense for the contractor’s management fee in lieu of  “profit.” Or they may use some combination of these pricing approaches. Whatever method is used, it’s essential for the company’s survival that they make enough money to cover all the company’s costs. The remaining net profit rewards the owner for taking on risk, and also provides money for new equipment,  for working capital, and as a hedge against future losses.

Many numbers get kicked around as the “right” amount of overhead and profit. In general, large companies have higher overhead than smaller companies. In some very small companies, where the owner is on the job site every day, the owner is often primarily working for wages, with a modest additional profit if all goes well.

Because everyone calculates the numbers a little differently, these number are slippery and difficult to generalize.  A national survey of 54 builder/developers by  NAHB (see below) showed an average net profit of about 9% on land-and-house packages. Overhead, marketing, and sales accounted for another 10% (financing is generally considered a direct cost of construction).  This is not far from the “10 and 10” sometimes thrown around for 10% overhead and 10% profit. Custom builders typically work on smaller margins of about 15% to 18% for overhead and profit on new homes, while remodeling contractors typically charge higher rates for overhead and profit. When times are tough, some contractors lower their markup (and profit) in order to attract more work with lower prices.

SINGLE-FAMILY HOME:  COST BREAKDOWN

Sales Price Breakdown Average % of total
Finished lot $76,591 23.3
Construction 222,511 58.9
Construction loan 6,375 1.7
Overhead 20,377 5.4
Marketing 5,297 1.4
Sales Commission 12,815 3.4
Profit 33,658 8.9
Total Sales Price 377,624 100%
Source: NAHB 2009 survey of home builders. Avg. house size: 2,716 sq. ft.

 

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   $10,000
+ Markup          2,500
Total Price     $12,500
 Markup  ÷ Price     = Margin
$2,500  ÷ $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 company’s overhead and to provide a net profit at the end of the year.

MARKUP VS. MARGIN

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

 

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Comments

  1. Brooks Dawson says:

    Jack,
    When does anybody get anything at cost. There is always a markup even when somebody says they are selling it at cost. Remember the higher the risk, the better the reward. Contractors take a lot of risk if things go wrong. You know the saying “Hope for the Best, but prepare for the Worst.” Twenty percent seems high to some people but that is reasonable in construction in most States. In retail you can get charged from 200% up to 1500% by the time the product goes from manufacture to showroom floor.

  2. I fully understand your explanation of how 125,000 will get you at full 20% markup. But, this is still a bunch of contractor bologna. Why do you get to add the money you will be receiving to the total in order for the amount not to equal 20%? Any business owner could do this funny math to receive a desired larger percentage.

    • Jack
      Next time you go to the grocery store and you’re standing in front of the teller, tell them you don’t want to pay retail — that you want it at their cost and let’s see how hungry you’ll be. Markup is not some flippant process to extort money from someone. Its the lifeblood that keeps a business in business. Why do you feel that contractors are somehow ripping you off if they employ the same standard and principles as all other businesses? Everything you have ever bought has had markup. I’m sure you don’t argue with the gas attendant every time you fill up your vehicle about their markups!

  3. You need to learn the math associated with the desired markup rather than depend upon a table like noted above.

    The math is rather simple: If you desire a 20% markup (Office Overhead, Soft Cost, and net profit) you simply subtract the desired 20% from 100% and then divide the Hard Cost by the difference between the 100% and the 20% (100-20=80).

    Assume a $100,000 Hard Cost and a 20% markup. What you must remember is that you are really looking for a 20% on the FINAL BID. Not a 20% on the Hard Cost.

    If you just add 20% to the $100,000 the bid would be $120,000. Now to check if you are actually meeting your objective of 20% on the contract amount, multiply 20% form the bid amount of $120,000 and you get $24,000 not $20,000. So you are $4,000 short of the desired 20% of bid or contract amount. You are actually only 16.67% of the total bid of $120,000.

    Lets redo this: Hard cost of $100,000, desired markup of 20% of actual bid.

    100%-20% = .80
    Hard cost $100,000/.80=%125,000

    Check: Bid/Contract Amount = $125,000 X 20% = 25,000
    $25,000/$125,000 = .20 or 20%

    The total difference is $5,000. This means that if you marked up the project by just adding 20% to the hard cost, you will need to hope that you overestimated your hard cost by $5,000 if you are to actually obtain the $25,000 Markup.

  4. This was article was so good to read because it really confirmed my own “knowingness” on the subject. Regarding the “Mistake on Mark-up” section, I will be honest, I have been doing it wrong and had no clue of this. As I have not finished high school as a teenager, I am not stupid, and think many contractors and professionals share in this idea. I believe the only reason I have not gone under is beacuse when I finish a bid, I always add negotiating money on top of everything. But still, most jobs finish tight and I always wonder, “should I have put more money in the bid” Did I estimate this wrong? Am I calculating my mark-up wrong? Or – I wonder how my competitor did his mark-up?” I actually worked in a company in Canada once that calculated their mark-up like its explained in this mark-up but it was never explained to me why they did it. IN reading this article, I get it! This to me is one of the best sources of information on the internet for my business.
    I guess, the only things that will be immediately noticeable is that if our competition does not know about how to calculate their profit margin properly, (such as I have been doing,) then our bids will be the higher most of the time. – But I would rather sign on a job KNOWING i’m going to make profit than wondering. – And yes, most of the time, we get the jobs because of a great portfolio and reputation – price is NOT always the first consideration.
    Thanks,
    GN

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