I’m going to do a 3- part series on markup vs gross margin, and why you need to understand the difference between the two.
Markup is the factor that, multiplied by your job cost, gives you your sales price. If you are using the correct markup for your business, that sales price will be what you need to pay all your job costs, overhead expenses, and make an 8% net profit. Looking back, you can determine the actual markup for any given point in time by dividing sales by your job costs.
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.
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, especially if the markup is too low. You won’t have enough to pay all job costs, overhead expenses, and make a reasonable profit.
Likewise, if your estimate isn’t accurate, you’ll also have problems. If it’s too low, your sales price will be too low. You’ll spend more money to build the job than anticipated, and the extra funds will directly reduce your profit first, then the funds you need to pay your overhead expenses.
You need to calculate your own markup based on your business needs.
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.
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.
Keep in mind that when you use your profit and loss statement to do these calculations, if the last line on your P&L isn’t an 8% net profit, change it to 8% for this exercise. If you haven’t been achieving an 8% net profit, your price is too low.
Unless there is something incredibly unique about your business (and there usually isn’t), these are the markup ranges contractors usually fall within:
- Remodeling Contractors = 1.50 – 1.70 +
- Specialty contractors = 1.35 – 1.50 +
- New Home Builders = 1.26 – 1.30 +
Be forewarned, 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 are including overhead expenses in your 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.
Our next post will be discuss using gross margin properly to arrive at the correct sales price for your work.
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