I cringe when I hear of contractors leaving money on the table by adding overhead and profit to their job costs. Don’t do it. Let’s take a look.
As an example, you know that your overhead costs average 32% of your total revenue, and you want a 10% profit. That means your average job costs are 58% of your total revenue.
You just estimated a job with total job costs of $1,000. You arrive at your sales price by adding overhead and profit to the job costs:
$1,000 + 32% overhead ($1,000 X .32 = $320) = $1,320
$1,320 + 10% profit ($1,320 X .10 = $132) = $1,452
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Now, job costs of 58%, overhead at 32% and profit at 10% means you should be using a 1.72 markup times cost to get to the sales price for your work. (For more on how to calculate your markup, read the book Markup & Profit; A Contractor’s Guide, or watch the videos.) If you prefer to use margins, you have a Gross Margin of 42%.
Now calculate your sales price:
Markup of 1.72: $1,000 X 1.72 = $1,720
Margin of 42%: $1,000 / (1 – .42) = $1,724
This means for the same job, you now have an additional $270, or $270 per thousand dollars of job costs.
Why? Because your gross profit (overhead + profit) of 42% is 42% of TOTAL REVENUE. If you use those figures and add them to your job costs, you are treating them as 42% of JOB COSTS – and they aren’t. You short yourself.
Do your own numbers and see for yourself. Don’t hurt your business.
The Bottom Line:
Do not add overhead and profit as a percentage on top of job costs — that calculation is wrong and costs you hundreds of dollars per job. Overhead and profit are percentages of total revenue, not percentages of job costs. The correct method is to multiply job costs by your markup. On a $1,000 job with 32% overhead and 10% profit, adding OH&P the wrong way produces a price of $1,452 — the correct markup method produces $1,720. The full explanation with worked numbers is in this article.
Related Articles:
How to Calculate Markup
Job Costs and Overhead
Is My Contractor Overcharging Me?
Cost-Plus Contracts
Estimating Construction Costs
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses. He is the author of Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations. More here.