I'm going to do a 3- part series on markup, gross margin and why you need to keep them separate. This markup vs. gross margin subject has too many confused. Based on the feedback that I get almost daily, a review of the difference between margin and gross margin is in order to get some poor souls back on track.
I know most of you know how to calculate the correct markup to use in establishing the sales price for your service or work. If you don't, read the book, buy the software, or watch the class. Many of you also know how to calculate the correct gross margin to set your sales price if you prefer to do it that way.
I had a conversation yesterday with a friend about a job he quoted in excess of $200,000. The owner had a quote on the same job for less than what my friend estimated the total cost of materials to be. Of course, the owner liked the lower quote better – if the job actually gets built, both the owner and the low-balling contractor will get exactly what they deserve. Nuff said.
Markup is basically your sales for any given point in time divided by your job costs. Turned around, your markup multiplied by your job cost equals your sales price.
Once you know your markup it's easy to reach the correct sales price for your work. Let's assume that you have done an estimate; you have all your numbers for labor, materials, specialty contractors, etc. Let's say the total estimated costs are $8,755.
You now multiply your job costs times your markup and you have the correct sales price. If your markup is 1.50, your sales price is: $8,755 x 1.50 = $13,132.50 or $13,133.
The two important figures, then are the job estimate and your markup. If your markup isn't correct, or is based on a figure someone else gave you, you'll have problems. You need to calculate your own markup based on your business needs.
You should be able to get all the numbers you need to calculate your markup from your own profit and loss statements. If you can't, it's time for a frank discussion with the person doing your books. It is difficult if not impossible to make financial decisions for your business if you don't have good information. If you have a question about this, please give me a call to discuss.
Keep in mind that when you use your profit and loss statement to do these calculations, your last line on the P&L must have an 8% net profit. If you aren't showing an 8% net profit now, you'll have to adjust your markup so that you can achieve an 8% net profit in the future. I'll cover how to do that adjustment in another post.
Unless there is something incredibly unique about your business (and there usually isn't), these are the markup ranges that you should fall within:
- Remodeling Contractors = 1.50 – 1.70 +
- Specialty contractors = 1.35 – 1.50 +
- New Home Builders = 1.26 – 1.30 +
Be forewarned, pilgrim, if your markup is below those ranges (i.e., less than 1.50 for remodeling, less than 1.35 for specialty contractors, less than 1.26 for new home contractors), you probably calculated something wrong or you are accounting for what I consider overhead expenses in job costs (which is okay as long as you're consistent). The large majority of contractors today who are going broke are not using these minimum numbers. In all of the 8 business cycles in construction that I have been a part of over the last 50+ years, I have never seen as many contractors going broke as there are today. Just by coincidence, I have never heard so many stories of guys cutting their prices to get jobs as I hear today.
Our next post will be on calculating your gross margin and how to use that number to arrive at the correct sales price for your work.