Are you pricing your construction jobs profitably? Join our guest blogger, Author & Consultant Michael Stone, as he breaks down how to price your work.
Written by: Michael Stone
It's a basic principle: Cash flows into your construction business when you sell a job. Cash flows out when you pay the costs of the job and your overhead. If you sell jobs for less than what it cost you to build the job and pay your overhead, you'll get behind. You won't have enough cash to flow.
Pricing your jobs correctly is the first step to positive cash flow. It's easy to do if you know the math. Determine your markup, the markup you need based on your overhead expenses and your profit needs. Apply that markup to your estimated job costs and use it every time. Now you know that if you make the sales and build your jobs the way you’ve estimated them, you’ll always have enough to pay your bills and make a minimum profit on your jobs.
To calculate your markup, you need three figures: your projected annual volume, your total overhead expense, and your profit goal. How can you estimate your projected annual volume, especially if you haven’t been in business very long or your volume hasn’t been consistent over the past few years? Try this.
Figure out how much money you wish to pay yourself for owning and running the company. Your salary is an overhead expense. It isn’t the net profit from your business; net profit belongs to the company for growth and reinvestment. Pay yourself a salary. A good rule of thumb is 8% for owner's salary, 8% for profit.
In the next 12 months, let's say you want to make a salary of $125,000. To support that salary, you’ll need to sell, build, and collect $1,562,500, because $125,000 divided by .08 (8% of sales) equals $1,562,500. Now you have a sales goal that will meet your salary needs.
Next, calculate your total overhead. Overhead expenses are any expense that can be charged to two or more jobs. Materials, labor, rental equipment, etc., are almost always a job cost. Overhead is everything else you spend money on. Your salary is an overhead expense, it’s not net profit, so be sure to include it.
To calculate the markup, look at what we know. We know our sales goal is $1,562,500. We know we want an 8% net profit of $125,000, and our overhead expenses are (in this example) $415,000, including your salary of $125,000. Subtract the net profit and overhead from your sales goal, and that leaves $1,022,500 for job costs.
Check: Job costs ($1,022,500) plus Overhead ($415,000) plus Net Profit ($125,000) = $1,562,500
Markup is calculated by dividing Sales by Job Costs. $1,562,500 / $1,022,500 = 1.5281 = 1.53 (Always round up). So, until you revise your markup due to changes in overhead or adjustments to your sales goal, your markup will be 1.53.
Example: Add up your labor, materials, any subcontractor quotes and any other costs such as rental equipment, plans, permits, etc. on your estimate sheet and get your total. Let’s say for the next job the total estimated job cost is $24,706.
Then: $24,706 X 1.53 = $37,800 sales price. The smart salesperson knows they always quote using odd numbers so this $37,800 number would become $37,824. That’s your sales price.
Of course, this assumes your estimated cost of $24,706 is reasonably accurate. If your labor costs for the last several jobs have been 6% higher than estimated, when you estimate the next job add 6% to the labor estimate and then total your costs. Apply your markup, then sell and build the job. Now you’ll find your estimated amounts and actual job costs coming in much closer together. That’s smart estimating.
It's not uncommon for contractors to cut their price to sell a job. That’s foolish mischief at its worst. Where will the money come from to pay your bills after you cut the sales price of a given job? I recently read a post from a contractor who said he would cut his price up to 10% to get the job. If he was pricing jobs to make an 8% net profit, he's now given away all his profit and 2% more that was needed to pay overhead expenses. He will be taking money out of his own pocket to build that job.
Don’t tell me you’ll make it up on the next job. I have yet to meet the contractor who cut their price to get a job and was able to increase the price on subsequent jobs to make up for the loss. It's a great theory but it doesn't happen. Why do you think it will be easier to get a higher price on the next job to make up for the low price on this one? And how is that fair to the next customer?
Recognize that when you cut your price, you’re putting your company at risk. Spend time polishing your sales presentation instead of worrying about your sales price, so you won't have to cut your prices. Calculate the markup your business needs to apply to all job estimates and use it without fail. Positive cash flow can only happen if there's enough cash to flow.
About The Author
Michael Stone, author of Markup and Profit; A Contractor’s Guide Revisited, Profitable Sales, A Contractor’s Guide, and Estimating Construction Profitably has more than six decades of experience in the construction industry. He offers business management and sales training assistance to construction-related companies with books and online classes on his website, as well as coaching and consulting services. He can be found on the web at www.MarkupAndProfit.com and can be reached by e-mail at info@MarkupAndProfit.com.
Who Are We?
Castagra is a roof coating manufacturer dedicated to providing sustainable and high-performance coating solutions. Learn more about our products here, or contact our team today to learn more about what we do and how we can help you!
