Our goal is to help contractors build more profitable businesses, so I appreciate hearing from those who are serious about making a profit. It doesn’t happen by accident; it starts with knowing the correct markup for your work and using that markup consistently.
I received a note from a contractor who is using his markup correctly and double-checking to make sure his price is right. Unfortunately, that double-checking has led to confusion.
Let me first begin by saying thank you for this wonderful resource. As I should be, I am using it to crunch my numbers as I start my business. An issue that I am running into is I have a discrepancy between marking up jobs with my markup factor and allocating my labor hours to a job based on the annual sales volume.
Let me explain in more detail. When estimating a job, I am using the JOB COST X MARKUP FACTOR = JOB PRICE formula. However, I like to double-check how “profitable” the job will be by taking the estimated job labor hours multiplied by my annual sales volume per labor hour rate. Since I am both the owner and the builder, I schedule jobs on the basis that I have 32 labor hours a week available (and the rest of the week will be spent on things I organize under either my owner’s salary or sales commission). I also assume that I will only work 48 weeks a year, or 1536 annual labor hours. If I divide my expected annual sales volume ($224,079.13) by my annual labor hours, I get $145.88 in sales per labor hour.
The discrepancy is that I will have a 65.1 labor hour job with a markup job price of $8,928.33, but if I consider what the job should be priced at for using 4.24% of my annual labor hours, the job price should instead be ~$9500. So while it appears that I have appropriately priced my job using the markup factor to have a profitable job, when I consider the job in the larger picture of needing to meet an annual sales volume, I’m already behind the ball (and will be laboring more than 32hours/week or 48weeks/year). This discrepancy seems to arrive when labor and material job costs are not balanced, e.g., it is a low material cost but high labor cost job, such as painting kitchen cabinets.
I’m missing something fundamental here, and I can’t put my finger on it. Would you be able to steer me in the right direction? Thank you very much for your help!
The writer identified where the problem is when he stated that the discrepancy arrives when labor and material costs aren’t balanced. His $145.88 average labor rate includes all material costs. The reason it doesn’t work is because his projects don’t have a consistent ratio of labor to material. A $10,000 job with $3,000 in material will have more labor than a $10,000 job with $4,000 in material.
Applying an average labor rate on every job is an interesting exercise, but it’s worthless unless there is a direct relationship between labor and all other costs (materials, subcontractors, permits, etc.), and it’s the same on every job. That never happens, so an average labor rate would only work if he sold his time and never incurred any material or other costs.
I appreciate that he’s taken the time to set company goals and has a measurement tool to track his progress. That’s what he should be doing because it lets him know when he needs to make adjustments so he doesn’t lose money. The only problem is that he’s measuring the wrong thing.
If you’re calculating and using the correct markup for your business, there are other things to look at to keep your business profitable.
- How accurate are your estimates? After every job is completed, compare actual costs to the estimate. If your estimates are too low, the costs incurred in building the job will eat into your profit margin.
- Are you on track with your projected sales volume? If sales are below what was projected, you won’t have enough revenue to cover your overhead. It’s time to recalculate your markup and possibly reduce your overhead.
- Have overhead expenses crept above the budget? If they have, you’ll pay for that overhead out of your profit unless you reduce overhead expenses or adjust your markup.
Some of you love working with the numbers and enjoy doing exercises similar to the one the writer was doing. That’s fine as long as it doesn’t lead you down the wrong path or take you away from promoting your business and making sales.
Always remember that you’re in business to provide a service and make a profit. You aren’t in business to sit behind a keyboard and fuss with numbers. Stay focused on activities that make money. The proof of how good you are comes at the end of the year when you’ve paid yourself a decent salary and have a net profit that’s at least 8 percent.
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