One frustration I commonly hear from builders before we start working together on their business is, “Why don’t my job profits come out as high as my forecast?”
Sounds a simple question, but the answer can be complex and diverse. There are many forces at play between pricing the job and counting the money, but one issue can be a misunderstanding as to the required MARK-UP to achieve the required MARGIN in the job. Get this wrong and you have set the job up to fall short of what you need at the very start; the pricing stage.
Why is this? It’s all a matter of perspective. When you price a job you have your QS hat on and are looking forwards; adding a MARK-UP to your direct costs in order to arrive at a selling price. Oversimplified a bit, but that’s the basic premise. When you have your owner’s hat on and checking the job profit & loss report, you are looking backwards and focused on the gross MARGIN. Maybe your accountant has told you, “You need to make 20% gross margin to survive”. Armed with this figure you price your next job by adding 20% to your direct job costs and think you will be okay. But when you run the figures at the end (if you do it at all) you only make somewhere between 16% and 17% gross margin. Even though the job went as planned somewhere you have “lost” 3-4% profit.
A (very) simple example to illustrate this conundrum:
Direct costs $50,000
+ Mark-up 20%
= Sales Price $60,000
Sales Price $60,000
– Direct costs $50,000
= Gross margin $10,000 = 16.7% (Gross margin $ ÷ Sales Price)
Your 20% target Gross Profit has become an actual of 16.7%
So what’s the answer?
Fundamentally, you need to realise that in order to achieve a target Gross Margin (Gross Profit) you need to allow a higher overall mark-up to your direct costs when calculating your sales prices. How much extra? The formula to calculate the required sales price is: Direct costs ÷ (1 – target gross profit rate expressed as a decimal) So, in our example above it becomes $50,000 ÷ (1 – .2) or $50,000 ÷ .8 = $62,500. Rather than selling the job at $60,000, you need to achieve $62,500.
I recommend you run this extra calculation when you are pricing your work and check you are allowing enough mark-up to achieve the profit levels you need in order to succeed in the long term. If maths isn’t your strong point, email me at email@example.com and I will send you a 1-page ready reckoner chart that shows what mark-up you need to allow in order to achieve a specific gross margin. We all love short cuts.