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Construction Programs & Results Inc

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Using Gross Margin to Price Jobs? Better Use It Correctly

by Michael Stone

Yesterday markup – today gross margin. Let's look at using your gross margin to calculate the correct sales price for your work.

Your gross margin is your gross profit as a percent of your sales price. If your gross profit on a $100,000 job is $25,000, your gross margin is 25%.

Gross profit is what is left after you pay all direct job costs. Gross profit is what you use to pay your overhead and your profit. Net profit is what you have AFTER you pay your overhead.

Let's assume your company has an annual sales volume of $150,000, overhead is 25% or $37,500 and we make an 8% Net Profit. Our gross margin is 33% - the 25% overhead plus our 8% net profit.

A gross margin of 33% simply means that your total overhead and profit equals 33% of your total sales – and your job costs are 67% of your total sales.

Let's use the same numbers we used in the markup scenario yesterday to calculate our sales price. Estimated cost of the job is $8,755. To use your gross margin, you have to divide your job costs by their percent of total sales – or,

$8,755 / .6700 = $13,067

Here is the mistake that happens when using gross margin. If you divide your job costs by .33, you end up with a sales price for your work of $26,530, which might put you a little high. You'll probably catch that mistake.

But too many think it's correct to multiply their job costs by their gross margin, and adding the result to their job costs. If we do that, we get $2,889 ($8,755 x .33) added to job costs of $8,755 you get a sales price of $11,644. That number leaves you $1,423 short of what you need for gross profit. How do I know?

Incorrect Calculation -
Sales price - $11,644
Job Cost - $8,755
Gross Profit - $2,889
Gross Margin – 24.8% (2,889 / 11,644)

Correct Calculation –
Sales price - $13,067
Job Cost - $8,755
Gross Profit - $4,312
Gross Margin – 33% (4,312 / 13,067)

If your business needs a gross margin of 33%, you need to use the correct calculation or you'll be in trouble. Subtract your gross margin from 1 (1 - .33 equals .67), and divide your estimated job costs by that figure.

Here are the gross margin ranges that you should be within:

REMODELING=34% – 42% +
SPECIALTY WORK=26% – 34% +
NEW HOME CONST.=21% – 25% +

Confused? It's very easy to get confused when you're messing around with gross margins. We'll talk more about that tomorrow when we discuss why a markup of 1.55 is not the same as a gross margin of 55%.

Part 1 - Markup, Margin and Why You Should Care
Part 3 - Markup, Margin . . . Does it really matter?

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