Builders are often confused when it comes to margin and markup.
The two terms reflect profit differently. It is vital to the success of your company that you are able to clearly understand the difference and how the two function in your finances.
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Financial experts estimate that at least three-quarters of installation contractors don’t know how to estimate the markup they’ll need to cover job costs plus overhead, and still turn their projected profit margins. It’s important to know the difference between margin and mark-up in your accounting, pricing, and contract format. To better understand margin and markup, and how to properly calculate them, let’s define each term, as well as use examples to show each function in your business.
Margin is a percent value that indicates how much of every dollar in sales is a business profit and how much is necessary to cover general overhead.
Markup is a percent value that shows the relationship of your sales price to your costs and has no real purpose in construction. A markup measures how much more you sell your items for than the amount you pay for them. It is not recommended to use markup terms in pricing discussions.
To understand how money is functioning in your business, it is also important to have a clear understanding of some additional finance terms. These terms-- and the money that they represent-- help to determine your margin and markup, aid you to further understand the profits in your company, and help you know how to talk about your pricing in contracts and with your clients.
The following terms are key to figuring out your margin and markup:
Revenue: The total income you collect on a contract. Revenue is the top line of your income statement and reflects earnings before deductions.
Cost of Goods Sold (COGS): All expenses that go into any project; all labor and materials that can be directly related to a project in whole or in part.
Gross Profit: The revenue that remains after all Cost of Goods Sold are paid.
Gross profit = Revenue – COGS
If you have trouble estimating the necessary markup to cover job costs and still turn a profit, you're among the nearly 75% of contractors in the same boat. However, joining the 25% of contractors who clearly understand margin and markup is critical to strengthen your bidding process, increasing your profit and reducing your risk. When you are making a bid on a contract, there are three key pitfalls to avoid— these mistakes can kill your profit margin.
If you build in a 10% profit margin and your general contractor is withholding a 10% retainage, stop kidding yourself. Waiting to pull a profit from retainage leaves you at a huge risk of a cash flow shortage until the job is completed and your retainage is paid out, which can take a long time.
Whether you use a factoring company, bank line of credit, SBA loan, merchant cash advance, or mobilization funding, the cost of outside funds must be built into the project costs of your job (or depending on the type of capital, into the overhead calculations), rather than digging into the project’s profit margin.
Thinking of submitting an artificially low bid in order to land the big job later? Don't. If anything goes wrong, that ambitious new project could mean financial ruin for your company, late paychecks for your employees, delayed payments to your vendors and sleepless nights for you, the business owner.
Now that you understand the important finance terms relating to your margin and markup, and you understand the important mistakes to avoid, download our Margin vs. Markup chart for some sample equations to help you get a real feel for how profit margin and markup are actually calculated.
This ultimate ebook covers all the important aspects of construction margin vs. markup - what is the difference plus how to calculate and avoid the pitfalls.
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