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
+ 25% 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. How do small errors within the unit rate calculations affect a job’s overhead and profit?

    • buildingadvisor says:

      A lot of variables affect the answer to your question. If the error is small and the item is a small part of the total job, then the impact will be modest. If the unit price applies to a large portion of the entire job, then an error of, say, 10% could significantly erode your overhead and profit. The problem is two-fold:

      1) You are marking up a lower number than your real direct costs, so overhead and profit are reduced
      2) You are spending more on direct costs than expected, reducing your overhead and profit further.

      If the error is large enough you can lose all your profit or end up taking a loss on the job. Here’s a simple example:

      Let’s say you bid a 20-square roof at $270/sq. and you add 10% for overhead and 10% for profit. You end up bidding $6,480, including $540 for overhead and $540 for profit.

      But the actual hard costs on the job come in at $300/sq. so you should have bid $7,200, with $600 for overhead and $600 for profit.

      If you do the math, you’ll see that you end up with only $480 ($6,480 – $6,000) for overhead and profit. So you end up with 0 profit and are $120 short on your overhead. So you’ve lost money on the job when you take your overhead into account as you should, as overhead are real costs needed to keep your business afloat.

  2. Should You Reveal Markup to Customer

    Should you reveal your markup if a customer asks? If they want a breakdown of the costs, should you identify your markup? I’m a remodeler charging 30% markup and my customer is asking for the breakdown. I really need to know this. Thanks.

    • buildingadvisor says:

      On cost-plus work (time and materials), it is customary to show your customer all your costs for materials and subs as well as your markup for overhead and profit.

      On a fixed-bid contract, most contractors do not disclose their markup, but some do. There’s no right and wrong – it’s really a matter of your business philosophy and the market you are in. In general, the people who disclose their markup are doing high-end work for professional clients who (hopefully) recognize the reality of markup – that if you don’t charge enough for overhead and profit, you can’t stay in business. They are often doing work by referral and are marketing their business more on quality than on low price. If you know you are not the low bidder, you can try to explain to the customer that the low bidder is not always the best choice as he may cut corners, use inferior materials or workmanship, or raise the final price with “extras” that were left out of the bid.

      It is also common to disclose the cost breakdown in a negotiated bid, in which case you are typically the only bidder.

      In a more competitive market, where you are competing with other bidders, contractors are less likely to disclose their markup, but may show some price breakdown on larger jobs such as framing, windows and doors, insulation, etc. The customer doesn’t really need to know your pricing formula as they can compare bids – they price they are going to pay – and make their choice.

      Disclosing your markup can help build trust or lead to bickering over price, depending on the individual client. You need to decide whether it will help or hurt your cause to disclose the information in this case. If they want to haggle on price, then it might be a lost cause whether you tell them your mark-up or not.

  3. phillip buller says:

    Average Margin on New Home

    What is the average Builder’s margin charged on a new home construction?

    • buildingadvisor says:

      Custom builders typically work on a gross margin of 15-18%, which translates to a markup of about 20-25%. Large developers often have higher overhead and higher margins to cover the overhead. These numbers can vary a lot, however, depending on what the contractor counts as overhead vs. direct costs – for example, his own supervision time.

      Sounds like you know the difference between margin vs. markup, but this topic is source of confusion for many contractors and customers.

      • Easy Formula for Margin

        It’s quite easy to manipulate the margin with the following formula:
        Start with 1.0 and subtract the desired margin (.2 in the case of 20%) Take that number (.8) and divide into the cost of construction and you will get a sales price with a 20% margin.

        Example #1
        1.0 – .2 = .8 (.2 =20%)
        Cost Of Construction = $100,000
        $100,000/.8= $125,000
        Margin = $25,000
        $25,000 equals 20% margin on a sales price of $125,000

        Example #2
        1.0 – .25 = .75 (.25=25%)
        Cost of Construction = $100,000
        $100,000/.75= $133,333.33
        Margin = $33,333.33
        $33,333,33 equals a 25% margin on a $133,333.33 Sales Price

        A whole lot of folks confuse markup with margin. It’s a costly mistake

  4. This is a great article and one I have struggled with. I have always listed out the cost, allowances etc…and have shown my profit/overhead to the customer, which freaks people out. Does anyone have a sample of what they give to their customer for the proposal?

  5. Hard to Justify Markup to Customer

    The main problem I have encountered as an independent contractor focused on finish work, is trying to justify costs, and the overhead it really takes to get the job done properly. Many clients don’t understand the cost of sandpaper, glue, and other disposables. More important are the costs to purchase tools and to maintain the tools you use for any particular job. Also, the time required to source and transport materials, and milling.

    To account for the unknown variables, I typically add 25% to my overall labor cost, based on “contingency” and “markup” (unknown variables of the labor and materials required in a typical remodel).

    Another important factor to consider, particularly if you are doing fine finish work, is the risk involved. I have done quite a few jobs where the piece of wood is unique, and picked out by the client (typically live edge slab-work). When there is no room for error, I tend to mark-up my work more.

    As an independent contractor, I’m not the cheapest option around – but I take the care to perform my work well, and that is what keeps me working. People respect craftsmanship, whether they think they do or not.

  6. 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.

  7. Funny Math to Inflate Price

    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!

      • Michael’s comments above to Jack truly represent reality, amen.

        Unfortunately, many people such as Jack have probably had a bad experience with a less-than-honest contractor, especially those who selected a contractor simply based on low bid – what they thought was to be the lowest cost. Like the old contractor told his clients, “The 3 most important things to most people always seem to be a good schedule, good quality work, and a good price.” After a long pause, he asked, “Well, so which two do you want?”

        Any lack of honesty however is certainly nothing unique to construction however! If we choose to be honest to ourselves, then we all know that there are honest people and some less-than-honest people in literally every type of business or non-business organization worldwide – for-profits, non-profits, and not-for-profits – no exceptions, period. Its always been this way, and always will be this way – Utopia has never existed, and never will in the real world.

        Back to construction, reputation is everything. So choose your contractor based upon their reputation, their experience, and their qualifications rather than just low bid.

  8. Learn The Math, It’s Pretty Simple

    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.

    • Finally, someone who understands the math of “margins vs markup”.

      Another way to explain it is to say that you divide by the reciprocal of the Margin you are trying to achieve. Granted this means you had to pay attention in school. 20% = .8 (80%) 15% = .85 (85%) and so on. Just another way of stating your math.

    • Should Larger Jobs Have Smaller Markup?

      Using the markup formulas in the article, when bidding a larger job with, say, $100k job costs versus a smaller job with $15k costs, should a contractor be concerned with bidding to high and not being competitive? Adding 40% markup to $100k is obviously much more than adding 40% markup to $15k. The worry is that you outbid yourself by adding too much to larger jobs. Any insights into this line of thinking?

      • buildingadvisor says:

        You are correct that most contractors get a smaller markup on large projects such as new homes vs. smaller remodeling projects. This is partly because of the larger budgets on new homes and partly because overhead costs are usually lower on new construction. Also, in most markets, builders cannot get the same level of overhead on new homes as they do on remodels.

        As for changing your markup on large vs. small remodels, some contractors do this if they need to to stay competitive. Every company handles this issue a little differently, but one way or another you must spread your markup over your volume of work so you end up recovering the required overhead and profit to operate your company.

        Regardless of the markup you’d like to charge, if the marketplace won’t accept it, then it’s not going to work. The amount you can charge depends on the market you are in and your reputation and marketing skills. Some companies are successful at charging higher than average prices by marketing themselves as the “Lexus” quality of building vs. the Kia. Often these companies are not in a competitive bidding situation – they have been chosen as the sole contractor for a job.

  9. Finally Understand Profit Margin

    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 because 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

    • It is the difference between mark-up or mark-down. Your mark-up from cost will never equal your mark down from retail.

      If I have a $100 item and need 40% from it (or $60) I cant pay more than $60 for it.

      Some are fooled by taking a $60 item and putting a 40% mark-up on it and wind up at $84. You just lost $16 in the margin.

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