According to IBIS World, the average net profit margin of construction businesses is just 3-7 %. Construction businesses must account for all costs, including overhead, labor and materials. Many construction firms do not include overhead costs in their bids.
You must know how to calculate your profit margin and accurately account for costs if you are looking to improve your construction business’ profitability. Learn the relationship between overhead costs and profits, plus six tips to boost profit in your construction company while reducing overhead.
Plan ahead to balance contractor profit and overhead
What is the overhead in construction?
Overhead is a cost associated with running a company. Overhead in construction includes direct costs that are directly tied to jobs and indirect costs which include the operational costs needed to run a company.
Rental of equipment or temporary office structures are examples of direct costs.
Indirect costs can include office salaries and benefits, building rent, marketing and advertising, legal fees and more.
Overhead costs are funds needed to run a construction company. A well-crafted bid will cover not only the costs of materials and labor, but also overhead to keep the business running. A good bid will also have a profit margin, allowing a company to continue to grow and reinvest.
What is the profit in construction?
Profit is what’s left after subtracting overhead costs, labor and material costs from the contract price.
Profit is calculated as follows: If a contract valued at $20,000 required labor and materials worth $15,000 and overhead of $2,500, then the remaining $2,500 represents the profit.
You’ll need your costs and your profit margin in order to calculate your proposed contract price. Imagine that you are taking on a project which will cost $7,000 for labor, materials and overhead. You’ll have to add $700 in order to make a profit of 10 percent.
It is important to note that contractor markups and profit margins are not the exact same thing. Contractors must include a markup over the cost of materials and labor. However, this markup also includes overhead costs. You may not be factoring your overhead costs if your markup includes only your profit margin. Each bid that you submit takes into consideration everything your business requires to run.
To mark-up correctly, you need to be aware of your overhead costs and your desired profit margin. This is how you can write winning bids and keep your business afloat.
How to calculate profit and overhead
You need to look closely at all the costs and expenses that are involved in a project before you can calculate your overhead.
Add up your monthly fixed expenses. These could include rent, debt repayments, insurance and more.
Consider your indirect costs, those that are necessary to keep your business running but not directly related to any one job. This includes office staff salaries, legal fees and marketing costs.
Calculate all your direct costs, including the rental of tools or equipment, as well as the hiring of project-specific staff.
You’ll have to pay for these costs in your bid. Let’s say, for example, that you had $4,000 in overhead expenses in a month. You’ll have to increase your bid at least $4,000 to cover overhead costs if you only accept one job in a given month. You can spread your indirect and fixed costs over multiple jobs if you accept more work, but direct costs must be included in the bid.
You can increase your bid after you have determined the markup needed for overhead. This will allow you to make a profit. A job that costs $2,500 for labor and materials plus $500 in overhead might result in a bid of $3,000 — which is a 5 percent profit on top of $3,000 in actual costs.
Six tips to increase profit and reduce overhead
The vision of your company should be growth. Growth comes not only from taking on larger projects or more volume, but also from increasing profits. Here are some tips to increase your profit margin while reducing overhead. This can help you boost your profitability.
1. Profit margins can be increased
Identifying your profit margin, and increasing it is a simple way to increase your income. Consider increasing your profit margin if your company has made eight or nine per cent profit on your jobs.
It’s not wise to raise your prices on existing customers over night. Let them know that your company is increasing its profit margin to match the rest of the market and gradually increase it in the next six or seven months. The new rate will be charged to new customers.
2. Discover what you are missing out on.
If you have always set your profit margin as 10 percent, or whatever number you choose — and yet consistently fall short of that goal, there is a good reason.
Look at your estimates and costs. Are they in line or are your estimates totally wrong? Take a closer look at your markup.
What is the overhead? What is included in that overhead? Include all indirect costs or are there a few that you have not included? You may have missed a percentage somewhere in the bidding process.
3. Construction management software
Consider automating and streamlining the parts of your business where it makes sense. Construction management software can help you streamline your accounts payable and receptive processes, as well reduce the workload on your office staff.
Also, by moving to a construction-specific software program, you’ll have access to drawing storage, compliance management, automated workflows, and other time-saving benefits to reduce the hours spent by office staff doing menial tasks. The software will do the data entry, so your staff can focus on other important tasks. This means more money for the company.
4. Create a policy for accounts receivable
You must first protect your current profit margin before you can increase it. Accounts receivable policies will help you recover as much profit as possible.
- Answering the following questions is important.
- Are you going to send out a preliminary notice about your job?
- Do you offer discounts for early payments? What is the discount and when will it be available?
- When will you send out a payment reminding? What is a notice to intent to lien?
- Will you be using a collection agency to collect debts?
- Do your policies protect your right to file mechanics liens in your state?
5. Attention to your Accounts Payable
Spend some time improving your accounts payable. Late fees can eat into your profits if you don’t pay your suppliers and subcontractors.
The use of automated software, such as the construction software described above, will give you a big boost. Subs and suppliers can submit payment apps online. This will allow you to turn them around quicker and avoid payment delays.
Ask your suppliers and subs if they offer a discount if you pay your bill in advance. They should be accounting for interest when they bid. You can save money by paying them early. They will then transfer that savings to you. It will reduce your overhead costs and increase your profit margin.
6. Beware of high-interest credit arrangements
Your profit margin could be affected by the interest rates you pay to your credit card company and material suppliers. The money you pay to borrow cash can quickly add up if you don’t account for these rates or if the job takes longer than you expected.
You can take a couple of steps. You can start by looking for a card that offers a 0% introductory interest rate. You can then call your credit card provider and ask them to lower the rate.
Plan ahead to balance contractor profit and overhead
You should not leave money over when you are putting together bids. Before bidding, you should know how to calculate your overhead and how much profit the business expects to make.
Do what you can to reduce your overhead and protect your profit margin to keep your business profitable and to stay ahead of the competition.