How Much of a Profit Margin Does Your Contracting Business Need?

A man is using a calculator while sitting at a desk with blueprints.

Getting profits from your business seems like it ought to be simple. You spend a certain amount of money on each project, and the money you make on top factors into your profits. In order to get enough money, you’ll need to research and set your profit margins. The amount depends on industry norms as well as your own business’s needs. Here are a few factors to keep in mind as you set your prices.

Profit Margin vs. Markup
When you’re thinking about how to set your prices, you’ll notice that there are a lot of industry terms involved. If you don’t know what they are or how to use them, you may make costly mistakes. For example, many people who are new to running a business don’t know the difference between a profit margin and a markup. A markup is the increase in price above the cost it takes to provide a service. Essentially, it’s the difference between the cost of the job and what you charge a client. By comparison, your profit margin is the difference between all of your business costs, including the cost of the job, subtracted from your total revenue. As such, your average profit margin is usually lower than markup.

Gross Profit vs. Net Profit
Now that you have a rough understanding of the difference between profit and markup, you should know that there are different figures use to estimate your profits. A gross profit is the simple difference between the amount of money you brought in for the project and the cost of the project. Of course, there are a lot of other aspects involved in running a business that you have to pay for as well. Those figures must also be subtracted from your gross profit, which leaves a net profit. The net profit is the money that you have left over, that you can use to do things like buy new equipment or expand your business.

Overhead
Overhead is the major factor that distinguishes gross profit from net profit. Overhead involves a lot of costs that you take to run your business that aren’t necessarily related to any individual project. These include:

You have to factor overhead costs into your profits for each project. As a general rule, you can take your total anticipated overhead costs for the year and divide it by the gross profits you expect to earn. That gives you a decimal amount that you can apply to your gross profit. For example, if your overhead costs you $.20 per dollar of gross profit, your net profit may be about 80% of the gross profit.

Competition
Of course, all of this discussion doesn’t tell you how much you should be marking up your services, to give you a set profit margin. For most businesses, having a net profit margin of around 10% offers a lot of flexibility. But it’s worth factoring in the profit margins of your competition, even if you won’t necessarily follow what they do. Generally, profit margins for construction businesses tend to be a lot lower. Evaluate your competition, and determine whether you need to follow a similar pricing scheme to compete, or if doing so is going to make it unprofitable for you to keep your business going.

Industry Standards
Prices for construction services are often region-specific, but you’ll also see a lot of similarity across the industry. Keep in mind that larger businesses may need a smaller profit margin than small businesses. They often have more access to capital, and they can do more and bigger projects. Remember that many businesses who fail to accurately estimate the cost of a job end up running a loss, not a profit, at the end of the project. Your goal is to keep making money so that you can continue to run your business. Be wary of trimming your profit margins as a way to secure more work.

Your profit margin is your key to helping your contracting business grow over time. To start, you’ll need to be a licensed contractor. For more information about taking the contractor licensing exam, visit CSLS today!