Many contractors struggle with their finances, simply because they fail to study the numbers and are unaware of their true financial situation. Often, it isn’t until after a project is completed that such contractors learn of their financial condition.
Among the majority of construction business owners, one common financial misstep is not tracking and understanding how estimates and bids compare with final job costs. Many don’t know their current overhead or profit markup, and worse, they guess what each should be.
Where’s the Money?
As a business coach, one of the first things I review is my client’s profit and loss (P&L) statement. A P&L statement is a scorecard of your performance as a business owner. After review of P&L statements, almost without exception, I observe that invoices and job costs are not tracked correctly or charged to the right codes or accounts (i.e., the way they bid and estimate projects doesn’t match how the projects are job costed.)
A recent client’s year-end P&L statement showed an annual overhead markup of 10% and a net-profit markup of 5%. When asked what markup he typically uses on bids, he replied, “We always use 20% total markup for overhead and profit.”
But, if that was the case, why wasn’t he wasn’t making 10% net profit markup instead of the 5% showing on his P&L statement? The client told me he was happy with the 5% net profit, even though he bid to make 10%. “Really?” I asked. “You’re happy losing 5% somewhere in the process?”
He wasn’t sure where the 5% profit shrinkage went, but he thought his estimated cost was likely not exhaustive. After a deeper dig, I discovered he was correct—the lost 5% could be accounted for in the items he forgot or didn’t include in his estimates, including equipment, fuel, permits, delivery charges, overtime, call-backs and supervision. All of these items were paid from the overhead account and, therefore, weren’t charged to the appropriate jobs.
Discovering Your Company’s Financial Issues
It requires a massive amount of effort to correctly estimate, bid on and be awarded a project. If you have good accounting software and staff who understand the importance of knowing and tracking the numbers, managing your finances only takes a few concentrated hours per week.
But before you can correct your financial missteps, you and your managers must make it a priority to get the numbers right. Which of these financial issues—accounting problems, estimating errors or job-costing mistakes—do you have?
- Not matching bid estimates to accounting charges for every job on your P&L statement
- Paying invoices, payroll and job costs to the wrong accounts or under the wrong county or state codes
- Not matching estimates to project budgets or accounting systems
- Padding bid estimates to cover things not included but not looked into
- Using labor rates in bid estimates that are not the actual costs required to cover taxes, health insurance, liability and workers’ compensation insurance, paid vacation, holidays, bonus pay, pension and profit-sharing contributions, downtime or shop time when there’s no work
- Not including extra time in labor-hour estimates to cover overtime, weather delays, call-backs, punch-list work or extra move-ins
- Not including costs for company-owned trucks and equipment in bid estimates and, subsequently, not charging for any equipment, making overhead absorb the cost
- Not taking into account costs for small tools, cellphones, tablets, trucks, fuel, mobilization, safety equipment and training time in your bid estimate
- Bidding general conditions, project management and supervision as a percentage add-on to estimates and bids versus calculating the estimated actual cost per job
- Charging too little for change orders, costs, and labor and equipment rates
- Charging the same overhead and profit markup on every job
- Not using markup percentages that cover annual overhead expenses in full
- Not knowing your annual profit goal’s necessary percentage markup
Using Variable Markup Distribution
To maximize your markup, use the list above to acknowledge the top financial issues you need to fix. If you aren’t sure of your financial condition, ask for help from a mentor or meet with your accountant. Remember: Your goal is to make money. And making money starts with knowing and tracking your numbers, as well as using accurate job costs to bid and calculate costs.
Your bids must match the way you job cost and line up with the way your income statement is laid out and presented. And you, before the accounting manager, must know and are responsible for accurate numbers that generate profit.
Next, take a hard look at how you mark up project labor, materials and subcontractors. You can use the same markup for every job, or you can use a better strategy, one which uses different markups based on job size. As you know, your competition tends to reduce total markup to win bigger contracts. And larger jobs attract larger competitors to bid against. The larger the contractor, the smaller the overhead percentage generally gets, as job size and volume increases.
The typical annual overhead markup for a $5 million to $10 million contractor runs from 15% to 20%, and sometimes more. The typical annual overhead markup for a $25 million to $35 million contractor is only 8% to 10%. Don’t fall into the trap of thinking these are the numbers for success simply because they are the norm. As jobs get smaller and smaller, your markup will increase to handle all the time, effort, supervision and overhead that small jobs require in comparison with larger projects.
As jobs get larger, your overhead will become a smaller percentage of your total job cost, and you’ll likely need to reduce your total markup to be competitive with larger contractors on bigger work.
The key is to balance sales with the anticipated number of smaller and larger projects using a job-size markup distribution plan. As you reduce markup on bigger jobs, make sure to increase markup on smaller projects to generate the total sales required to meet your annual overhead and profit goal.
Caution: When using this strategy, don’t be tempted to go out and win lots of big jobs at a lower markup—you may end up busy and broke. And do not use these examples to determine your business’s unique markup needs.