All builders have one major consideration when starting a new construction project—the costs associated with the project. Their primary objective is to reduce all the costs, while maximizing the profits.
Now, this brings us to two things—overheard and profit margins. Most builders have a challenge in calculating these two correctly. This, in turn, has led to very tight budgets, slow business growth, as well as losses in some cases. So, when running a business in this industry, you need to know the industry standard for calculating overhead and profit.
However, you must understand that overhead and profit vary greatly between different companies, projects, and business sizes. That means, we can only determine the profit made by builders using a percentage.
Understanding overhead costs
All businesses have their regular expenses. Now, this is what we call business overhead, which is the cost that ensures your business remains open.
The expenses of a business are further broken down into:
- Direct costs – Direct costs are the expenses connected to certain departments or projects. These costs include labor costs, equipment and machinery.
- Indirect costs – these are the general and administrative costs that builders incur when working on a project. However, indirect costs are not connected to any specific tasks. Examples of indirect costs include office expenses, booking and accounting, office equipment, legal costs, taxes, and insurance, among others.
Besides, you must consider all the costs of materials, as well as the costs of the project to know your full overtime. Builders must determine all these overhead costs before determining how much they will charge for a certain project.
So, how much profit do builders make?
A profit margin determines the degree to which a business activity, in our case a building project, makes money through dividing income by revenues. So, we can define profit margin as the money that a business makes after subtracting all the expenses. If you want to cost a project to make sure that it has a healthy profit margin, you must mark up the total cost of the project.
To determine their profit margin, builders need to do the following:
- Deduct the overhead, payroll, and materials, among all other expenses from their revenue
- Divide this figure with their revenue to get a decimal
- Multiply the decimal by 100 to get the percentage value of their profit margin
The average profit margin that builders make ranges between 15% and 45%. However, this will depend on the efficiency of their business when it comes to managing overhead expenses in relation to the generated revenue. This, in turn, is determined by the business model, financial efficiency, and pricing structure.
Calculating profit margins
A builder’s minimum profit margins should be around 10%. However, 15% – 45% is ideal depending on the project.
In our example, we shall work with a theoretical profit margin of 10%. So, if your revenue for a project is $1,000,000—this is the amount that you bid and the client agreed to pay. If the overhead costs are $200,000, and you spend $675,000 to complete the project, you should be guaranteed to make at least a 10% profit.
So, the formula to use in our case will be:
Revenue – overhead costs = project costs and profit
$1,000,000 (revenue) – $200,000 (overhead costs) = $800,000 (project costs and profit)
Next, you will need to deduct project costs to get the profit using the following formula:
$800,000 (project costs and profit) – $675,000 (project cost) = $125,000 (your profit)
So, $125,000 is 12.5% of your revenue
($125,000 ÷ $1,000,000 = .125 or 12.5%) which is your profit margin
Please note that calculating your profit margin is a bit complicated. So, it’s important to review your numbers several times to make sure that you understand your overhead costs and profit margin. This also will help you to stay on the right track and maximize your profit.
If you don’t know where to start, don’t worry, as calculating the profit margin for your business can be a bit challenging. But, if you want to get everything up and running immediately, you need to consider pricing your expected profit on a daily basis and then working backward.
For instance, you can begin with a realistic figure to net daily. Fix it on your project cost, determine the sum, and do the calculations to determine your net profit percentage depending on other costs. Then, you must check to see if you can apply this figure across all the projects. See if your new profit percentage seems fair to your clients and whether your business can remain competitive with this figure.
According to the tenant build-out contractors from AFS General, Florida, it takes some trial and error to determine the final profit margin that works for your business projections and goals. And, you might need some professional help with this. So, if you need professional assistance to make sure that you run a professional business, seek the assistance of an accountant. Their experience and expertise can help propel your business in the right direction, in addition to assisting you in making the right decisions.