Keeping your construction business profitable requires accurately accounting for overhead costs and identifying your ideal profit margins. When coming up with an estimate, many general contractors fail to properly account for their overhead and other related costs resulting in sub-par profit margins.
Understanding your ideal profit margin helps you stay on top of your expenses, and prevents cash-related bottlenecks that put your operations at risk. In this article, we’re going to take a look at the average profit margin in construction, how overhead costs affect your margins, and how to correctly account for them.
Disclaimer: The pricing stated here is based on average data from third-party research as of this writing. Prices may still vary.
How Is Profit Margin Computed In A Construction Project?
Profit is the amount of money you make on a project after subtracting all of your expenses. On the other hand, the profit margin is the amount of money expressed as a ratio or percentage relative to your overall costs versus revenue.
Identifying the kinds of costs that make up your expenses is essential to understanding your profit. Let’s review the different costs involved in computing for construction profit margins.
Costs that are required for the successful completion of a project are called direct costs (also known as cost of goods sold or COGS). These charges relate to a specific project and do not include expenses tied to your day-to-day costs of doing business. COGS differ from overhead expenses as this is tied to the production of revenue while overhead expenses are related to your day-to-day business operations like office rentals.
Your COGS gives you an idea of how well you are managing resources for a specific project. Having a low COGS (in relation to your net profit) means you are delivering your projects efficiently.
Some COGS or direct cost examples include:
Water and Fuel Expenses
Temporary Site Offices
Also known as operating costs, these are the expenses related to your day-to-day operations regardless of the projects in your pipeline. These expenses are necessary for keeping your doors open and aren’t directly linked to a revenue-generating activity as in the case of building a new construction project. Overhead expenses are typically shared proportionally across all projects.
The following are examples of overhead expense:
Administrative and Executive Payroll (including insurances, benefits, and taxes)
Occupancy Fees (e.g rent)
Revenue is the total income that comes into your construction business before any expense is deducted. You must bring in enough revenue to cover your expenses if you want your business to turn a profit. Gross Profit
This is the amount of revenue that remains after deducting your COGS. When expressed as a formula, it looks like this: Gross Profit = Revenue - COGS
For example, if you priced your estimate at $20,000 and the costs related to completing the project is $10,000, then your gross profit from this contract is $10,000.
This is the amount that is left after both overhead expenses and COGS have been deducted from the revenue. When expressed as a formula, it looks like this: Net Profit = Revenue - COGS - Overhead
Here’s a simple example, if your total revenue for the month was $300,000 and your monthly COGS is $160,000 and your monthly overhead expenses are $120,000 then your net profit for that month would be $20,000.
Construction Markup And Margin: What’s The Difference?
Confusing the terms “markup” and “margin” is a common pitfall for many contractors. One key difference between markup and margin is that your markup has to account for more than just your direct costs (COGS). It must also clear your overhead and make a profit. Thus, you need to understand what percentage of revenue makes up your overhead, and what percentage of revenue you want as profit.
Markup is the amount added on top of your prices to cover your direct costs (COGS) plus a percentage of your overall overhead expenses to generate profit.
Margin(Gross Profit) is your remaining revenue after your direct costs or COGS have been paid. Computing for your gross margin doesn’t include overhead costs yet. Margin is typically expressed as a percentage of your revenue.
How Much Profit Margin Should I Charge For A Construction Project?
Finding your ideal profit margin involves a little bit of trial and error with your profit markup. A good margin to start with is 20% based on the “10-10 rule” in construction. This refers to 10% overhead and 10% profit which is considered an industry standard. Because every construction company is different in its size, operations, and finances, there is no hard rule in place for this.
Many factors such as your business size, niche, project backlog, risk appetite, bid competitiveness, financial runway, and revenue goals all influence your optimal profit margin. Increasing your margin may be achieved by either 1) reducing your costs or 2) increasing your prices. Higher estimates could result in your bids being outpriced by your competitors so a careful assessment must be done to strike a balance.
Counterintuitively, it’s not unusual for large construction companies to lower their profit margin on a per-project basis when submitting their estimates. They do this to make their bids more competitive. Established general contractors will generally have a larger client base, and this allows them to spread out their overhead expenses across many projects thus enabling them to operate at lower margins per project.
Average Profit Margins in the Construction Industry
We’ve included this table to give you a benchmark of average profit margins in the construction sector as a guide in determining your profit margin targets.
How To Compute Construction Profit Margin
Computing for your ideal profit margin is crucial in helping your business stay profitable. Gross profit margin indicates how much a construction company profits from its projects. While net profit margin shows how much a company is making money overall.
Here’s the formula for computing your profit margin:
Average Construction Profit Margin Sample Computation
First, determine your monthly overhead. Make sure that you account for all expenses thataren't related to your direct costs (COGS).
Here’s an example:
Next, determine your revenue per month. This is the total amount of sales you’ve generated for the month without applying deductions. For example, let's say you made $100,000 this month.
Now, determine your direct costs or cost of goods sold (COGS) for the month. This is the sum of project/job-related costs that have accrued for the month. For example, let's say your total COGS for this month totaled $60,000.
Now let’s calculate the gross profit margin using the formula provided earlier.
| Gross Profit Margin= (Sales – COGS) ÷ Sales
Here’s how it would look using the sample figures.
Construction is a high-risk and low-margin business. General contractors need to strike a balance between profitability and competitiveness when preparing a bid.
If you want to improve your profit margins, raising prices doesn’t always sit well with clients. Competition is stiff in the construction world, slightly increasing your prices could be the difference between a winning bid or losing one.
Construction technology like Togal.AI helps increase your profit margins by reducing your overhead. Our AI estimating software takes out the most time-consuming part of the estimating process by automating the takeoff process; saving you and your team hundreds of hours on manual labor - ultimately reducing your costs.