Business Building: How Much Profit Should Contractors Make?

Words: George Hedley

Construction business owners often ask me: "How much profit should we expect to make? - 5%, 10%, 15% or more?" Most don’t know how much money they should make and don’t have a specific profit target to aim for. Some have heard 15% is a good target, but they aren’t sure if 15% profit is net or gross. Most claim their profit goal is to make as much money as possible or to make more than they are currently making. Is this a target? "As much as possible" or "more!" More than what? How can you measure this or track your progress towards more? These are not clear targets or goals. Without a clear, concrete number to hit as your profit goal, how can you determine what sales or mark-up you need to achieve your goal?

A young steel contractor came to me for business coaching advice. He told me his five-year goal was to work really hard, be totally stressed out, hopelessly in debt, and make no money. Guess what? He achieved his goal! I’m not impressed with people who own construction companies, are busy, overworked, underpaid, or boast about their latest sales figures without making much profit, increasing their equity, and building wealth. What I admire are organized companies that have clear annual gross and net profit targets, hit these goals, and make the expected return and high-margin profit for the risk they take.

Always Make a Profit!
Regardless of the economy, the goal in business is not to stay in business, keep your crews busy, and make as much money as possible. The goal of your business is to always make a profit. Unfortunately, 92% of all business owners reach age 65 with little or no net worth! It's not how much you make and spend that matters; it's how much you keep (after overhead, job costs, personnel, and a fair salary for the owner). And then it’s how much your money makes.

Your competitors, markets, location, project difficulty, qualifications, expertise requirements, and customers determine the amount you can charge for overhead and profit. Smaller contractors generally have larger overhead expenses than larger contractors. This creates markup differences that can vary by 5% to as much as 20%. Some contractors also have competitive advantages such as set-aside preferences like WBE, MBE, or 8a HUB-Zone certifications, which give them higher markups to win contracts. Some public projects with bid lists open to anyone with a performance bond and a license attract low-priced competitors who may not know their costs or want to keep their crews and equipment busy. If you increase your markup rate, you’ll likely achieve fewer sales and therefore make less profit than you want. Reducing your markup rate will also cause your company to perform higher sales volumes to meet the same net profit goal.

Profitable construction company owners have a vision of what they want. They have written goals in many areas including business, customers, operations, financial, personal, and profit. They have precise measurable annual goals including:
* Sales Revenue
* Job Cost
* Gross Profit
* Overhead Expenses
* Net Profit
* Set Your Annual Financial Goals Using the ROOH Method (Return on Overhead)

An easy way to calculate your company sales and profit goals is to use the "Return on Overhead" (ROOH) method. Construction company owners commit to investing in annual overhead expenses to build, run, and manage their businesses. They invest money in hopes of making a return on their annual overhead costs. The average ROOH for general contractors and subcontractors is 25% to 50% ROOH. The target successful top contractors use is 50% ROOH to develop their financial plan shown below. The ROOH can vary by annual revenue, project type, job size, location, and your competition. Verify you calculate the following formula with the ROOH that matches your company characteristics. If you need help, contact me for input.

Annual Profit and Loss Income Statement - Example
* Sales Revenue: $3,750,000
* Job Costs: $3,000,000
* Gross Profit: $750,000
* 25.00%
* 20.00%
* Overhead Expenses: $500,000
* 16.67%
* 13.33%
* Net Profit: $250,000
* 8.33%
* 6.67%
* OH + P Mark-Up is Gross Profit / Job Costs = 25% Gross OH + P Margin is Gross Profit / Sales = 20%

Annual Financial Plan - Based on Return on Overhead - Example
* Annual Overhead Expenses: $500,000
* Annual Return on Overhead Goal x 50%
* Annual Net Profit Goal (Pre-Tax): $250,000
* Annual Overhead Expenses: $500,000
* Annual Projected Gross Profit: $750,000
* Average OH + P Mark-Up (OH + P / Job Costs): 25%
* Average Gross Profit Margin (OH + P / Sales): 20%
* Annual Sales Revenue Required to Hit Goals (5 / 7): $3,750,000

In this example, the company will hit its annual overhead and profit goal of $250,000 if it averages 25% mark-up and achieves $3,750,000 in sales revenue.

Do You Have Overhead & Profit Goals?
* What’s your Net Profit Goal?
* What’s your Overhead Goal?
* What’s your Gross Profit Goal?
* What’s your Average Markup?
* What’s your Revenue Goal?

Companies without precise profit goals almost never make the money they want. It's hard to hit a fuzzy moving target that doesn't exist. It's sort of like playing golf without greens or holes. Companies that set targets, track costs, profit, overhead, and watch what they achieve are in control, organized, and one step ahead of their competition. To get a copy of "Profit 101 For Contractors," email: GH@HardhatBzcoach.com. Fix your profit target and revenue goals. Keep them in front of you all the time, share them with your people, track your progress, and make it happen.

ABOUT THE AUTHOR
George Hedley CPBC is a certified professional construction business BIZCOACH, consultant, and popular speaker. He helps contractors build better businesses, grow, profit, develop leaders, improve estimating, field production, and get their companies to work. He is the best-selling author of “Get Your Construction Business To Always Make A Profit!” available on Amazon.com. To schedule a free introductory coaching session, get his monthly Hardhat Hedlines BIZ-TIPS e-newsletter, download his templates and tools, or watch his webinars or online video courses at Hardhat BIZSCHOOL online university for contractors, Visit www.HardhatBizcoach.com or e-mail GH@HardhatBizcoach.com.
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