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Overhead, Profit in Construction - Using the Figures Wrong Hurts Your Business - Comments

Comments

Hello - I read this and can't figure out how you arrived at 1.72 markup? Can you explain? Thank you

Peggy -

Details on how to arrive at your markup is covered in the book, Markup & Profit, and in the audio/video tapes. It's a mathematical formula, using your job costs and overhead. That's a 320-page book that walks through the hows and whys of the numbers in your business, not something we can explain in a blog post.

But let me explain how to know the 1.72 markup is correct. If you have job costs of 58%, that means for every $100 in revenue, $58 is job cost. Markup is applied to job cost to determine sales price - if you estimate your job costs will be $58 on any given job, multiply 58 by 1.72 and you'll get a sales price of $99.76.

Michael

Sonny Lykos (not verified) /

Here's another example:

Say your overheaad and profit is 40% of total sales. The novice would think he only has to then add 40% to his cost. So let's try that. I jobs costs - all materials, subs, and labor comes to $1000. By adding 40% - or $400, you arrive at a selling price of $1400. So, using my original logic, if we multiply that $1400 by 40% we'll end up with that $400. Well, 40% of $1400 is $560, leaving $840. But we know that the jobs COST total was $1000, but we only recaptured $840 - so we lost $160 on that job. Had it been a jobs with costs of $10,000, we would have lost $1600.

So, in reality, if your overhed and net profit are 40% of your total anual sales, then you must use a MARKUP or 67%. Here's the proof. Take that $1000 cost again, and multiply it by 67% and you end up with $670. Add that $670 to the $1000 for a selling price of $1670.

Now, take that $1670 and muliply it by 40% and you end up with $668 - close to your total overhead and net profit. Again, take that $1670 and mulitply it by 60% - what's left over from 100% minus 40%, and you end up with $1002 - BINGO, your total costs of $1000.

Final word: Do not ever try to explain the above to any customer because if you do, they will never understand it (as you didn't) and think that you are conning them or lying to them to "steal" their money. They, like most contractors have a hard time grasping even basic accounting.

Somewhere along the way I learned a formula that has been helpful and simple for me. I can't recall the book at this time though I have searched to double check it. Basically, you divide your direct job costs (materials, subs, labor, etc.) by 100% minus your overhead and profit mark up percentage. So for example, if your overhead and profit is 20%, you would divide your job cost (let's say $1000 for sake of argument) by 80%. This gives you $1250.00. Then take that amount and multiply it by your overhead and profit percent (20%). This gives you $250.00. Add that to your direct job cost and you get $1250.00 which is your selling price. Double check your work by subtracting your mark up from the selling price and you should end up with your direct job costs.

Sample Formula:
20% Mark Up
$1000/.80*.20=$250.00

40% Mark Up
$1000/.60*.40=$666.00

By the way, if you want to find out what your simple mark up percentage is you can simply take your mark up dollar amount and move the decimal point to the left one space (or multiply by .10) and you will have your percentage. For instance, in the 20% mark up sample your mark up would actually be 25%. Check it you and you will find that it works. Use any numbers you like.

Hope this helps. Happy contracting!

I have been using a standard markup of 30% with an established marked up labor rate to achieve the desired profit. Though I just saw a 3 tiered mark up. When you do this I see making an additional 3% though the trouble I see is what to call these three tiers, overhead, profit & ?

Thoughs.

Tom

Rocelle (not verified) /

Hello,

I have a question. If a restoration company decided to manage the contractors that I have picked are they legally entitled to the O & P of these contractors? Even though they are already charging me an hourly managerial fee? What as the consumer do I get out of the O &P as far as guarantees of work done by the other contractors I hired since they are not their contractors?
Thanks,
Rocelle

Tom -

I'm not sure where you see a 3 tiered markup, so I don't know how to answer your question.

Rocelle -

Where should I start? I don't think a restoration company should agree to manage someone they didn't hire. Your criteria for picking a contractor is not the same criteria a professional would use.

But the bottom line is that the contractor is entitled to whatever you agreed to in your contract with them. This is an unusual situation and I frankly don't understand why anyone would get into it. It looks like a problem waiting to happen. It's situations like this that keep attorneys and arbitrators in business.

Michael

susantha (not verified) /

Hello,

In our organization, we have Managers, Engineers, Supervisors, Foreman & Labours.
Please advice me, When i preparing a New rate for a extra work, Which categories of man power have to be include in Overhead & Profit?

Great information on property insurance industry, materials, and contractor's overhead and profit.

Teruaki Hiraoka (not verified) /

I am writing to request your assistance in preparing a document related to indirect costs
(general requirements, markups, overheads etc. listed in the attached Excel table).
We are now faced with an urgent need for information, this e-mail message to you for your kind consideration.

We have prepared the attached Excel table for comparing indirect costs for large-scale construction projects.
The percentages given in the “RS Means” column (highlighted with red borders) on the Excel table were selected
by us from RS Means.
We would like you to:
(1) Check whether the percentages selected by us (mainly figures given in page 11 of RS Means)
are appropriate for large-scale construction projects,
(2) Advise us on the appropriate or prevailing percentage for each indirect cost item in large-scale construction projects
in the United States, if the percentages selected by us are not proper,
(3) Advise us on components of each indirect cost item, commonly considered in large-scale construction projects in the U.S.,
(4) Advise us on procedures (commonly used in large-scale construction projects in the U.S.) for calculating each indirect cost item,
(5) Provide us with copies of supporting documents for prevailing indirect cost percentages such as historical data
on past construction projects; recognized reference materials; frequently-cited literature; text books; and handouts.

For your reference, a PDF file is attached which contains the pages of RS Means we referred to in preparing the Excel file.

We also would like you to advise us on the information given in RS Means. Page vi (General Conditions) reads that:
For General or Prime Contractor, costs for General Conditions may range from 5 to 15% of the Total Cost.
The 5-15% of the "total cost" is equal to approximately how many percent of the "direct construction cost"?

John (not verified) /

I am a small general contractor located in Snellville, GA outside Atlanta. What should the target profit margin goal be?

Thanks

John

devon /

John, your profit should be at least 8% of sales, preferably 10%. It doesn't matter where you are, and remember that your profit is not your salary - your salary should be included in your overhead.

Henry (not verified) /

What is the national average for "Profit & Overhaed" or is there a national average guide for the various states. For instance, what would be considered as the average Overhaed & profit rate charged by contractors in New Orleans for a remodeling or restoration construction job.

Michael Stone /

Henry

There is no national or regional or even local average for overhead, regardless of your location. Every contractor's numbers will be different. As Devon said in her post above, your minimum profit goal should be 8%, preferably 10%. Those that run their business like a business will often make even higher profit percentages than that.

Our book Markup and Profit; A Contractor's Guide explains all this in detail.

Michael

Non-profit (not verified) /

I understand that overhead and profit is a percentage of the whole. But overhead is based off of last years sales percentages, which includes labor, material and etc. This is where it gets to be tricky for me. Take the following simple examples:

Based on 10 hrs of labor cost at $50/hr

Last years sales is the first row
Bid 1 Bid 2
Material $500 100 900
labor $500 500 500
------ ------ -----
Direct $1000 600 1400
Cost

OH 10% $125 75 175
P 10% $125 75 175
-----------------------------------------------------------
$1250 750 1750
equals $75/hr 65/hr 85/hr

So what's the answer because every project that I bid in the following year will have different material and labor ratio?

We are bidding a government job and this statement has me a lttle confused.

"need to show all direct costs and then add 10% for overhead calculated off of the direct cost and then 10% for profit calculated off of the direct cost (they do not allow you to "mark-up" overhead).

Can you explain how to show this on the bid.

jayne (not verified) /

This sounds like a great book. I just ordered it for my husband.
I am curious if this markup you are using of 1.72 would apply overall to subs, materials, and the gc's own labor on the job.
Where we are the standard going rate for a good carpenter working along is 40.00 per hour. So, if my husband bids a job including this hourly wage would you add that to the cost and then add on the 1.72 percent. What about subs that have their own insurance etc.?

I have been observed that my husbands estimates are often right on when it comes to calculating costs, but like so many he is apprehensive about applying a big markup like this. He's been using a 1.4 percent which has been working out okay, not great just okay.

Thanks for you response.

jayne (not verified) /

sorry about those type'o's:-)

Michael Stone /

Jayne:

Most of your questions and the answers will be found in the Markup and Profit book when you get it.

I don't know why anyone would be apprehensive about using their required markup. Your customers don't know what you should be charging. If they did, you would not be necessary. You must charge enough to cover your job costs, your overhead and make a fair (8%) net profit or you will go away. 1.4 times your job costs is a good way to go broke in remodeling. Wish there was a nicer way to say it. 1.50 times your job costs is the minimum you should use as a remodeling contractor.

Michael

jayne (not verified) /

thank you Michael. I definitely agree with you. I founded and operated a nationwide herbal body care company for over 25 years. We were coast to coast dealing with corporate conglomerates, so I understand business:-). I think that the dilemma in carpentry is as most people say, there are so many not charging any mark up at all and this makes those trying to survive by running their businesses wisely look bad. The guy down the road (hypothetically speaking) that charges 40 per hour for his time and never puts a markup on materials for example. As the one that does the books I see that "overhead" is a very real thing.
Thanks again.

Hi Mike I'm a contractor and like many others have not been putting in profit & overhead into the pricing but have started adding it in. I spread the costs of profit and overhead over all the items in my pricing. My question is do you have to disclose to customers during discussions of the propoal where profit/overhead are? Should it be a separate line item on the proposal? That would seem to be a serious negotiation point for the customer. Thank you.

Michael Stone /

John

I don't know of any laws that require you to disclose your O & P on work you are proposing. I hear about a lot of people around our industry and others involved in putting construction projects together that think contractors should just disclose all their proprietary information about their business to them for their review before they pick a contractor to do their job. That is nonsense. I would not give them anything other than a fixed figure price quote. You should not disclose overhead and profit anywhere on your proposal. That is no ones business other than yours. When was the last time that you got a line item for overhead and profit from your doctor, dentist, attorney, grocer, haberdasher, auto repair shop or anyone else? One number, period.

Michael

to figure your profit should divided by .90 to get a true 10 percent to check it just work your formula backwards take your total bid price subtract your over head then your job cost and divide the profit into your bid price and see if it comes out to ten percent then try again taking your total job cost + overhead and divide it by .90 then check it

I have been in concrete and excavation business for twenty six years and overhead really is a big key factor in submitting my bids and i know there is so many differnt ways of figuring overhead wheter you tack it on just to labor and to materials and labor i have played with them all but i do really like this concept of basing off of total revenue, now would you try to cover the same percentage of overhead on each job you bid or would you or do you keep a log and as you reach your break even point start droping your overhead which naturally it is to be more competive on your bids, contractors in my area is just giving there talents away

I believe i understand how you came up with the 1.72 percent by taking 100 and dividing by your average total job cost, but why would you figure out also your margin of overhead and profit at 42 percent so would you bid price be $1720 or $1724 i know its only four dollars,but what is the correct bid price

Hi All,
Greetings from across the pond...(UK)
I am researching building Contractors rates and OHP. We are working on a methodology to reduce building costs, while maintaining quality and profitability for Small,Medium Enterprises (SME).
I was curious after reading most of your posts that you do not seem to have a nationally recognised definition of estimating practice. ( or am I wrong here?) In the UK we have a code of estimating practice - which is quite comprehensive and shows the way to "build up" rates. It seems we have a universal problem on both sides of the Atlantic that most building contractors and SME builders are worried that they will either under price a job, and loose money. Or Over price it and not be competitive?
I was recently told this saying.. "that in the absence of Value price becomes the prime consideration" - So the debate about "Marking Up" a cost and adding a profit in my opinion should also include a reference to the particular industry you are in. Your Customers will tell you what value they place on your services - there isnt a "magic formula"

Steve (not verified) /

It's funny how you contractors can justify paying O&P on total revenue. Which by definition already has O&P added to it. So, a 20% O&P on total revenue is really a 25% O&P. A 40% O&P is really 67%. Be honest and stop playing games with people's money. Tell the customer the truth!

Jim (not verified) /

First off it is as much simpler process. If your Average Net Profit per Job is 30% then your Actual Job Cost(including whatever amounts you want to) is 70%. Simple math will get you the sales price if you know what your Cost is: .70(Cost)= Sales Price. Using your figures above: 1000/.60 = $1666 -- Thus no fancy 1.72 formulas are needed.

Bill (not verified) /

any help would be greatly appreciated!

I read the comment number 3 from Sonny and it makes complete sense. but let's say the company you work for takes 25% from the total invoice and you want 25% profit from your job. how do you calculate both the markup and the discount to where at the end both parties get 25%. let's say a fridge replacement costs $1,000 - I want 25% for my time and delivery/installation and I need to include 25% discount that the company is going to take from the final invoice. adding discounts doesnt work for me as I end up losing money, $1000 + $250 +250 = $1,500 . take 25% off $1500 and you have $375 going to the company and me ending up with $125 instead of the $250 (25%). what is the right formula to use in order to have the right amounts going to the each party everytime?

I charge my customer my labor rate cost, my fixed cost is $55.63 per hr. and my overhead per 4 man working 8 hr a day,5 days per week and 4 weeks per month pays my overhead. Which makes my overhead cost at 2.14 per hr. Am I doing this correctly and, what should be the cost of my labor rate that I am charge my customer?

Michael Stone /

Jimmy:

Piling overhead expense onto your labor is OK until you or an employee can't work. Then their is no income to pay the bills. Overhead is 24 hours a day, 7 days a week so you can't make up that loss.

Better to total your job costs and use a minimum markup on that number of at least 1.55.

Your labor rate should be calculated:

Employee or your rate per hour times a burden factor of 1.35 and that is the number you use on your estimate sheet. If you are in California, that number is 1.48.

Then you multiply that rate times the hours to be worked and you get the total hours for the job. That number times your markup is a very good way to stay in business and not build your customers jobs out of your pocket.

Michael

Lou (not verified) /

None of this makes any sense to me as a successful contractor. In the first place you have no idea what your overhead costs are going to be, but to start you would need to establish what your past overhead costs were. All that does is give you a basis for estimating what your overhead costs will be. For example, lets say one year you do a million dollars worth of billable work and the next year you do 2 million dollars worth of billable work. Your actual overhead costs for doing the one million dollars isn't going to double for doing the two million dollars unless you basically open an equal sized and cost related company. That isn't ever going to happen. Unless the management decides that they want to make up the difference in the actual cost of the overhead as a bonus to themselves or others to reflect a solid percentage of the overhead. It simply cannot be done.

The higher your sales volume the lower the actual percentage cost of overhead.

The key to bidding any job is to know the market and to know your company. You should in a few years know about what you need to do and how you need to mark things up to make the money you want, but you must have some foresight into the market itself. You cannot successfully pick a random formula based on percentages alone. If you do you are setting yourself up for failure.

If you just want a percentage basis to start or run a new business then just give it your best shot until you have handle on what it takes. There's an enormous amount of change considerations; taxes, safety requirements, fuel costs, housing costs, labor costs, miscellaneous business costs, etcetera that are all fluid.

Steven B (not verified) /

Is there such a thing as 'industry standard' overhead costs on separate trades i.e. painters, or finish carpentry, or concrete polishing or plumbers? Could it be so simple to have a standard to work by until company history established it's own 'standards'.???

Michael Stone /

Steven:

There is no industry standard for overhead costs at any level of residential or commercial construction. Overhead expenses will be different for every company. The percent of sales that an overhead is can fall within a range, but the numbers will almost always be different from company to company.

You can easily establish your overhead with a little planning but you must then have the discipline to stick to those numbers like glue once they are set. When a company spends more on overhead than their projections, either they did a poor job of planning or simply over spent the budget. The "IWANTITRIGHTNOW" disease is the biggest problem for most contractors.

You can read all about this stuff in our book, Markup and Profit; A Contractor's Guide.

Michael

Lou (not verified) /

Estimating overhead does take planning. I'm not sure about a "little" planning. Basically what you are doing is planning your company. Perhaps Markup and Profit; A Contractor's guide would help with that?

A couple of things to watch out for in particular situations:

1. If you are starting a business, because you know the field and you know what "you" can accomplish in the field, but don't be so sure that your workers can do the work as quick or efficiently as you. You need to aim lower than your standard. After all, if you have the confidence in starting the business in the first place, you must feel confident in what you can do. It is a completely different standard when you're just a worker plugging along in life trying to make the owner enough money to see you as being an asset.

2. "Things" happen. Don't get so busy with what you are doing to get sloppy with your work or let any employees get sloppy. Slow is always better than having to redo something. As soon as possible maintain monetary cushion. It is a must to budget for that as an overhead cost until you have the liquidity to go through a rough period (I like to have cash reserves for a year). Yes, Uncle Sam will take some of that, but they can only tax it one year.

3. Budget for the highest reasonable amount of GL and auto insurance you can afford. Not having enough is one area that will put you out of business fast. As for work comp you want to keep your mod rates heading down, which means paying attention to safety. If you have an incident OSHA will be on you like a duck on a junebug. If you have an event it will take a year or two to affect your mod rate. Budget for that in your mark up if that occurs.

I do like the idea of a book that explains to contractors how to figure markup and profit.

Michael Stone /

Lou:

All the stuff you talk about above is in the Markup and Profit; A Contractor's Guide book. I even throw in a free autograph when they are purchased from us.

May the profits be with you,

Michael

Hi There from SA

I was wondering whether you could perhaps assist me with some advise on our costings as well...

We usually calculate our customer jobs as follow:

total material costs x 45% x 65% = your selling rate which most of the times results to a 2.2 material factor. Is this correct?

ken (not verified) /

Constructus Say
Bid to high = "no job"
Bid low = Good news "You got the job" Bad news "you got the job"

Mike B (not verified) /

Ken,

Very good observation. I concur!

Michael Stone /

Jason

You need to read our book, Markup and Profit; A Contractor's Guide. Unfortunately, we are out of stock on that book until early next year.

In the mean time, you might consider our coaching service. You can read about it at: http://www.markupandprofit.com/coaching.html

Michael

jason mcfaun (not verified) /

I own a small H.V.A.C instillation business in massachusetts . It is just me and my partner we are each own 50 percent 0f the company . So are you saying that are hourly labor rate which is 60 an hour for each of us the total being 120 an hour for the two of us . Should be figured in to are overhead ? I generally mark my stock up 26 percent and put another couple of hundred or more depending on the size of the job . I am getting the feeling by reading what you had to say that iam leaving money on the table . So after reading how I quote a job could you please give me your input . I have just started my H.V.A.C company I have already quoted 3 jobs that way and finished them . I am about to put a quote together for 5500 square foot house this is the biggest job I have quoted for my company . Please give me all the advice you can . Can I quote this house the way I have been quoting or will I lose alot of money . Please reply fast I have to put it in have no other jobs lined up and its winter.

shamsher Singh (not verified) /

I want to find out the rate analyses with over head for road and bridge work in excel formet. please send me reply

Steve M (not verified) /

Look up the Eichleay formula. Simple and recognized by many US courts when calculating OH&P for owner-caused delays.

Jim:

I might suggest your read our book, Markup and Profit; A contractor's Guide Revisited. It would give you a much better understanding of the requirements of pricing your work.

Steve:

The Eichleay formula was originally concocted to deal with the problems caused when contractors got, and still get involved with a government agencies of all kinds. I have rarely seen that formula used for non-governmental work and it would not apply here.

Michael

GENE (not verified) /

OK--...EXAMPLE: I HAVE MATERIAL COST OF $1,200.00 PLUS 9% TAX = 108.00==$1308.00......I HAVE A LABOR COST OF $600.00 PLUS 55% BUDREN COST= $350.00 (ACCORDING TO MY ACCT.) ==$930.00
I ADD THE TWO T0GETHER AND GET $2,238.00=== JOB COST --
I MULTIPLY BY (15%) AND GET MY TOTAL JOB COST AND PROFIT --$2,573.70
IS THIS PROFITABLE? REMEMBER THIS IS CONSTRUCTION..

Gene:

As I mentioned above to Jim, read our book, Markup and Profit; A contractor’s Guide Revisited. It will give you an understanding of the requirements of pricing your work.

The numbers you outline above should total $3236 + tax for a total of $3344 sales price to the customer. That is using a markup of 1.55 on job costs and adding your tax after that. Taxes should never be included with job costs before markup. That is just asking for a lawsuit from a customer.

Any less markup in today’s economy and you won't be in business long. No construction related business can survive using the numbers you outline above. 15% won't begin to cover your overhead expenses let alone having any money left over for profit. Your city, county, state and federal fees alone on construction projects range from 6% to 9% of the sales price of your work depending on the state you live in. How are you going to pay yourself and the rest of your overhead with the difference between the 15% you mention above and the government required fees? The truth is you can't and won't.

Michael

Anna (not verified) /

Hello,
My father's home burned and we hired a contractor to complete the rebuilding. I have a few questions related to this project. The contractor is a carpenter/cabinet maker and he along with 2 of his men did most of the framing, carpentry work, etc. He was responsible for scheduling things like painter, sheetrockers, roofer, etc. however, he did not pay them directly. I paid him weekly for his/2 men labor costs. Also if he needed to pay the painter X amount, I would add that to his weekly draw. My father (has owned plumbing/electrical/heating and air company for 30+ years) and brother (works for my dad) did all of the plumbing, electrical, and HVAC in the rebuilding. I was the one responsible for handling of all money including paying bills, deciding on materials, ordering most of the materials, scheduling delivery of materials, all record keeping, managing cash flow, etc.. I would call these duties that of a project manager, as I have put in countless hours working on getting the project completed. However, I have done these duties gladly and free of charge for my father. One other note before I ask a few questions is that the "contractor" underbid his construction labor cost by approximately $3500. So I have paid him more in labor cost than was originally estimated. The insurance estimate for total repair was $68,000. He underbid in several areas; however, the construction labor was the most significant amount that was underbid. The plumbing/electrical/HVAC were actually done for alot less than was originally bid due to my dad and brother doing this work. We only had a certain amount of money to work with from the beginning and didnt really have room for additional costs as money is now running low. The project is nearing an end.
1. Do I pay the contractor 20% OHP on all money spent, including his weekly labor? Even the $3500 in extra labor costs?
2. Do I pay the contractor 20% OHP on plumbing/electrical/HVAC since this was done by dad/brother?
3. Do I pay the contractor 20% OHP at all as I did many of the duties of a general contractor?
I want to pay him every dime I owe him and do not want to cheat him out of any money he is owed. I also do not want to pay him more than I really should and I just dont know exactly what that is. Trying very hard not to have to dip into personal money to finish project. Also worth noting is that there is no signed contract just mainly a verbal agreement and his estimate that was turned into insurance company along with estimates from other contractors. The adjuster then came back and said $X is what I am going to pay you. Any guidance you could give me would be greatly appreciated.
Anna

Shelley (not verified) /

Hello,
I see that all of the information given here pertains to adding profit and overhead costs into a bid. Does your book cover the topic of how to figure out what your labor costs are (which would be included in job costs)? I am considering purchasing this book, but I want to make sure that my question will be covered in the book as well. Thanks!

 

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