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Always Make a Profit

05/15/24

Answer this question: ‘How much profit should we make?’ Your answer was probably one of the following: “5%,” “10%,” “15%,” “More,” “As much as I can get." In a recent survey of over 2,500 construction company owners:

  • 66 percent of companies had NO specific profit goals
  • 70 percent of companies had NO overhead goals
  • 50 percent of companies had NO sales volume goals
  • 92 percent of all company employees had NO written goals

Shoot for nothing, and you will hit It every time

Most construction companies shoot for moving targets by attempting to make ‘as much money as possible’ or ‘more’ than they are currently making. ‘As much money as possible’ is not a target. ‘More!’ More than what? These are not clear targets or goals. 5%, 10%, or 15% are not clear targets either. As your sales and job costs vary each month, your total markup earned changes, while your fixed cost of doing business remains the same. This causes your net profit to move up and down like a roller coaster.

A specific annual sales target of $3,000,000, an overhead target of $400,000, and a net profit goal of $120,000 are specific fixed targets you can shoot for and attain. Not “More,” and not “as much as possible.”

  • What is your annual sales target?
  • What is your annual overhead budget?
  • What is your annual net profit goal?

Always make a profit

The goal in business is not to stay in business or keep your crews busy. The goal of business is to always make a profit. According to a latest Construction Financial Management Association study, companies who have specific strategic plans with clear targets and goals make 33 percent more profit than companies without targets. According to Concrete Construction magazine, only 25 percent of all contractors actually make a profit every year. Additionally, 92 percent of all business owners reach age 65 with $0 net worth! It’s not how much you make that matters, it’s how much you keep (after overhead, job costs, staff, and a fair salary for the owner).

Run your company like a business

Unfortunately, most small- and medium-sized general contractors and subcontractors do not run their companies like a business. A "business" has a business plan, sales goals, job cost goals, an overhead budget, and profit goals. A "business" pays its president or owner a fixed and reasonable salary every month (plus year‑end bonuses from the net profit). A "business" prepares monthly financial statements, profit and loss statements, income statements, and balance sheets. Most importantly, a "business" should make a profit.

A "business" without ALL of the above is not a "business.” It is a place to go to work; a place to "try" to make some money; a place to "try" and cover expenses; and a place to "try" to have some leftovers to pay for the owner’s lifestyle.

Get a return on your investment

If asked to invest $100,000 in a friend’s new start‑up contracting business, what annual return would you want —10%, 15%, 25%, 50%, or more? After considering the risks, you should never invest in a new construction business that doesn’t offer at least a minimum guarantee of 15 to 20 percent annual return on investment. Your fixed cost of doing business (overhead) is an investment in your future ability to make a profit as well. Every year you decide what overhead costs you will need to run your business. You staff accordingly, rent an office, seek jobs to bid, and hope enough business comes in to make a profit. Likewise, you must also make a minimum 15 to 20 percent annual return on the fixed overhead investment you commit to in advance every year.

Aim at a fixed target

Construction companies should make a minimum 20 percent return on overhead every year. This is the minimum target to shoot for. If your annual overhead is $400,000, you should expect a minimum net profit pre-tax of $80,000. Remember, this is the minimum, and that is often too low to shoot for. Aim at a 40 to 50 percent return on overhead as a higher target to hit. For example, if your overhead is $400,000, your pre-tax net profit goal would be $160,000 to $200,000. Now you have a minimum target and a higher target to shoot for. These are specific goals you can aim at and then track your progress.

What is your fixed cost of doing business?

First, determine your fixed cost of doing business or annual overhead costs. Overhead costs include everything you need to run your business without taking into account any jobs under construction.

Overhead costs include:

  • company management
  • administration and accounting
  • estimating
  • marketing and sales
  • your office and utilities
  • computers and supplies
  • all other non-job-related charges or business costs

Job costs include:

Job costs are not a part of your overhead. These include everything that occurs out in the field or on the jobsite that must be job charged. Your job costs should include:

  • project management
  • supervision
  • pro-rata shares of project management or supervision time
  • all field labor costs
  • field labor burden and fringe benefits
  • field labor workers compensation insurance
  • liability insurance for jobs and labor
  • field trucks and equipment

A typical $3,000,000 construction company’s overhead is shown in the example below. Your task is to calculate your accurate fixed annual cost of doing business. This is the ‘nut’ you have to crack before you can break even every year. Always include a fair and reasonable salary for the owner or president of your company. If your owner runs some jobs, split his or her time between overhead and job costs such as project management or supervision. Also, field labor job costs must include workers compensation insurance and liability insurance. These are not overhead charges as they don’t occur unless your field crews are working on jobs. Be sure to put those costs into your job costs and not into overhead. Another mistake is putting all of your company vehicles into your overhead. Most vehicles are used out in the field and should be job charged, including the insurance, gas, and maintenance.

Annual Overhead

(Fixed Cost of Doing Business)

Fixed Expenses

Salaries (Includes Burden & Fringes)

- President

$80,000

- Estimating

$70,000

- Administrative

$45,000

- Accounting

$45,000

Vehicles- Non-Job Charged

$15,000

Facility, Rent & Utilities

$25,000

Office Supplies & Equipment

$15,000

Telephone, Shipping & Postage

$10,000

Estimating & Bid

$10,000

Marketing & Promotion

$10,000

Insurance -Office Only

$20,000

Interest & Banking

$3,000

Accounting

$10,000

Legal & Professional

$10,000

Technology

$10,000

Service, Closed Job & Warranty

$12,000

Miscellaneous & Other

$10,000

TOTAL ANNUAL OVERHEAD

$400,000

Markup versus gross profit

To make a profit after paying all of your overhead costs and job costs, you must know the markup and gross profit you can make in the market in which you compete. For starters, be aware of the difference between markup and gross profit. Markup is the percentage you markup your job costs when bidding a job. Gross profit is the total overhead and profit you make as a percentage of total sales. See the examples and formulas below for converting markup to gross profit:

Job Costs

$100,000

Markup (OH & P) X

20.00%

Total Markup

$20,000

Total Bid

$120,000

Gross Profit (OH & P)

16.67%

Mark-Up Vs. Gross Profit

Mark-Up = Overhead & Profit/ Costs = $20,000/ $100,000 = 20.00%

Gross Profit = Overhead & Profit/ Revenue = $20,000/ $120,000 = 16.67%

Converting Markup To Gross Profit

20% Markup =??? % Gross Profit

Markup/ 1 + Markup = 0.20/ 1.20 = 16.67 % Gross Profit

Markup

Gross Profit

35%

25.93%

30%

23.08%

25%

20.00%

20%

16.67%

18 %

15.25%

15%

13.04%

12%

10.71%

10%

9.09%

8 %

7.41%

6 %

5.66%

Track your bottom-line performance

One of the best ways to determine the markup and gross profit you can expect in your competitive market is to look at your trends on completed jobs. Keep a completed jobs chart handy and updated at all times. Include the start date, job name, project manager, superintendent, foreman, contract amount, bid markup, final actual markup you made, and the gross profit percentage you actually made after project completion. Study the competition and economy trends to determine what sort of markup you can hope for on future jobs based on what you have been getting.

Start

Job

PM

Supt

Fore

Contract

Markup Bid%

Markup Final%

Gross Profit >Final %

2/12

A

JP

BD

HG

$100,000

22.0%

20.0%

16.67%

4/17

B

PS

CT

MK

$150,000

16.0%

15.0%

13.04%

6/21

C

FV

WR

PL

$75,000

20.0%

22.5%

18.37%

8/13

D

JP

PF

SD

$125,000

18.0%

17.5%

14.89%

9/14

E

PS

MN

CF

$50,000

20.0%

25.0%

20.00%

Average

       

$100,000

19.2%

20.0%

16.67%

Volume and sales goals

You are now ready to determine what sales target you must hit to achieve your net profit goal. You know your fixed cost of doing business or annual projected overhead. You have a pre-tax net profit goal of 20 to 40 percent return on overhead. You are tracking the trends of your completed jobs and are aware of the markup and gross profit you can get in the marketplace within which you compete. Now it’s time to figure out how much volume you need to hit your goals.

Seven- Step Formula to Always Make a Profit:

   

Low Goal

High Goal

1. Fixed Annual Overhead

 

$400,000

$400,000

2. Return on Overhead Goal

X

20%

40%

3. Annual Net Profit Goal (Pre-Tax)

(1 X 2) =

$80,000

$160,000

4. Projected Gross Profit (OH & P)

(1 + 3)

$480,000

$560,000

5. Average Total OH & P Markup Projected

 

20.00%

20.00%

6. Average Gross Profit Projected

 

16.67%

16.67%

7. Annual Revenue Goal

(4 / 6) =

$2,879,424

$3,359,328

Looking at the seven-step formula to always make a profit, as shown above, the company’s annual overhead is projected at $400,000. The return on overhead goals is 20 percent minimum with a high target of 40 percent. This gives the company a minimum pre-tax net profit goal of $80,000 and a high goal of $160,000. This will require a total gross profit to achieve the overhead and profit targets of $480,000 and $560,000 accordingly. By studying completed contracts and looking at the market trends, the company determines they can achieve a 20 percent total overhead and profit markup and a 16.67 percent gross profit margin.

To determine how much volume is needed to hit the company’s goals, divide the total gross overhead and profit projected (#4) by the gross profit percentage anticipated (#6). ($480,000 / .1667 = $2,879,424 annual sales at an average markup of 20 percent).

This is the best way to determine the total sales you need to hit your goals. Companies without precise overhead and profit goals never make enough money and probably won’t make a profit. It is hard to hit a fuzzy target that doesn’t exist and moves around. Companies who track costs, target profit, control overhead, watch what they keep, are organized, and are in control will stay one‑step ahead of their competition. Fix your overhead, set clear profit targets, and then shoot for the revenue you need at the markup you can get to achieve your goals. Keep targets in front of you all the time. Share them with your people. Track your progress. Make it happen and you will have money in the bank.

Business - Commercial Real Estate Industry

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This article contains general information only. Sunflower Bank is not, by means of this article, rendering accounting, financial, investment, legal, tax, or other professional advice or services. This article is not a substitute for such professional advice or services, before making any decisions related to these matters, you should consult a qualified professional advisor.